Ben Aris in Berlin -
Russia is in the final stages of selling off its power sector, but portfolio investors have very few options when it comes to buying a ticket for what will be one of Russia's last big privatization rides. That should change if Prosperity Capital Management completes an IPO of a subsidiary on the London Stock Exchange's main board in the last quarter of this year.
Prosperity has been investing into Russia for a decade and into power assets since 1999. Now it has consolidated its own power holdings, and those of some smaller funds, to create the New Russian Generation (NRG) fund. Once listed, it will give portfolio investors direct access to Russia's ongoing electricity privatization.
"We are the largest shareholder in three of the [territorial generating companies] with over 25% in some companies," says Mattias Westman, director and co-founder of Prosperity. "We will list the fund on the LSE main board in the fourth quarter of this year. The value of the company is estimated $1.6bn and we are hoping to raise $200m."
The share price of the newly formed wholesale and territorial generating companies - known as OGKs and TGKs in Russian - have been soaring as strategic investors pile into a once-in-a-lifetime opportunity to get a slice of the biggest power market in Europe.
Currently, the only real choice for portfolio investors who want exposure to the Russian power sector is to buy shares of the incumbent UES. As the company is slated to be wound up by next July, UES shareholders will be given shares in all new generating assets after the company before then, making the buying of UES shares a blunderbuss approach to investing into the sector. "If you buy into UES, then you will get 'one of each' [pro rata shares in all UES' generating companies], which are not all in great places such as Siberia where you are dependant on one big customer," says Westman.
And there is the problem of Gazprom. The state-owned gas monopolist has pre-arranged to take over a few assets, such as OGK-2 and OGK-6, which has killed investors' interest; OGK-2's IPO a few months ago was a flop and OGK-6's IPO has been postponed. Shareholders in UES will be landed with stakes in Gazprom-controlled power generators that may be hard to get rid off.
Not so with Prosperity's NRG. Prosperity has been buying what it thinks are amongst the most attractive of the power plants to go under the gavel and Gazprom has no interest in investing in any of these three main companies, all of which are due to be sold between December and the end of the first quarter of 2008. "All the TGKs will be sold in the next six months and we will use the money raised to participate in the process. When they become private, they can be run in a more efficient way and so made more profitable," says Westman.
All three of the TGKs are in the populous Moscow region, which boasts a wide diversity of customers and a vibrant local investment climate. Of the regional power markets, the Moscow region is amongst the best.
Russia is already the fourth-largest power market in the world, measured both by installed electricity capacity and output, and with economic growth running at over 6% every year since 2000 it's on its way to rise further in the ranks. But its power sector is notoriously badly run and in dire need of massive investment.
Westman says the value of NRG is not in the share price appreciation that the company's stakes in the TGKs should enjoy during the bidding process this winter, but the upside that will come from simply cutting costs and introducing some discipline into the management of the company. "The reality is we will be better at cutting costs in our companies that someone like Gazprom will be in theirs," says Westman.
NRG is a Guernsey closed-ended investment fund that is managed by Prosperity and owns a 27% stake in TGK-2, and 19% stakes in both TGK-4 and TGK-6. Goldman Sachs and Morgan Stanley will act as joint global co-ordinators and book-runners for the IPO.
New Russian generation
Prosperity started to invest into the power sector in 1999 with the First Pioneer Fund, which has been one of the biggest contributors of assets to NRG - created earlier this year by merging several Prosperity funds that also have stakes in a number of electricity distribution companies, including MRSK Center and MRSK Volga-Center.
While NRG already holds significant stakes, the plan is to increase these stakes as much as possible during the privatisation tenders next year. But it is not clear what will happen during this bidding process. In the worst case scenario, the price for the new shares will go sky high and Prosperity can cash out. In this case, investing into the company will be like investing into a listed private-equity fund that takes the money and runs off with a handsome profit.
"If the prices go shy high, then we will cross that bridge when we come to it. But even in this case, we will still be a large minority shareholder; we will still have board seats, but we won't be as active in the company," says Westman. "This could be a nine-month adventure ending with us cashing out, but it is not likely."
More likely the price will be closer to those set in other auctions, in which case Prosperity will increase its stakes in the companies and attempt to run them as a business.
Even if Prosperity fails to buy a significant package of shares in these generators as it is already a big stakeholder, it can partner with the eventual winner of the new shares and run the companies together. Prosperity is anticipating this outcome and has already entered into talks with a number of European strategic investors to form an alliance in bidding for the assets. Until the bidding starts, it won't be clear which is the most likely scenario. However, Westman argues that all three are attractive.
"E.On paid 60-70% more than the traded value [in an auction for OGK-4 in September] and more than Gazprom paid for its assets," says Westman. "But as we are a semi-incumbent, we believe we have an advantage in the process."
The appeal of the listed vehicle is that even latecomers to the Russian power sector have the option of entering the market after the privatization has finished by doing nothing more than buying NRG shares on the LSE.
Undoubtedly, Gazprom has introduced some real uncertainly into the whole UES privatization process; the poor price that OGK-2 attracted and the delay of OGK-6's auction has seriously unsettled potential investors looking at the docket of power sales. All eyes will on TGK-4, the first of the three TGKs to go under the hammer in December, to see if interest in Russian power assets has really waned or if OGK-2 and OGK-6 were just special cases.
But with no core shareholder to put everybody off, TGK-4 has been attracting interest from a number of strategic investors, including Germany's E.On, Korea Electric Power, and the Czech Republic's CEZ in addition to NRG, which have all expressed an interest in buying into the company. "The Russian Government is committed to achieving a liberalised wholesale electricity market by 2011, and we have been involved in the reform process, which has been designed specifically to attract foreign investment. We believe this process is going to reshape Europe's power market, with energy intensive industries looking east to reduce costs," says Westman.
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