Global Economics

Rosneft IPO: Less Than Meets the Eye


Ever since the days of Catherine the Great, whose minister Grigory Potemkin constructed phony villages of happy, prosperous peasants to please the empress, Russia's leaders have been known for their skill at window dressing.

In much the same way, it could be said, Russia's current President, Vladimir Putin, has engaged in an elaborate public-relations exercise, on the eve of the G8 summit in St. Petersburg, that is designed to show the West how his energy policies are being embraced by the international investment community.

The exercise in question, of course, is the initial public offering of Rosneft, Russia's state-owned oil company, which started trading on the London and Moscow stock exchanges on July 14, in one of the largest flotations of all time.

LEAP IN VALUE. On the face of it, the IPO was a resounding success. Rosneft will have raised an impressive $10.4 billion by listing 13% of the company. What's more, the shares were priced at $7.55, near the upper end of the range that had been forecast when the IPO was first announced.

That values Rosneft at $79.8 billion—an enormous market capitalization, though still far less than giants such as ExxonMobil (XOM), Royal Dutch Shell (RDS-B), or Total (TOT) (see BusinessWeek.com, 4/10/06, "Rosneft: A Deal Both Tempting and Troubling").

"Clearly this is a watershed deal for Russian capital markets. Overall, we can say that the market has understood the potential of this company," says Gergely Voros, London-based managing director at Morgan Stanley, one of the banks that advised on the IPO. The only wrinkle: Most of the shares were bought by other oil companies or by Russians—not the big institutional holders needed to give Rosneft investment credibility.

YUKOS ASSETS. A successful liftoff was particularly important for the Kremlin because of the tremendous controversy surrounding the offering from the start. Rosneft owes most of its value to assets that were acquired (critics would say "stolen") from Yukos, the privately owned oil company that was bankrupted by exorbitant tax demands when its major owner, jailed tycoon Mikhail Khodorkovsky, displeased the Kremlin with his political activities.

Yukos cried bloody murder, and tried unsuccessfully to block the IPO by filing a complaint with London's Financial Services Authority (see BusinessWeek.com, 7/10/06, "Up Against the Kremlin").

Critics of the deal included the likes of veteran financier George Soros, who called on investors to boycott it on ethical grounds, and Putin's former economic adviser Andrei Illarionov, who called the deal illegal and "a crime against the Russian people," because none of the proceeds will go into the state budget.

CALLED A "FAILURE." So the fact that the IPO was pulled off at a good price is a much-needed boost for the Kremlin on the eve of the G8. But, just like Potemkin's villages, Rosneft's IPO may not be quite the gleaming success that it appears at first sight. The biggest problem: the lack of institutional investors who subscribed for the issue.

"The most significant objective has been a failure," says one banker close to the transaction. "Without an institutional investor base, you are not going to be able to push the value of the company, and you are not going to be able to realize the full potential of this company in stock market terms," he adds.

That's because Rosneft and the Kremlin achieved their objective largely by cutting bilateral deals with strategic investors, such as British Petroleum (BP), China's CNPC, and Malaysia's Petronas, which acquired 21% of the issue. India's state oil company ONGC is expected to follow with an investment worth up to $3 billion.

COZYING UP TO THE KREMLIN. True, that's a vote of confidence in Russia from oil players. But, financiers note, the main motivation for oil companies to heed the Kremlin's call may not be the attractiveness of Rosneft shares, per se. Rather, experts say, oil companies stand to reap indirect benefits, in terms of goodwill from the Russian government—including future access to Russia's closely guarded energy resources.

"It's best described as a glorified private placement. It is not a market-oriented deal," says Eric Kraus, fund manager at the Nikitsky Russia Fund. Strategic investors, he says, "want to send a valentine to Mr. Putin saying 'We care.' They want to do business in Russia and get access to the world's best oil market."

Of the remaining funds, 43% was raised from Russian investors—a constituency even more open to pressure and influence from the Kremlin. Well-known Russian tycoon Roman Abramovich alone is rumored to have invested several hundred million dollars in the issue. That strongly suggests that the Kremlin has been busy twisting arms and calling in political favors to ensure the deal is a success. The deal also attracted $450 million from individual Russian retail investors, who were encouraged to buy shares with a wave of TV and billboard advertising.

PREMIUM PRICE. According to a statement by Rosneft, international portfolio investors bought the remaining 36% of the issue. Yet many were put off by the high price tag for Rosneft shares—in practice, a bigger deterrent than the ethical, political, or legal concerns emphasized by the company's critics.

Ivan Mazalov, Moscow-based fund manager at Prosperity Capital Management, one of the largest portfolio investors in Russia, points out that Rosneft was priced at a considerable premium to privately owned Lukoil, its major Russian peer.

That's despite the fact that Rosneft's profits per barrel are just 60% of Lukoil's, and that—in stark contrast with Rosneft—Lukoil has a proven corporate governance record. "You can draw your own conclusions," he says, when asked if his fund is buying any Rosneft shares.

NO TRACK RECORD. True, the reluctance of more investors to buy into Rosneft doesn't necessarily mean that the company is a turkey. Analysts and investors say that Rosneft's ambitious production growth target of 7% per year may well be realistic, if only because its strong political ties with the Kremlin mean it's sure to get preferential treatment in the hunt for new reserves. But when it comes to management, Rosneft is at best an unknown quantity.

"The management has no track record whatsoever of running a company of this size," says one banker in Moscow. Until it shot to prominence by assuming the assets of Yukos, Rosneft was a relatively small and insignificant player (see BusinessWeek.com, 6/21/04, "Back to the Future for Yukos?").

Perhaps, as the Kremlin's favorite child and major icon of Russia's resurgent oil power, Rosneft will indeed prove to be the El Dorado that its backers say it is. But until the Kremlin can persuade more bona fide stock market investors to like the company, its IPO may instead turn out to have been just another Potemkin village.


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