A Lloyd's of London quality management certificate for a European Ball Bearing Corporation plant in Volzshky, Russia

Original Article

Russian Builders, Factories Lure Bond Investors With 10% Yields
By Todd Prince and Cecile Gutscher
Bloomberg Financial News

Nov. 16 (Bloomberg) -- Russian manufacturers, construction companies and retailers are selling a record amount of bonds, enticing investors with yields as high as 10 percent.

Don-Stroy Group, the builder of Triumph Palace in Moscow, Europe's tallest apartment building, sugar producer Prodimex Group and ball-bearing maker European Bearing Corp. are among about 20 companies that have privately sold more than $3 billion this year, up from $2.6 billion in all of 2005, according to data compiled by MDM-Bank in Moscow.

The three Moscow-based companies, which have no credit ratings and don't meet global accounting standards, lured investors with bonds that pay at least 3 percentage points more in annual interest than Russia's state-controlled natural gas monopoly OAO Gazprom. They also yield more than twice the 4.2 percent average on European investment-grade securities, according to Merrill Lynch & Co. indexes.

``It's the final frontier for emerging-market specialists,'' said Peter Harvey, who oversees $3.8 billion of assets as head of credit at Cazenove Capital Management in London.

The Russian corporate bonds help boost returns as a decline in defaults drives down yield premiums in the U.S., Europe and Asia. The extra yield, or spread, for company bonds over Treasuries narrowed to about 110 basis points this year, from an average 162 basis points in the previous five years, according to a Merrill Lynch index of investment-grade and non-investment grade securities. A basis point is 0.01 percentage point.

Bonds rated below BBB- by Standards and Poor's and Baa3 by Moody's Investors Service are considered below-investment grade.

Fewer Defaults

European companies missed payments on 0.5 percent of their bonds in the past 12 months, compared with an average default rate of 2.55 percent over the past three years, according to Moody's.

Russia also became more attractive as the ruble gained 7.7 percent against the dollar this year. The economy, spurred by surging oil revenue, is projected by the International Monetary Fund to grow 6.5 percent.

Russian companies, including energy producers and banks, have sold a record $15 billion of international bonds this year, 30 percent more than the same period a year earlier, Bloomberg data show. Dollar-denominated debt sold by Russian companies returned 6.6 percent since the start of the year, according to JPMorgan Chase & Co. indexes.

Don-Stroy, Prodimex

Don-Stroy raised $150 million by paying interest of 10 percent a year on notes due in 2010. European Bearing sold $150 million of 9.75 percent three-year notes in October. Prodimex Group, Russia's biggest producer of white sugar, issued $100 million of 10.25 percent securities due in 2011.

Don-Stroy General Director Timur Batkin says his company's debut sale of securities is the ``first step'' to an initial public offering. European Bearing President Andrei Tatanov said the notes sale will help it borrow more cheaply in the future. Prodimex officials were unavailable to comment.

Moscow-based Gazprom's $1.2 billion of 8.625 percent bonds due in 2034 yield 6.4 percent, down from more than 9 percent when the notes were sold in May 2004. The securities yield 181 basis points more than U.S. Treasuries.

``Emerging-market investors have a desperate need to make up returns as spreads on top-tier Russian bonds have narrowed so sharply,'' said Cazenove's Harvey, whose holdings include Russian debt.

Energy companies were the first Russian borrowers to regain the confidence of foreign investors after the government defaulted on $40 billion of domestic debt in 1998. Moscow-based OAO Rosneft, Russia's second-biggest oil company, in 2001 was the first firm to sell securities to international investors. A month later, Gazprombank, owned by Gazprom, followed with its own sale.

`Filtering Down'

``The tremendous hydrocarbon growth story in Russia is filtering down from bigger institutions to smaller companies,'' said Alex Williamson, an analyst at Finisterre Capital LLC, a London-based hedge fund with $350 million of assets under management. ``A lot of issuers who were too small and not profitable enough are now in a position to issue.''

Smaller Russian companies are outperforming the larger oil companies in the bond market. Moscow-based advertising firm Gallery Media Ltd.'s $175 million of 10.125 percent notes due in 2013 have earned 6.2 percent since they were sold in May, beating returns of 5.4 percent on Gazprom's $1.75 billion of 9.675 percent securities due the same year.

Investors get higher yields on the bonds of Russia's builders, manufacturers and retailers because they are also more vulnerable to a slide in the ruble. Russia's oil and gas companies typically earn revenue in dollars, and secure their borrowing against export contracts.

Searching for Yield

``There is still a lot of money looking for higher yields,'' said Steve Fisher, head of corporate business at Citigroup Inc. in Moscow, which arranged Gallery's bond sale. ``Investors no longer want to be doing the same five names all the time.''

Troika Dialog, Russia's second-biggest mutual fund manager, with more than $1 billion, declined to purchase debt sold by Don- Stroy and European Bearing because the risks are too high for the yields offered, fund manager Oleg Larichev said.

``Russian spreads have narrowed, pushing small, risky-names to come to market,'' Larichev said. ``Some of them really deserve much higher yields than are in the market.''

Some bondholders are concerned that the end of President Vladimir Putin's eight-year term in 2008 may lead to increased government spending and lower taxes, Moody's said Nov. 2. The elections are keeping the ratings company from raising Russia's Baa2 rating, its second-lowest investment grade.

``I think there's going to be some volatility next year with the election,'' said Cristina Panait, an emerging-market analyst at Payden & Rygel in Los Angeles, which manages more than $50 billion of assets including Gazprom and Russian government bonds.

Growing Market

Investor support for Russian companies is helping Putin reduce the economy's dependence on oil and natural gas, which account for about 66 percent of exports. Putin is increasing subsidies for farmers and plans to boost spending to support the auto, aviation and defense industries, he said last month.

``We've definitely increased the number of Russian names that we hold,'' said Richard Segal, head of research at Argonaftis Capital Management in London, which manages $750 million of emerging-market debt. ``Russia is a high-growth market, so there will be more companies tapping the international bond market.''

To contact the reporters on this story: Cecile Gutscher in London at cgutscher@bloomberg.net and Todd Prince in Moscow at Tprince2@bloomberg.net.

Last Updated: November 15, 2006 19:18 EST