Rusal IPO attracts attention to Hong Kong

The decision by Russian resources firm United Company Rusal to list in Hong Kong earlier this year could herald a number of copycats in the next few years.

The first sign that United Company Rusal's pending listing in Hong Kong was more than just another commodities company looking to tap the markets came during the company's first press conference here in early January. The meeting room at Credit Suisse's offices in Central, which was admittedly not the largest venue that could have been chosen, was chock-ablock with reporters trying to push their way in to ask questions, without tripping over the masses of microphone cords on the floor or causing any of the dozens of TV cameras to fall over.

Of course, the majority of the questions were about Rusal's debt situation; its access to expansion capital; the legal troubles of its controlling owner, Oleg Deripaska; and the unprecedented moves by the Hong Kong regulators to prevent most retail investors from participating in the initial public offering amid concerns about the company's large debt burden. However, there was also a clear sense that this was something of an historic event: the first Russian company to go public in Hong Kong, finally giving some real credibility to the local stock exchange's efforts to lure companies from outside Greater China to its main board.

That this key step was to be taken not just by any Russian company, but by the world's largest aluminium producer, gave the event a bit of extra weight -- never mind then the current status of its balance sheet.

The IPO was successful and Rusal got $2.24 billion in gross proceeds to help pay down its debt. But the trading performance after the debut in late January was disappointing to say the least -- by mid February the stock was down 31% -- and has left investors with mixed feelings about the newcomer. Still, most observers believe that Rusal does mark the beginning of a trend that will see a series of companies from Russia and the former Soviet Union list in Hong Kong in the coming years.

Ronald Arculli, the chairman of Hong Kong Exchanges and Clearing (HKEx), which operates the Hong Kong stock exchange, has said that based on the feedback following the Rusal listing he is "cautiously optimistic" that there will be more Russian companies listing in Hong Kong this year, raising in the order of $2 billion.

Of course, the HKEx isn't favouring companies from any particular country or jurisdiction. Its lobbying efforts have been spread quite wide and have included trips to Australia, Mongolia and Canada.

But Russia and the former Soviet CIS states do fit a theme that many think could be Hong Kong's strongest card in the fight against the lure of other major exchanges -- energy and resources.

Located next door to China, which is gobbling up commodities of all kinds to feed its rapid expansion, Hong Kong could become, in time, a listing hub for companies that count China as one of their key export markets for iron ore, coal, metals, minerals and other commodities.

According to bankers and analysts, there are a lot of resource companies globally looking at the Hong Kong market, because of this proximity to China. There are sizeable comparables trading in Hong Kong already, and commodities are also becoming a truly global business, which means it is well-understood even outside a company's "home" market.

"I truly believe that Hong Kong will become a large listing vehicle for resource-based companies during the next five to 10 years," said Marshall Nicholson, global head of equity capital markets at Bank of China International, which was one of the eight bookrunners for Rusal's listing. "It will not be substantial this year or next year, but I think there will be a real trend. And I feel pretty confident about that."

And given Russia's large share of the world's natural resources and the fact that it shares a border with China, Russian companies are expected to play a big part in this trend - accompanied by some peers from other resource-heavy nations such as Australia, Mongolia and Canada.

Other draws are Asia's large savings pool, which ensures the availability of long-term capital, and higher valuation multiples in Hong Kong versus Moscow - although Russian bankers say they believe Russian companies are mistaken to believe that they will automatically be able to achieve the same multiples that are awarded to their Chinese peers.

"Hong Kong is a place where you can tap into a growing source of wealth and capital," said Michael Hanson-Lawson of East Capital, a Stockholm-based fund management firm that specialises in investments in Eastern European markets, including Russia. The vast majority of funds based in this region don't have the capacity to invest outside Asia, so if Rusal had listed in London, it would have missed out on this potential money pool, he added.

One sign that this isn't just a one-off, but indeed an emerging trend that could have implications for Hong Kong for the long-term, is that at least three Russian investment banks are looking to increase their presence in the city, citing Rusal as the catalyst. Or, as Arculli of the HKEx put it: "I imagine they are not coming here for the domestic business. Clearly they want to be the vanguard for their clients ... I think [Rusal's listing] has gone quite a long way of actually demonstrating to the Russian marketplace that Hong Kong is an option."

Renaissance Capital and partially state-owned VTB Capital are both said to be in the process of opening offices here, while Troika Dialog plans to use the facilities of its new shareholder, Standard Bank, in Beijing, Shanghai and Hong Kong, as a base for its China-linked activities.

London is a big competitor, however, not least because many Russians have an emotional connection to the city. They like to visit London and many also send their children to school in England.

According to Dealogic, in the past five years, 30 Russian companies have listed in London, with a peak of 13 companies in 2007. They have been joined by another 14 companies from the CIS states, primarily Kazakhstan and the Ukraine. And there is no reason to expect that the stream of companies from these countries seeking to list abroad will not resume now that the global economy is recovering.

For big companies, a listing in Moscow is not really an option. There is a lack of long-term capital available in Russia and listing locally makes it difficult to raise capital overseas. If the Hong Kong stock exchange can capture even a small portion of those that have their sights set abroad it could make a real difference in terms of diversifying away from its reliance on mainland Chinese companies.

And despite the hiccups with the Rusal listing, the timing for Hong Kong to push its case may be just right. Bankers say there is a bit of a push factor away from London right now as many listed companies feel they didn't get much support during the crisis when institutional liquidity dried right up. Part of the Hong Kong attraction is that retail investors account for about 25% to 30% of the turnover, compared with only 5% or so in London -- a phenomenon that does help to add daily liquidity. The possibility of getting a prominent Chinese investor or company as a shareholder through the cornerstone process that is so common in Hong Kong is also a big draw, they say.

Rusal was denied the retail angle after the Securities and Futures Commission decided to require a minimum HK$1 million ($128,803) investment in the IPO, effectively blocking most retail investors from participating, but it did get a small $20 million cornerstone investment from Malaysian tycoon Robert Kuok, who runs a number of businesses in Hong Kong with strong links to China. Rusal also got large cornerstone investments by Russia's Vnesheconombank and two other international cornerstones.

"Rusal created so much interest," said Claire Suddens-Spiers, head of the Asia equity advisory team at Rothschild, which acted as a financial adviser to Rusal with regard to the IPO. "I think once the share price improves and a second Russian company lists here, there will be a lot of momentum. And in the long-term the HKEx has achieved what it set out to do."

"We need a couple of successful ones. Preferably cleaner, less indebted stories that already have a China angle -- the market is absolutely ready for that," added a banker, who preferred to remain anonymous.

And it seems the wish for a cleaner story may become reality as the Russian company that looks closest to follow Rusal to Hong Kong is much less indebted, has a simpler ownership structure and is known for its transparency and good management. SMR, a mining company that is also owned by Deripaska, was pre-marketing an offering in early May through BOC International and Deutsche Bank, but decided to postpone the launch due to the market volatility. The integrated producer of molybdenum, a metal used as an alloy in the production of stainless steel, was expected to raise about $150 milion to $200 million.

While it is questionable whether another Deripaska-owned company is the right way forward if the aim is to broaden the Russian investment options in Hong Kong, SMR has been looking at a potential listing in Hong Kong for at least a couple of years and many observers thought that it would even be the first one -- until the financial crisis forced it to put the plans on hold. Its strong balance sheet meant SMR met with no objections from the regulators when it came to offering its shares to retail investors and thus had the look and feel of a traditional Hong Kong IPO. SMR is, however, a lot smaller than Rusal, which makes it less of a must-own stock.

Other companies pondering Hong Kong as a possible listing destination, sources say, include yet another Deripaska company, power generator OAO EuroSibEnergo; Russian Rail, which may be looking to spin off its freight and cargo operations; a couple of oil companies; and iron ore and gold miner Petropavlovsk, which is already listed in London but has said that it is considering a Hong Kong listing as part of the financing for new iron ore projects in the Far East of Russia.

Most observers argue that serious listing candidates ought to have a China or Asia angle to make it work. Simply being Russian isn't enough to take part in this emerging trend; investors need to know and understand the assets. That means we are unlikely to see real estate companies with their assets in Russia, domestic retail companies or financial institutions with a focus on the Russian market list in Hong Kong any time soon.

Arculli said that the issue of whether a China or Asia story is needed to list in Hong Kong was one of the questions he kept getting asked during his latest trip to Moscow in February.

"I responded that from an exchange perspective, no. From a market perspective, [an Asia story] is better. But on the other hand, even if you have no business in Asia today, if you reckon that Asia is going to be a customer of yours over the next three to 20 years, then why not list here?"

So far, expressions of interest have come primarily from resources companies, but also from logistics firms and one or two financials, Arculli said, adding that he finds it particularly encouraging that the interested parties include state-owned Russian companies. In that context, Hong Kong's experience with the privatisation of Chinese state-owned enterprises and the string of such IPOs on the Hong Kong exchange since the mid-1990s, could be useful, he said.

For Asian investors, Russian companies do offer diversification and, according to Hanson-Lawson, who markets East Capital's funds to investors in this region from his Hong Kong office, the interest in Russia and Eastern Europe among Asian investors did increase between 2006 and 2008. It came to a halt with the subprime crisis in 2008, but since the fourth quarter of 2009 interest and curiosity about investing in emerging markets outside of Asia has been recovering.

And little by little Rusal's share price has been reclaiming some of the lost ground. By the end of March the stock was trading around $9, or about 17% below the IPO price. Analysts generally also see value at current levels: seven of the nine research reports published in March have a buy or outperform recommendation on the stock and Troika (which rates it a hold) said it views the company as an "in-the-money call option on the global commodity markets and economic growth". Alas, for those with a long enough investment horizon, Rusal's Hong Kong listing may still turn out to be not just an historic event, but a worthwhile investment as well.

This story was first published in the April issue of FinanceAsia magazine. Since then, Rusal's share price has come under renewed pressure and on May 31 it closed at K$7.49 -- 31% below the IPO price.   

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