Market enjoys steady stream of IPOs

A YEAR AGO, the Western press were predicting a sudden boom in Kazakh IPOs listing on the London Stock Exchange. If the boom has been slightly slower coming around than expected, the LSE has still enjoyed a steady stream of deals from the central Asian republic, which has helped strengthen the relationship between London and Almaty — indeed, the Lord Mayor of London even invited a troupe of Kazakh cavalry to ride at his inauguration.

The biggest equity deal of the last 12 months was KazMunaiGaz E&P's $2.3bn IPO, launched in September, which sold 39% of the state owned oil and gas company to foreign and local investors. Askar Balzhanov, CEO of KMG E&P, says: "The listing of our company was more evidence of Kazakhstan's openness to foreign direct investment."

The deal also took slightly longer in coming to market than investors expected, partly because the subsidiary was created from scratch especially for the IPO, and KMG's board had to decide which assets to put into the subsidiary. In the end, it was denied a stake in the Kashagan oil field, but was given 1.5 bn barrels of oil in reserves, making the subsidiary the second largest oil producer in Kazakhstan behind KMG the parent company, with revenues of around $3.3bn a year.

The deal was lead managed by Credit Suisse, Morgan Stanley and the local brokerage Visor Capital.
Michael Carter, managing director at Visor Capital, says Visor was particularly active in selling the deal to local investors: "Around 70% of the shares were placed in Kazakhstan."

Carter insists that most of this share, worth $1.61bn, went to the pension fund sector, which was surprising considering the sector has hardly had any IPOs to digest, and can now suddenly digest such a large amount of fresh capital.

 

KMG model for corporate governance

Other equity market privatisations in the CIS have also tended to sell large amounts of shares to 'local investors', like the Rosneft $10.6bn IPO for example, and one wonders if perhaps local politicians aren't masquerading as babushkas. It may not be purely a matter of private gain — politicians may feel deals like KMG or Rosneft are international benchmarks for their country, so it is in the national interest to support the deal and make sure it is a big, ostentatious success.

But Visor's Carter says: "There is a very active domestic pension fund sector, which has $8bn under management. The weighting of the funds in equity has doubled over the last year or so."

The KMG E&P deal was also slightly delayed because the financial consultant advising the company, Ernst & Young, recommended going the extra mile for tightening up the company's corporate governance, in order to reassure foreign investors as to the company's transparency.

"We have a special corporate governance system which protects minority investors," says Balzhanov. "The most important feature of it is the board of directors, which includes three independent directors. All three are based in London. They have significant authority. Every major decision cannot be passed without the approval by a majority of them."

Sir Richard Evans, former CEO of BAE Systems and now a member of the board of the Kazakh state holding company Samruk, which manages the state's stake in KazMunaiGaz, says the success of the KMG E&P deal has helped convince the government of the necessity of making such corporate governance steps compulsory for all of Samruk's companies.

He has used the KMG model as a basis for the creation of a new corporate governance code, which will lead to the hiring of some 50 non-executive directors, mainly from London, for the 11 other companies in Samruk, which include KazTelecom and KEGOC, the Kazakhstan Electricity Grid Operating Company. He says these companies will be ready to list on the LSE by around 2008.

 

Kazakhstan and Britain forge ties

The Kazakh government is taking some remarkable steps to bring London-style transparency to Kazakh companies while bringing Kazakh companies to the London market. Sir Richard has himself hired a 170-strong team of consultants from Ernst & Young, KPMG and other firms to advise Samruk. Around 60 non-executive directors, mainly British, have joined or will join the boards of Kazakh firms preparing for London listings.

Around $6bn in Kazakh equity has been listed on the LSE so far, and another $6bn could be listed over the next 12 months. So this is a remarkable relationship — a remarkably trusting relationship — that is growing up between Kazakh and British financial markets.

Vladimir Shkolnik, the deputy head of the presidential administration, says: "The president welcomes IPOs and the potential of our country is reflected in the excellent performance of deals like KazMunaiGaz." And Zhanar Aitzhanova, deputy minister of trade, underlines Kazakhstan's openness to foreign expertise. "What Kazakhstan is lacking in general is not resources, not a favourable investment climate, but technical expertise and know-how," she says. "And that's what Richard Evans and his team are bringing."

 

Banks choose IPO route to capital

Some other important deals have come to market in the wake of KMG E&P. The financial sector has been a particularly rich source of deals — retail lending is growing at rates of around 100% a year for the top banks, and this coupled with new capital adequacy requirements is making it essential for the top banks to find new capital.

Some banks have opted for the sale of majority stakes to strategic investors — ATF Bank sold an 85% stake to Unicredit this year, for around four times book value, while a controlling stake in Bank Caspian was bought by the Baring Vostok fund, also this year.

But more banks have been opting to go the IPO route while foreign investors make up their mind whether to buy or not. Kazkommertsbank was the first to market, raising $957m in GDRs on the LSE, lead managed by UBS, JP Morgan and KKB Securities.

Halyk Bank, the largest retail bank in Kazakhstan, followed soon after, with a $748m deal in December, lead managed by Credit Suisse and Deutsche Bank. "The Halyk Bank IPO was a great success, and was 15 times oversubscribed." says one banker close to the deal. "It came at a 30% premium to KKB, which was also a very successful deal."

Neither deal has done particularly well in the secondary market, however. One banker in Almaty says: "KKB's preferential shares attracted a lot of hedge fund interest because they were cheaper than the ordinary shares and there was speculation they would be convertible. The pref shares took a nosedive when the CEO announced they wouldn't be convertible. Halyk Bank's shares haven't done that well either. There may be a perception among foreign investors that the market is over-heated, after the IMF warned as much in April."

Another big 10 Kazakh bank, Alliance Bank, bravely launched its IPO in July, amid serious global equity volatility following the collapse of the US sub-prime housing market. It was priced at the bottom of the pre-pricing range, but still managed to raise $700m. A spokesman at, one of the lead managers, says: "The shareholders decided to use the momentum and price the deal despite the choppy market conditions. They had strategic interests to cover."

Other banks, such as Bank TuranAlem and possibly Bank CentreCredit, are also considering launching IPOs in the next 12 months, though they are also open to selling stakes to strategic investors.

 

Mining, real estate join the party

The two other sectors to have provided the bulk of the Kazakh IPOs so far are mining and real estate.

In mining, two years ago copper mining giant Kazakhmys executed a very successful deal, which is so far the only IPO from the former Soviet Union to have opted for a primary listing on the LSE. Since then, KazakhGold raised $197m in December 2005, then another $115m through an accelerated global tender in January 2006. UK investors accounted for 50% of the demand, which was sole managed by INC.

ING also bought ShalkiyaZinc to market in December 2006. The zinc-lead ore miner managed to raise $117m though the price of zinc then fell sharply, which has dragged the company's shares down with it.

The market is still waiting for the big deal from the mining sector, Eurasian Natural Resources Company, which accounts for 6% of Kazakhstan's GDP. The company has registered itself as a UK corporation in the run-up to the deal — which bankers say is likely to raise at least $2bn — but the firm has a lot of due diligence preparation to do. It should list in the next 12 months, if market conditions improve.

In the real estate sector, the Chagala Group decided to go for the main LSE market rather than the AIM market because of what its lead manager, ING, called "growing investor scepticism towards AIM". It raised $120m in December, selling a 58% stake.

Jeroen Van Crommenacker, vice president of equity capital markets at ING, says: "There's definitely a lot of demand for that kind of company. In general, the bigger the company, the better. What's important is the size and liquidity of your shares once you have listed."
ING also brought Kazakh real estate and paper company Kagazy to market in a $275m IPO in July. It was priced at the lower end of the pre-pricing guidance.

 

Small deals, specialist funds

The oil and gas sector has also provided some other, smaller deals. For example, BMB Munai managed to raise $60m in July via a convertible bond issue which was lead managed by UniCredit Grop (HVB). Karim Makki, head of equity-linked bond origination at UniCredit Group (HVB), says: "The shareholders didn't feel their stock price was doing justice to the company's performance. Doing a convertible, rather than a secondary offering, opened them up to another pool of investors, who viewed the deal very positively."

While the number of listed Kazakh companies steadily increases, the market is also seeing the growth of specialist funds dedicated to Kazakhstan, which invest in both listed and unlisted companies. For example, East Capital has just launched a central Asia fund, which has raised $100m. The fund, which will be 90% invested in Kazakhstan, was quite oversubscribed, East Capital says.
East Capital's CIS financial institutions fund has also been increased from $350m to $500m. Its largest single investment is $100m in Bank TuranAlem.

Altima Partners also launched a $270m hedge fund in October, which will mainly invest in Kazakhstan. Edmund Limerick, partner in the fund, says: "The rationale for the fund is the strong macro-economic story of the country, and the committed drive from the top to liberalise the economy. We are in negotiations to buy a bank and oil services company, and we're also interested in real estate and mining deals."

 

New indices, index-linked products

With more Kazakh companies listing abroad and more emerging market funds looking at big Kazakh floated companies like Kazakhmys and KazMunaiGas E&P, some brokerages and exchanges have moved to set up Kazakh indices, and sell index-linked notes connected to them.

For example, in April Moscow brokerage Aton Capital launched the first international composite index for Kazakh stocks. Julia Bushueva, co-head of research at Aton, says its index is more suited for international investors than the Kazakhstan Stock Exchange index, because half of the companies included in Aton's exchange are only listed in London — including KazakhGold, Kazakhmys and Shalkiya Zinc. ENRC will also only be listed in London when it comes to market in the next 12 months.

"We decided to construct our own index, with the goal of reflecting the performance of the Kazakhstan-related companies that are most liquid and most developed in terms of business scale and operations," says Bushueva.

In July, the Vienna Borse followed Aton's lead with the launch of its Kazakhstan Index, or KTX. It includes the big Kazakh companies listed on the London Stock Exchange, and Vienna brokerages such as Raiffeisen are now building structured derivative products based on the index.

While billions of dollars in foreign capital is flowing into the Kazakh market, billions of dollars in Kazakh capital is also flowing into foreign markets. The outstanding deal in this respect is the successful bid by the Trans Central Asia consortium for Turkish petrochemical company Petkim, which the state auctioned off in July.

The bid, for $2bn, has yet to be fully approved, but if it is, it will be the largest foreign acquisition by a CIS company. The consortium is dominated by CaspiNeft, a firm with links to Bank TuranAlem's shareholders, and also includes the Eurasia Industrial Investment Group and Russian bank Troika Dialog.

The advisor for the consortium is Credit Suisse. A source close to the deal says: "The M&A culture is here to stay now. Kazakh companies like Bank TuranAlem are getting much more experienced in cross-border acquisitions. I wouldn't be surprised if Kazakh capital finds its way to northern China, Ukraine or India."

 

Subprime fallout hits Kazakh stocks

The outlook for Kazakh equity markets became somewhat choppier in August, when problems in the US subprime market rippled out across all global equity and credit markets. The MSCI emerging market index fell 11% in three weeks, with every emerging stock market being dragged down. Kazakh stocks were among some of the worst hit. For example, Kazakhmys suffered the biggest fall on the FTSE during the August correction. Global volatility, a downturn in copper prices, and reports that the company was facing "challenging operational conditions" due to a shortage of machinery, all combined to drive the company's shares down by 30% in three weeks. Other global mining companies also had heavy losses in August.

And Kazakh banks suffered from investor fears that they were over-extended in the international debt markets, and thus vulnerable to a potential global liquidity squeeze. Bank TuranAlem, the heaviest borrower in international markets of all CIS financial institutions, was worst hit, with spreads widening on its credit default swaps from 300bp to 600bp.

Roland Nash, head of equity strategy at Renaissance Capital says: "The market clearly believes that there is genuine risk for the refinancing of some of the weaker credits in the CIS. Should one of these institutions face a sharp liquidity event, it is likely to cause further shocks to the financial sector across the region."

It is questionable to what extent BTA can be characterised as a 'weaker credit', given its net income is growing at rates of around 40% and that its main shareholders are cash rich and well connected to the equally cash rich government. Nonetheless, the volatility in its CDS spreads could at the least derail BTA's plans for an IPO later this year, and the consequent lack of capital could slow the bank's growth, and increase the necessity of a strategic sale to a foreign bank.

Other banks have also seen their stocks slide. Merrill Lynch's Christina Marzea thinks Kazkommertsbank could lose up to 20% of next year's earnings because of higher international funding costs. The negative view of Merrill and some other analysts comes despite KKB releasing very strong first half of year results, with net profit up 56%.

KKB's chairwoman, Nina Zhusupova, has said that the bank would not proceed with a planned secondary offering of shares, or with new debt issuance, because of global volatility. "Given the current price for our shares, it makes no sense to tap the markets," she told investors in a conference call in August. Its share price has fallen from £22 at the start of the year to around £15.

However, it is not all bleak in the short term for Kazakh stocks. The short term outlook improved after the US Federal Reserve cut the discount rate in mid-August, which gave the FTSE its biggest rally for four years. One of the biggest gainers was Kazakhmys, which rallied 10% after UBS issued a buy note on it, calling it "one of the best value stocks in the UK mining sphere". Credit Suisse also called the company "a bargain".

While it seems likely that other Kazakh stocks will rise from their present slump, and that the economy as a whole will certainly weather this global storm, the problems in August have highlighted that Kazakhstan's increasing openness to and reliance upon global capital markets does not always make life easier. Even something as distant as the US subprime market can have important effects on Kazakh companies' funding. That will make the Kazakh government all the more eager to encourage the growth of the local capital markets in Almaty, to give Kazakh companies alternative funding options.

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