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Business news, 26.04.2007 17:38

Russian Markets

gaz by Ivan Bokhmat, Olga Golub, Stanislav Ponomarenko

FX and money market Yesterday the rouble gained seven kopecks to trade at RBL25.70/USD on the back of weaker-than-expected US macro statistics, namely home sales and consumer confidence.

According to traders, the market is currently going short on the dollar, pulling the greenback down against the euro. Today''s release of German IFO figures could be a catalyst for further rouble growth, while the US currency has a chance to rebound after the publication of statistics on durable goods orders.

However, with current market sentiment we remain rouble-optimistic, seeing it today within the range RBL25.67-25.74/USD. On the money market, interbank overnight rates are at 2.5-3%, supported by growing nostro balances and CBR deposit accounts (RBL1184.2bn cumulatively). Rouble liquidity remains excellent, significantly boosted by IPO pipelines and negative sentiment on the dollar in general. Expectations of further strengthening of the euro are increasing, with market players becoming more optimistic about a new rouble revaul. Today we expect liquidity to remain stable, even in the wake of significant bond placements.

Rouble bond market On Tuesday, activity in the market calmed down somewhat compared to the end of last week. On the threshold of coming scheduled primary placements, players preferred not to make any large movements. Nevertheless, thanks to the healthy rouble liquidity environment, local debt continues to be in a good shape.

In the government segment, price changes were insignificant around 2-5bp and the positive trend in corporate bonds prevailed. Additional support for local bonds is coming from the external market. Today, the indicative Russia''30 has reached a six-month price high with yields hitting 5.57% - again the trend was shaped by growth in US Treasuries.

Today, the market''s attention will be on the primary market where RBL22bn of paper will be offered. The most interesting placements are Moscow region-7 (RBL16bn) and Lenenergo-3 (RBL3bn).

Placement commentary Lenenergo-3 Lenenergo was established in October 2005 as a power distribution company operating in St. Petersburg and the Leningrad region.

Along with MOESK and Tyumenenergo, Lenenergo is to remain a stand-alone regional distribution company, not being merged into the larger, inter-regional MRSK. This is due to its scale of operations - St. Petersburg is a large and industrially developed region with a total population exceeding 6m people.

The company''s grid network consists of more than 51,400km of overhead and cable lines. RAO UES is the company''s main shareholder, owning 56% of its shares, while Finnish energy consortium Fortum controls 35.45%. Lenenergo also plans to issue additional shares in favour of the City of St. Petersburg, which will become an owner of a blocking stake (25%+1 share), allowing for a quasi-sovereign status.

Connection tariffs remain the company''s main source of income. Set by government regulation, Lenenergo''s connection tariffs are among the highest in Russia at US$1400/kW (compared to US$340/kW for Tyumenenergo), which is why actual collection is likely to be well below the plan. For instance, according to our estimates, MOESK collects only about 30% of intended connection fees. Lenenergo plans to increase its earnings from connection by an average of 110% YoY, but this figure is likely to be over-optimistic.

The company''s investment programme for 2007-2010 is very large at US$4.9bn, with most of the money planned to be spent on expanding the network and lowering energy losses (currently at 14-15% compared to 9-10% of that of MOESK). Investments are to be funded from extensive borrowing (57.7% of total spending), share issue (4%), and amortisation and connection fees (38%). However, as security of the power supply remains one of the region''s top priorities, investments are not likely to be reduced even if the company''s own funds grow slower than expected, thus increasing the dependence on external sources.

As the company was established only in late 2005, it is not possible to compare year-on-year performance. The company''s EBITDA grew steadily in 2006, reaching US$111.32m, which places Lenenergo far behind MOESK and Tyumenenergo (approximately US$280m and US$147m, respectively). The company''s debt/EBITDA ratio is currently quite stable at 1.51x, but upcoming borrowing could increase this to 4-5x in the next few years. The planned issue is to be Lenenergo''s third. Its second bond, Lenenergo-2, is trading at a current yield of 8.32% to five-year maturity. As Lenenergo-3 is being issued under basically same terms and is to be traded to maturity, we believe the company will have to offer a premium to Lenenergo-2, given its increased debt/EBITDA. However, the acquisition of 25%+1 shares of Lenenergo by St. Petersburg could provide the bond with a quasi-sovereign status, thus limiting risks.We estimate a fair yield for the bond to lie within the range 8.25-8.45%, corresponding to a 8.10-8.28% coupon.

Moscow region-7 The Moscow region is one of the most dynamically developing regions in Russia, profiting from its close geographical location to the capital. Its gross regional product grew 10-12% pa over the last few years compared to the country''s average of 6-7% pa, and over the medium term, is expected to maintain above-average growth, forming a solid base for tax proceeds in the regional budget.

The active investment policy of the Moscow region accounted for a roughly 3% deficit of the regional budget, down from 12.1% in 2005. In 2007, the budget deficit is planned at 6.2%, requiring some financing via debt.

In November 2006, S&P revised its outlook on the Moscow region from stable to positive, while keeping the long-term foreign currency rating at BB, four notches below the country''s ceiling. Further economic development, debt profile restructuring and introduction of medium-term budget planning are thought to be triggers for future credit rating upgrades from S&P. Currently four-year Mosreg-6 is the longest duration Moscow region bonds, and is currently trading with an 81bp spread to OFZs. Taking into account that Mosreg-7 matures in seven years, we arrive at a 90-100bp fair spread to OFZs, ie assuming around a 15bp premium for an extra three years. For example, the spread difference between four-year Mosreg-6 and three-year Mosreg-5 is 10bp. Thus, we view a fair yield range for Mosreg-7 at 7.25-7.36%. The pricing of Mosreg-7 below the mentioned range makes Mosreg-6 more attractive. The bond is being auctioned at price for a preset semi-annual coupon of 8%.

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