It looks as if 1996 will go down in history as the year emerging markets bounced back with a vengeance, pushing trading volumes in depositary receipts to record heights
When Peter Neyev travelled from Moscow to the floor of the New York Stock Exchange two years ago, the IR director of Lukoil already knew what he wanted for his company: a Big Board listing. Even then Neyev hoped Lukoil would become the first Russian company to trade on the most prestigious stock market in the world. After several more roadshows, and extensive paper wrangling with the Securities & Exchange Commission, Neyev's dream looks like becoming reality. Lukoil expects to list on the NYSE some time in 1997.
Pioneering the way forward for a country and its companies in need of capital is not easy. But pilgrimages like Neyev's are increasingly common as issuers from across Eastern Europe, Africa, India and Asia seek new ways to bring their capital raising message to the burgeoning DR market. This year has already seen the first DRs from Croatia, Egypt, Morocco and Lithuania; a resurgence of Asian and Indian issuance; and renewed deal flow from countries like Mexico and Brazil which were victims of the Tequila Effect.
In some cases, companies are coming from stock markets that until recently did not even exist. Chris Kearns, who is responsible for Russian and Polish ADRs at depositary Bank of New York, remarks on the evolution: 'People forget that the Russian equity market was only born in 1993. It is early days for Russian ADRs, but in a short time we have seen enormous strides. The shocking thing about these emerging markets is how quickly everything changes.'
The first step for many emerging markets issuers is a Level-I ADR, which raises no new capital but allows trading of the company's stocks on the OTC market. Other mechanisms popular with emerging markets issuers are Global Despositary Receipts (GDR) listed in London or Luxembourg, and 144A-Regulation S securities. These don't require compliance with rigorous US accounting standards but do give the issuer a toe in the water, which can serve as a useful stepping stone to the much greater challenge of a full exchange listing on the NYSE, Nasdaq or the Amex.
The rapid growth of emerging market DRs is easy to explain. Global investors in search of higher returns and greater investment diversity are again turning their attention to emerging market equities at an unprecedented pace. That thirst for investment in high-growth stocks is nurtured by capital-hungry companies which recognise the opportunities offered by the depth and breadth of the US capital market. For many, the DR instrument answers both the demands of the investors and the capital raising desires of issuers.
Still, developing new markets takes time. Russia has had plenty of demand for its equity, but there was no investment instrument for US investors when depositary marketing teams first scoured the country in 1994. India is challenging China as the world's largest capital market going into the next century, but the country is only now streamlining its share sales to ease investment by foreigners. South Korea, whose government is taking steps to improve the health of its market for foreign investors, has world class companies like Hyundai, Samsung and Korea Mobile Telecom relying on DRs for capital.
Overall, Citibank's ADR group notes a total of 57 out of 86 new programmes in the first half of 1996 are from emerging markets, compared to 26 out of 86 new programmes in the first half of 1995. These figures show that emerging markets have recovered from last year's low prices, and Citibank expects a continued high pace of new ADR issuance out of both Latin America and Asia throughout the second half of 1996. Korea, Taiwan and Indonesia all have active issuance pipelines, as do Argentina and Chile, while new deals are expected in the emerging markets of eastern Europe, Portugal and Turkey.
'Confidence in emerging markets is back on track,' proclaims Eduard van Raay, vice president of Latin American ADRs at JP Morgan. 'Last year was one of the worst ever in terms of issuance for these markets, especially for Latin America. But the economic fundamentals are holding out better than everyone thought in Latin America, and Mexico led the region's recovery by pre-paying the emergency loan arranged by Clinton much faster than expected.'
Alexandra Hahn, managing director and head of Bankers Trust international corporate trust and agency group, says the biggest change wrought by the Mexican peso crisis was a change in the mindset of international investors. 'Now investors are focusing much more on company fundamentals and less on the country,' she comments. 'If one quality company, like Croatian pharmaceutical company Pliva or Lithuania's Vilniaus Bankas, can capture investor attention, it draws the spotlight to its peers and opens the door to more offerings. And, as we know, all these emerging markets have huge capital needs that will not go away.'
At SBC Warburg, which is renowned for its breadth of global research, emerging markets analysts focus on both the sector and geographic pictures when studying companies. 'Looking at companies from two angles gives a better understanding of the forces driving current operations and, in turn, this gives a better insight into future performance,' says Michel Hanigan, head of ADR research and sales in New York.
'Overall,' Hanigan continues, 'these markets represent many things that investors value, such as rapid economic growth and rising consumer income. During the last four years, we have seen the number of emerging market ADR programmes grow faster than the asset class as a whole. It has reached the point where they comprise almost 40 per cent of all sponsored programmes.'
Hanigan notes that SBC Warburg's clients are increasingly diversifying their portfolios towards emerging market investments. In May, the brokerage firm hosted a junket for US institutional clients to meet the managements at some 19 companies in Taiwan, China and Hong Kong. Notably, these investment managers were not the usual global investor hot shots. They were mostly domestic mutual fund and pension fund managers who have at least 20 per cent of their portfolios invested internationally, and who are interested in finding more emerging markets opportunities.
As a way of evaluating portfolio diversification, SBC Warburg global strategist Andrew Garthwaite is currently looking at the sensitivity of global markets to Wall Street. He observes that a number of emerging markets are cushioned from the Street's swings.
For instance, compared to the Netherlands, which has 55 per cent of its market owned by foreigners and a relatively high correlation coefficient of 0.45, Taiwan's market is just 4 per cent foreign owned and has a low coefficient of 0.03. South Korea actually has a negative correlation of 0.15 over the last five year period.
Generally, emerging markets still remain vulnerable to the vagaries of Wall Street and its fickle investment community. This was dramatically demonstrated once again in July as two Indonesian deals, a $238 mn offering for PolySindo and a $130 mn offering for Pasaraya, as well as a $55 mn GDR from Saw Pipes of India, were withdrawn because of a lack of overseas investor demand. Such negative events can make governments wary of the trail to western-style capitalism, and hurt the confidence of global investors.
Perhaps the most common fear among foreign governments and issuers is that DRs will syphon too many shares to the US and that home market liquidity will fall off. Bankers Trust has studied the issue for a Latin American government, comparing trading volume and share prices before and after the establishment of DR programmes. The data revealed that DRs have a positive effect on overall liquidity of the home market, while trading value in the local market stays the same or goes up. Now the depositary is conducting a similar study for an Asian government, and the results are expected to be much the same.
'Based on extensive research, we have found that DRs improve the health and vitality of the local market,' says BT's Hahn. 'More trading opportunities are created, and a new pool of investors is attracted by the easy arbitrage opportunity between the DR and local market. The result is that the attention garnered by the DR issue increases the turnover rate in the home market. We have not seen a fall-off in emerging markets as might be expected.'
As governments in China, South Korea, India and elsewhere fine-tune their stock markets to draw foreign investors directly into the economy, the DR remains the mechanism of choice for emerging markets issuers tapping western capital. Brand new names will continue to appear on the roll call of countries with DRs, while established blue chip issuers from around the globe use the instrument to finance their future expansion and broaden their investor base.
Lukoil of Russia and Telefonica del Peru are just two of many possible examples whose ADR and supporting IR programmes we look at in more detail for this survey. Lukoil's Capital Crusade
Boris Yeltsin's long campaign for the Russian presidency had a serious supporter in Vagit Alekperov. As president of Lukoil, Alekperov predicted the shares of Russia's largest oil company would rise several times if Yeltsin won his bid for another term in power. 'We are worth much more than the price at which our shares are sold at the moment,' he announced.
Alekperov was alluding to the fact that investors were worried that energy giants like Lukoil and Gazprom would be nationalised if the Communists returned to rule the Kremlin. That was a scary prospect for international investors, with around $1.5 bn of the company's $5.5 bn market capitalisation in the form of ADRs.
Lukoil plans to be the first Russian listing on the NYSE. Considering the company's track record to date, Lukoil's Big Board bid in 1997 should be a shoe-in. Lukoil is also poised to launch the first international IR campaign by a Russian company this fall. Peter Neyev, Moscow-based director of IR, stresses that Lukoil has already laid the groundwork with basic disclosure of financial and operating data through the Russian and western media. With a six-person team, along with vice president Leonid Fedoun, Neyev has developed ongoing relationships with analysts and institutional investors.
'The next stage of marketing Lukoil shares will be to launch a strategic IR programme designed according to international standards,' explains Neyev. 'We will individualise Lukoil's presence outside Russia, not only when it comes to distributing information but in personally communicating with the major analysts and investors.'
The company has already interviewed major US IR firms and selected a short list from which to choose its agency. As part of the new IR effort, Lukoil will use the Internet for electronic distribution of information, such as the annual report, monthly news bulletin, investor Q&A, and a Russian stock market watch.
Neyev remarks that the goal of Lukoil's investor relations function is to maintain the liquidity of the company's shares and broaden the investor base while the company strengthens its shareholder structure. Shares of some nine subsidiaries have been converted into one Lukoil share, making enterprises scattered across the Russian hinterland work together more efficiently for the benefit of shareholders.
Access to foreign capital will be of prime importance to Lukoil, as around $2 bn a year will be invested in an array of projects starting next year. The company is rapidly becoming a world-class oil competitor, and would be a formidable presence listed alongside world leaders like Royal Dutch Shell and Texaco. In early 1996, US engineering firm Miller and Lents pegged Lukoil's western Siberian reserves at some 8.5 mn barrels of crude. Using Miller and Lents' methodology, Lukoil estimates its total reserves in Russia at 10.5 mn barrels - topping those of Shell.
Lukoil's quest for western capital stretches back to 1994, when Bank of New York first visited Russia, a year after the birth of the country's equity market. Chris Kearns, responsible for BoNY's Russian DRs, recalls that Lukoil executives were already eager for a New York listing at their first meeting. 'It was fantastic and surprising news,' Kearns says. 'Since then, Lukoil has done incredible work, raising the quality of the company accounts and level of disclosure to international standards.'
Lukoil soon arranged a trip to New York, and NYSE officials welcomed executives onto the trading floor. That 'familiarity' tour brought executives face-to-face with institutional investors. After four roadshows, in September 1995, Lukoil launched a 2-tranche convertible bond offering, with the balance sold in March. The $400 mn worth of interest-free bonds, representing 11 per cent of Lukoil's outstanding equity, were mandatorily converted to common stock in April, with some 90 per cent immediately turned into Rule 144A ADRs for institutional investors. The investors included Atlantic Richfield Co, which holds 8 per cent of Lukoil.
In the meantime, Lukoil launched the first Russian Level-I ADR programme with BoNY in January, allowing secondary market trading of its shares by US investors. Along with the 144A ADRs, the company now has 18 per cent of its voting stock in the form of DRs. 'Lukoil was the pioneer,' says Kearns. 'In its wake, other companies waiting for a breakthrough found it much easier to establish an ADR programme, and a flow of issues was unleashed.' He notes that there have been ten new Russian programmes since the beginning of the year, with twelve more already in the documentation phase.
Investor interest in Russia keeps growing, and Lukoil already hosts two visits a week from US institutions, including investment banks like Credit Suisse First Boston, Morgan Stanley, Salomon Brothers and JP Morgan. These houses send analysts and clients for presentations; and Lukoil regularly attends investor conferences at home. A recent example was an event held by Brunswick Brokerage, a western-style, Moscow-based securities firm.
Key to Lukoil's ongoing investor relations effort will be a financial evaluation currently being prepared by accounting firm KPMG. Armed with a three-year US Gaap balance sheet, management will be able to compare Lukoil to western oil companies using international valuation standards. The story those numbers tell should be a good one: according to Lukoil's 1995 annual report, the second one in English with one-year Russian standard financials, the company's 1995 pre-tax profits soared to $680 mn, up from $193 mn in 1994.
BoNY's Kearns affirms that Lukoil remains the biggest ADR headliner from Russia for some time, and that the company appears to take IR very seriously. 'Establishing an ADR programme is a first step,' Kearns concludes. 'After that is accomplished, the company story has to be sold to investors. Lukoil has been proactive in getting its message across, while monitoring its shareholder base, looking at its peer group and targeting its IR resources.' Cracking the Ice
It was a dramatic test of investor demand. Telefonica del Peru defied fears this year that the market could not absorb its $1.1 bn stock offering by attracting over $4.5 bn in orders from international investors. As the stock traded rapidly upwards, the verdict became clear: the Tequila Effect is history, and the largest Latin American offering since Argentine YPF's $2.66 bn IPO in 1993 was a resounding success by all measures.
'It was very well received,' confirms Raul Risso, investor relations and finance officer for Telefonica del Peru. 'We have a good balance of institutional and retail holders in the US and Peru. Every investor who wants Peruvian exposure wants to hold Telefonica. With over 20 per cent of the daily volume on the Lima Bourse, the stock is a good proxy for the market and that is very beneficial to us.'
Lead underwriters JP Morgan and Merrill Lynch successfully placed around $600 mn worth of ADRs in the US, and $200 mn internationally, in some 500 institutional accounts. The rest was taken up by Peruvian institutions and retail buyers in the local market, with Banco de Credito coordinating the domestic tranche. Eduard van Raay, vice president of Latin American ADRs at JP Morgan, notes that a successful US offering was vital for Telefonica's capital needs. 'The local market cannot absorb such an issue,' he says. 'The deep US capital market has no problem in investing the money when they believe in an issue.'
The only hitch in the deal came with the sharp reduction of the domestic offering. With orders worth some $324 mn, Peruvians were only allocated $140 mn in shares. This incited discontent among local investors, who believed they should be allowed to own as much of the Peruvian jewel as possible. In response, the government sold a further 3 per cent to meet demand.
Despite this glitch, Telefonica says it is committed to the local shareholder base. Risso marvels at the list of over 250,000 new Peruvian investors, many of them small retail shareholders who bought packages worth $200 to $8,000 at a 10 per cent discount to the institutional offering and with a staggered payment scheme. 'Many of them may not be sophisticated investors by some standards, but they are long-term holders,' Risso says, echoing British Telecom's desire to reach retail investors ten years back.
Telefonica's offering represented the Peruvian government's remaining 29 per cent stake in the company, which was formerly a government-owned monopoly. Part of Telefonica's attraction is its controlling shareholder, Telefonica de Espana, which acquired a 35 per cent stake in 1994 and is known for bringing management know-how to Latin American telecoms. The Spanish company helped launch Telefonica on an ambitious growth strategy, installing new telephone lines and replacing old ones. Since then, telephone penetration has grown from 2.9 telephones per 100 people to around 5.2 today.
That explosive growth helps explain the interest in Telefonica stock outside the traditional pool of emerging markets investors. Big orders for shares came from large cap growth funds, which have profited greatly from the US market in the last two years and are now seeking value elsewhere.
'With the visibility of the company, and the novelty of investing in Peru, there are many Telefonica shareholders who are entirely new to emerging markets,' says Felicia Vonella, VP and head of Dewe Rogerson's Latin American group. The firm has added Telefonica to a slate of Latin clients that include Chilean and Argentine telcos. Vonella compares Telefonica's approach to that of HK Telecom, which attracted many first-time international investors with its highly visible message.
There was a considerable volume in Telefonica's ordinary shares being changed into ADRs following the offering, notes van Raay, indicating that there were a lot of international investors already holding the stock who wanted to benefit from the liquidity and convenience of the New York ADR market. The existing interest in the stock was not surprising given the enthusiastic research published by JP Morgan and Merrill Lynch, among others, in the months before the offering.
Telefonica's success was undoubtedly boosted by the ability of the company's financial officers to explain Peru to investors in the aftermath of Mexico's peso crisis. To help them, underwriters hosted a 'country' roadshow of top government leaders in the weeks leading up to Telefonica's own corporate roadshow. Indonesia went on similar tours before the PT Indosat and Telecom Indonesia issues.
Once the politicians had done their thing, Telefonica hit the road and Risso was along for the first few stops on a 30-city, three-week tour that went from the US to Japan and Europe, then back to the US. 'It was mostly a matter of selling the Telefonica story in one-on-one meetings,' he reports. 'It soon became obvious that the message was a good one, and our stock price rose from the first day to the last.'
Since returning to Peru, Risso has been busy raising Telefonica's IR effort with the help of Dewe Rogerson in the US. He has already organised a press release and a conference call to announce second quarter results with some 99 participants. Dewe Rogerson's Vonella says the conference call matched the high standard of Latin American IR set by Chile's CTC in its communications with investors. Risso remarks that the IR programme is helped immensely by Telefonica's CFO Manuel Garcia Garcia, whose inside know-how was developed as director of Spain's securities commission and manager of Telefonica de Espana's pension fund.
'We cannot just sit back and wait for investors to fall in line,' Risso says. 'We have to go out and get the sincere opinion of analysts and investors about our stock. We have to focus on giving equal importance to the local and international market, with press releases in both English and Spanish and simultaneous quarterly presentations. In this way, we can achieve our capital raising objective and keep our ADR investors excited about our story.'