2018 marked the worst year for Russian initial public offerings on record. How did Russia get here and what is the market’s outlook?
One way to measure economic development in emerging markets involves analyzing stock market activity alongside the number of companies which have initial public offerings (IPOs) both domestically and internationally. Russian investment banking has been turbulent during the 21st century. Highs included the IPO of the largest company of the year in 2007, and lows include a poor 2018 which had 0 IPOs. However, local currency Russian equities were one of the top performing assets in 2018, alongside Brazilian equities and US treasury bills.
Brief History of Investment Banking and IPOs in Russia
In 1992 Russia began to establish domestic stock exchanges. The Moscow Interbank Currency Exchange (MICEX) was the first to be formed, and became the country’s largest exchange, managing about 70% of Russia’s total trading volume. By 2011—MICEX’s final year before combining with Russia Trading System (RTS) to form MOEX—230 companies were listed on the exchange. RTS, founded in 1995, was the first regulated stock market in Russia, trading shares of just over 280 companies at the time of its merger with MICEX.
As Russia entered the new millennium, the Kremlin began to turn to investment banking as a strategic priority: greater M&A deal flow and more IPOs would signal a robust economy and attract outside investors. The plan worked. Russian capital markets developed meteorically, with the stock market (MICEX) growing ten times in value. In 2007, fundraising totaled $19B, with 20 IPOs taking place, mostly in the financial services, real estate, and energy sectors. Vneshtorgbank (VTB), Russia’s second largest state-owned bank, saw the world’s largest IPO that year, totaling $8B. These numbers are especially impressive considering that publicly traded Russian companies are legally required to list at least 30% of their equity, but MOEX lacks the liquidity to support micro-caps below $500M. Russia has consistently lost out on the opportunity to add a few extra billion dollars by not IPOing many small companies.
2007 was undoubtedly the high point for Russian capital markets: Less than 20 years after the collapse of the Soviet Union, Russia represented 7% of the global IPO market. But the 2008 financial crisis changed everything: as global credit unwound, Russia’s IPO market sank to $100M in 2009. In 2010 it rebounded to $4.4B (1.6% of the global IPOs), only to fall back below $4B in 2011. Since then Russian IPOs have just totaled over $2B once, in 2017 primarily because of EN+’s (ENPLq.L) large IPO. (EN+ remains the last Russian company to have gone public.)
The brief rebound in 2017 was followed by a devastating 2018, which saw no IPOs of Russian companies. The driving forces behind the market’s collapse were US/EU sanctions, the US-Sino trade war, emerging market uncertainty, and rising US treasury yields. In 2018 over 10 Russian companies were expected to IPO and break the $4B threshold. However, rising US interest rates triggered emerging markets (EM) outflows in May, forcing Russian companies to delay or abandon their intention to go public.
Russia’s non-existent IPO market in 2018 did not mean doom for the stock market. Sanctions and depressed oil prices hurt the public markets, but Russian equities still managed to outperform the rest of EM by staying flat. MSCI Russia was down 0.4% year over year, for example, while MSCI EM was down 16%. Other major emerging markets significantly underperformed as well: Turkey (-43%), South Africa (-27%), Egypt (-22%), China (-18.75) and Poland (-14%).
2019 and Beyond
The World Bank projects Russian economic growth of between 1.5 and 1.8% until 2021, while the Bank of Russia forecasts slightly less positive GDP growth around 1.45%. Fiscal stimulus policy measures may promote higher growth rates after 2019.
Regardless of the short-to-medium term macroeconomic environment, a few trends that have been gaining momentum are likely to persist. First, Russian companies will continue to dual list in Russia and abroad. In the past, the most popular way for large Russian companies to raise equity capital was to go public in London while also listing in Moscow, providing access to both local and international investors. Recently, however, many Russian companies are considering being listed on Asian stock exchanges, especially Hong Kong (SEHK). There are three reasons for pursuing this strategy:
The requirements for information disclosure are lower in Asia than in the US or Western Europe.
Geopolitical tides have turned, and Russia is warming to China while its relations with Washington remain poor. This shift in IPOs as part of that more significant trend.
Most importantly, RUSAL’s public offering on SEHK in early 2010 demonstrated that the SEHK and its investors favored Russian companies’ IPOs over western ones, an advantage that Russian companies would not have in any other region of the world. Moreover, since RUSAL’s IPO, Russian businesses have shown signs of attracting Asian investors over European or American ones. Chinese investors are reputed to be less risk-averse than their European counterparts since they come from an EM economy and feel comfortable doing business in opaque political and legal environments.
The investment banking outlook for 2019 presents a mixed picture. Most of the companies that wanted to raise equity capital in 2018 will look to do so in 2019, especially if favorable macroeconomic conditions persist. The number and quality of public offerings may also be affected by the downwardly trending Russian banking sector. Dozens of banks have lost their license since 2014, and some have had to resort to being bailed out by the Kremlin. However, the banking system may have bottomed out following the recent Alfa Bank news. Almost all domestic banks, including those engaged in investment banking, have sufficient foreign currency liquidity to repay their maturing external debt obligations in the upcoming year. If the banking sector rebounds from 2018, IPOs could be poised for a comeback as well.
The other factor that will significantly determine the character of the IPO market in 2019 is the quality of Russian stock exchanges. The outlook for Russian equities in 2019 is flat but closely tied to oil prices. If oil stays around $69/barrel, then the RTS index will have a muted performance. If the market sinks, it may be another weak year for IPOs, as companies that have cash in hand will look to go public in more promising economic environments in the coming years.
Peter Simon is the co-founder and head of SSUinsight (ssuinsight.com). He received his BA in government and history from Cornell University and his MSc in Russian and East European Studies from the University of Oxford. He has previously worked for the US Department of Defense and 60 Minutes. His research interests include East European equity and debt markets as well as local political parties. You can find him on twitter @Petersimon419.