Committee for Russian Economic Freedom

Neil Buckley, the Eastern Europe editor of the Financial Times, writes on the Valdai Club website today about the IPO shortfall in Russia, summarizing the dismal first half of 2011 for Russian companies looking to go public:

Analysts originally forecast private companies could raise more than $25bn in 2011 from so-called initial public offerings of their shares, up from only $5.5bn last year. In fact, only $3.9bn was raised in the first half of the year from a mere six deals.

Seven other planned Russian IPOs were postponed in the same period, he notes, prompting:

…more soul-searching about Russia’s lack of attractiveness to international investors, even as president Dmitry Medvedev has announced measures to try to improve the investment environment. It comes as domestic investors also seem reluctant to invest in Russia ahead of parliamentary elections in December and next March’s presidential poll – leading to billions of dollars of net capital outflows in recent months.

Mikhail Khodorkovsky

While IPOs the world over have underperformed, Russia’s case is especially gloomy, as investors have been burned by Russian IPOs not materializing and poor performance with those that did, at least in the traditional extracting industries like metals and mining. (Search engine Yandex is the successful exception mentioned here.)

Buckley concludes by citing the political discount, often called the “Khodorkovsky discount” after the imprisoned former chief of Yukos whose case represents many of the challenges faced by Russian entrepreneurs today, that keeps Russian markets undervalued:

It is difficult to achieve top valuations for Russian IPOs when its whole market remains undervalued largely because of the political “discount” investors apply to the country [due to] perennial concerns over corruption and weak rule of law, [which] seem to reflect uncertainty over the outcome of the presidential election, and whether Russia will be able to conduct reforms needed to boost its flagging economic growth.

Russian search engine Yandex debuted today on NASDAQ at $25 a share over it’s $20 its pre-IPO estimate. However, political risk looms large over its future performance. And smaller companies seeking capital from international markets face a tough environment. Nadia Popova writes:

Foreign investors are also becoming increasingly sensitive to political uncertainty ahead of Russia’s presidential elections in 2012. What’s more, lacking ruble liquidity has pushed local investors to start selling their current holdings, all the while showing little interest in buying new stocks.”

Paul Gregory of the Hoover Institute cautions investors to remember the Khodorkovsky trial when looking to Russia for big returns:

Let us hope the Khodorkovsky case will not be forgotten outside of Russia. The Council of Europe, Freedom House, and Amnesty International have concluded that Khodorkovsky was charged and imprisoned in a process that did not follow the rule of law and was politically motivated.”

“Any company considering investing in Russia should think twice. Those companies who invested in good faith in Yukos lost everything. They were politically expropriated. Major international companies, such as Shell and BP, have suffered arbitrary treatment at the hands of Russian officials and have no recourse. Companies considering entering the Russian market are assured that such things will not happen to them. They should realize that anyone doing business in Russia could find themselves in Khodorkovsky’s shoes.”

Russia Helicopters is the latest Russian IPO to be postponed because of political risk. Unable to release required details about its military contracts, Russia Helicopters joins four other IPOs this year that failed to close. Yandex is the most ambitious Russian IPO since it chooses to list on NASDAQ and must follow US securities law. Its $1 billion IPO is expected to be completed later this year.

The trend in increasing political risk for Russian IPOs is on the rise and the Russian government becomes more entwined with businesses in Russia. Today, Prime Minister Vladimir Putin’s cabinet approved the appointment of deputy premier Sergei Ivanov’s son to replace a first deputy prime minister to head the supervisory board at Russian Agricultural Bank. With political appointments at the helm, it may be increasingly difficult for Russian companies to access international capital markets as investors seek returns with risk.

Russia is a land of big appetites. But it’s starting to look like investors’ hunger for risk has become “very dainty,” a trader at CF Global in London tells Bloomberg News. Indeed, Russia’s Micex Index is the first among benchmark measures in the world’s 20 largest equity markets to fall at least 10 percent from a recent peak, the common definition of a correction, since mid-March, Bloomberg reports.

Yandex, the Russian internet firm, is preparing for a $1 billion IPO on the NASDAQ but news about its IPO is mainly about the political and oligarch takeover risk in the prospectus as well as having to provide information for the FSB, Russia’s secret service, on contributors to well known whistle blower Alexey Navalny. Investors may flock to the IPO as Yandex is the sixth most visited website in the world.

However, they should take note that just seven months after Mail.ru IPOed in London in November 2010, Mail.ru’s founders sold their stake last week and the stock fell 20%. With pervasive government and oligarch intervention in business in Russia, accessing foreign exchanges and investors may be the only way for Russia’s entrepreneurs to recoup their initial investment.