Russia kicks off privatization with VTB SPO

Russia’s privatization program kicked off in the middle of February after the government sold a 10 percent stake in the country’s second largest bank, state-owned VTB Bank, and raised a record $3.3 billion.

“This is … proof of trust in the Russian financial system," said Prime Minister Vladimir Putin after the deal was closed.

The secondary public offering (SPO) of the stock was met with lukewarm, but sufficient, demand from investors. VTB’s stock was initially offered in May 2007 in what was dubbed at the time “the people’s IPO.” It raised $8 billion in the biggest IPO of that year.

Small investors flocked to the sale, spending about $1 billion on shares, but the government was left with egg on its face after the share price tanked and the market crashed in September 2008.

The share prices have never fully recovered: The state sold global depository receipt shares to international investors at a price of $10.56 during the IPO, but was only able to muster $6.25 with the SPO this time round.

Understandably Russia’s retail investors remain hopping mad over the “people’s IPOs” and the debacle has badly impaired the state’s ability to float more companies, as the already-skeptical general public only had its suspicious about the government’s investment promises reinforced.

Still, at least the state was able to sell the shares to willing investors. Prior to the VTB IPO, Russia struggled badly with the 2006 $10.6 billion IPO by state-controlled oil firm Rosneft, and had to lean on the country’s leading oligarchs and foreign partners like British oil company BP to buy shares and rescue the deal.

The fact that the Kremlin got the VTB sale off the ground at all is impressive, given the awful market conditions at the moment. After a strong run in 2010, equity investments into emerging markets have done badly this year. Money is flooding out of emerging markets as a result of rising inflation fears investors believe may derail investment. In the two weeks prior to the VTB deal, investors took over $10 billion out of emerging markets, some of the biggest redemptions since the crisis began in 2008.

Russia, however, was the only major country to attract net new money. The country received $267 million of direct investment for the fourth week in a row in the run up to the VTB deal. Having largely missed out on the investment rally in 2010, the Russian market remains even cheaper than normal, and it was already the cheapest major stock market in the world last year.

With price-to-earnings ratios down to 7 and on their way to 6 this year compared to ratios in the middle to high teens in other Bric countries, the traditional logic that has driven much of Russia’s equity investment in the past has started to kick in: It doesn’t matter how bad Russia’s image is, at these prices, stock valuations can only go up.

While the VTB SPO was not a smashing success, it will do. The state plans to roll out more blue chips this year as part of the effort to fund an enormous 1 trillion ruble ($33 billion) investment program into much-needed infrastructure.

However, more ethereally, the state has also said that it wants to get out of business. The Kremlin doubled its ownership of listed companies over the last two years by taking stock in exchange for loans during the crisis, and now controls about 40 percent of Russia’s total market capitalization.

“The state is now the biggest shareholder in Russia, and so for once, its interests are aligned with those of investors; it wants to see the market do well even more than anyone else,” said Chris Weafer, head of strategy at UralSib.

The privatization drive is also intimately linked to the ongoing fight against corruption and boosting productivity. The Kremlin has realized that employees steal from publicly owned companies, which are all badly run. A whole raft of public sector reforms were drafted last year and are due to be implemented in 2011 and 2012.

Next up will be an SPO of state-owned retail banking giant Sberbank, the biggest bank in the country and the bluest of Russian blue chips. The share sale is slated for the end of this year or possibility the start of next year as part of the process of preparing state-owned companies for sale.

“Russia is shifting to a ‘target-based’ budgeting process for the public sector. The lion's share of budget funding will be allocated to some 50 programs run by various ministries. Financing will be determined on the basis of how well each program hits its established targets. The new approach will be first applied in the drafting of the 2012 federal budget,” said Seija Lainela of the Bank of Finland.

All in all, the state plans to raise 1.8 trillion rubles ($60 billion) in the medium term through privatization of about 900 state-owned companies. For 2011 to 2013, revenues are expected at 298 billion rubles, 276 billion rubles and 309 billion rubles, respectively. 

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