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Reasons Not to Invest In Russia Are Growing

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Reasons Not to Invest In Russia Are Growing

TNK-BP Battle, 
Putin’s Pique Roil 
Local Stock Markets
July 28, 2008

MOSCOW — Tough talk on one resources company and inaction toward chaos at another have dealt a harsh blow to Russia’s investment case, as investor concern turned toward the political environment.

Russia’s failure to cool the gloves-off battle for control over oil company TNK-BP, coupled with Prime Minister Vladimir Putin’s outburst toward miner Mechel, slammed the Russian stock markets Friday.

That left the benchmark RTS index, already stuttering amid falling commodities prices, languishing at a six-month low and in bear-market territory, with investors jumping for cover and some even drawing comparisons to market situation of a few years ago surrounding now-bankrupt oil producer Yukos.

On Friday, the RTS index slid 5.6% to 1951.29, down 15% on the year and 22% from the May 19 record. A bear market is frequently defined as a 20% decline from an index’s peak. Sales were indiscriminate, with blue chip stocks such as Gazprom, Rosneft and Sberbank down 4% to 5%.

“We’ve had three pieces of bad news and the risk premium has gone up,” said one Moscow-based broker. He was referring to the departure from Russia of TNK-BP Chief Executive Robert Dudley amid visa problems, Mr. Putin’s comments against Mechel, and allegations by an exiled fund manager that fraudsters had made off with $230 million in taxes having stolen three of his companies.

The damage was done Thursday evening as the chief executive of BP‘s Russian joint venture left the country following continued run-ins with authorities over his visa, a situation that many observers link to a dispute between the U.K. oil major and its billionaire local partners. Russian officials, at least publicly, have refused to step in, with the negative buzz surrounding the saga largely to blame for recent outflows of international funds by portfolio investors.

Exacerbating the market tension, Mr. Putin criticized Mechel’s pricing policy for coking coal, saying the company charged domestic customers double the international price in the first quarter and ordering an antitrust probe. “Putin’s attack was couched in terms that suggest a personal conflict the question now is whether it will turn out to be a shot across the bow and quickly heeded, or a second Yukos affair,” said UniCredit strategist Julia Bushueva.

The massive tax claims and criminal proceedings that accompanied the attack on now bankrupt oil producer Yukos prompted international investors to abandon Russia in droves. That company’s former owner and Chief Executive Mikhail Khodorkovsky remains in prison for tax evasion and recently appealed for parole as new President Dmitry Medvedev begins an overhaul of the legal system.

Adding to the negative atmosphere was Hermitage Capital Management boss Bill Browder, once Russia’s biggest portfolio investor but now banned from returning after repeatedly criticizing the country’s corporate-governance environment. Mr. Browder, now based in London, is continuing to rail against the system from afar.

“The last train carrying the optimists out of Russian equities has just left the station,” said UralSib strategist Chris Weafer.

Although many observers in Moscow expect that situation to ease as Mechel acts on Mr. Putin’s remarks and amid a consensus among analysts that a state-run energy company will buy the Russians out of TNK-BP, the already-flimsy confidence in Russia’s market was shaken.

Indeed, investors are re-evaluating the risk premium they assign to Russia. “Applying the Yukos-era equity risk premium would lower our fair value For Russian stocks by around 25%,” Renaissance Capital said.

“The current market P/E of 8.7 may no longer offer a sufficient discount,” warned UniCredit, referring to the overall price-to-earnings ratio. P/E ratios are used as a valuation metric; by contrast, the Standard & Poor’s 500-stock index in the U.S. has historically traded at a P/E in the mid- to upper-teens.

Write to Andrew Langley at [email protected]

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