[lbo-talk] FT: Yukos = investment opportunities!

Michael Pollak mpollak at panix.com
Mon Nov 3 11:27:16 PST 2003


November 3, 2003

The Financial Times

Yukos investment opportunities

John Dizard

Let's say Enron had accumulated billions of dollars, along with a lock

on key energy industry assets, through corrupt methods. Let us further

assume, just for fun, that its top executives had used some of that

money and power to buy influence on the political process. Do you

think that the Washington Post, the New York Times, the Carnegie

Endowment, and much of the rest of the commentariat would be

trumpeting outrage at the arrest of Enron's chairman Ken Lay and CEO

Jeffrey Skilling?

That is a fair analogy, I think, to the western reaction to the arrest

and imprisonment of Mikhail Khodorkovsky, the head of Yukos, the oil

company, and supposedly the richest man in Russia.

Yes, yes, I know, President Vladimir Putin and the Russian prosecutors

are engaged in selective prosecution. Given the enterprising nature of

much of the population, what other kind of prosecution is possible in

Russia?

Most of the time, pomposity and self-righteousness on the part of

editorial writers and think-tank hacks is just random noise. However,

perhaps because ExxonMobil might turn out to have been a little hasty

in choosing strategic partners in Russia, the reaction to the

Khodorkovsky arrest has, I believe, created a number of speculative

opportunities.

The decline in Russian stock and bond prices following the arrest of

Mr Khodorkovsky is a sign of how quickly Russia has returned to being

a respectable country for mainstream investors. Look at the 14 per

cent one-day loss in the Russian equity index a week ago.

Only easily frightened, conventional portfolio managers would have

panicked like that. Back in the day, the hard-core Russia players

would have thought Mr Khodorkovsky had got off easy. The threat of a

10-year sentence? As Solzhenitsyn quoted a camp guard in The Gulag

Archipelago, "The sentence for nothing at all is 10 years."

Not too long from now, though, those pale and trembling portfolio

managers will be terrified of underperforming their benchmarks, and

they will be buying Russian assets again. They have actually done the

cold-eyed speculators a favour. Russian asset prices had been getting

a little ahead of themselves, and the Khodorkovsky affair has

introduced some welcome volatility that can be faded at a profit.

Let's take the Russian Federation's 8.25 per cent dollar bond of March

2010. When Moody's upgraded Russia's sovereign debt to investment

grade on October 8, the bond's spread over the equivalent US Treasury

paper rallied from 212 basis points to 184 basis points "off the

curve". That's some nice vol. By the end of last week, the 2010 had

widened to 225 over the Treasury curve.

Russia's sovereign debt is most often compared to Mexico's, as both

are considered "crossover" credits, right at the border of investment

grade and junk. Mexico's equivalent to Russia's 2010 is trading at 175

over the curve. Given investors' continued yield hunger, another half

percentage point is going to be hard to resist for another couple of

months.

Furthermore, the fundamental story in Russia continues to look very

good. Russia is running a current account balance surplus equal to 10

per cent of gross domestic product. That would be the equivalent of

the US taking more than a $1,000bn from foreigners in surplus exports

and investment earnings. Think the T-note would be catching a bid if

that were the case?

Say the whining editorial writers are right and Russia faces a new

dark age of a dominant state and shrinking "civil society"? That would

be good for its sovereign bonds, right? If the Khodorkovskys of the

country get fewer dollars (or euros) from oil and gas exports, there

are more to cover the state's debt service.

Without too much of a reach, you can go further out on the risk curve

and turn an even better ruble. Look at Gazprom's bonds. Gazprom, which

is already controlled by the state, is the biggest natural gas company

in the world. If western Europe wants relatively clean electric

generation, heat, or petrochemicals, it is going to buy Gazprom's gas.

Last week, Mr Putin said foreigners would be able to own shares in

Gazprom with the same rights as Russian nationals, a change from the

current "ring fence". Gazprom's 9^5/[8] bonds of March 2013 are

selling at 405 basis points over the US Treasury 10 year. You're

getting a fat junk bond yield for what's really an investment-grade

sovereign risk.

The nervy move right now is to buy Russian equities. Mr Putin and

those around him are going to make some conciliatory moves to the

business community. Remember that their problem with Mr Khodorkovsky

and his associates wasn't so much their business conduct as their

interest in mounting a political challenge to Mr Putin.

What, you may ask, about the public's reaction to such a cynical bet

on an authoritarian Russian administration? The Russian public, you

may be assured, would be deeply gratified to see all of the Yeltsin

era oligarchs hanged in Red Square.

The US, British, and continental European publics could not care less.

Their conviction that a liberal-democratic civil society in Russia

could be built on money and organisation provided by corporate

gangsters was absurd.

The oligarchs, by the way, have taken care to throw a bunch of "grant"

money in their direction over the past decade, so take that into

consideration before you worry about getting the think tankers'

approval.

© Copyright The Financial Times Ltd 2003.



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