BARRONS’Online: Russia's Gazprom: the Big Ugly Duckling: WHAT'S THE LARGEST ENERGY COMPANY in the world? Guess Gazprom and you're right, but few American investors probably realize that. Not well-known here, the Russian state-controlled natural-gas monopoly has more hydrocarbon reserves than ExxonMobil, Royal Dutch Shell, British Petroleum, Total and Conoco Phillips put together.”(ShellNews.net)
INTERNATIONAL TRADER - EUROPE
By VITO J. RACANELLI
Global Stock Markets
MONDAY, NOVEMBER 1, 2004
WHAT'S THE LARGEST ENERGY COMPANY in the world? Guess Gazprom and you're right, but few American investors probably realize that. Not well-known here, the Russian state-controlled natural-gas monopoly has more hydrocarbon reserves than ExxonMobil, Royal Dutch Shell, British Petroleum, Total and Conoco Phillips put together.
Some money managers have dubbed it "Saudi Arabia, publicly-listed," alternately captivated by those huge, undervalued reserves and repelled by the behemoth's legion of problems.
Right off the bat there's the unusually large premium on Gazprom American depositary receipts traded here, compared to the underlying ordinary shares traded in Moscow. The ADRs closed Friday at 37.35, 35% above the local shares. Foreigners currently aren't allowed to own the ordinaries, but many fund managers buy into "gray schemes" run by Russian local entities that do own them. But others can't or won't do that, increasing demand for the small number of ADRs available.
Gazprom holds about 20% of the world's gas reserves and satisfies a quarter of Europe's needs. Yet, on a stock-market-value to reserves measure, it sells at a 97% discount to Western oil majors, notes William Browder, who owns Gazprom in funds at Hermitage Capital, where he's CEO.
Gazprom should be a no-brainer. Yet it is deeply flawed, and caution is warranted. The good news is that Russian President Vladimir Putin has promised to eliminate the "ring fence" around the local shares, so foreigners can buy them. This is likely to happen in 2005's first half. Consequently, Gazprom's weighting in Russian indexes will rise significantly, and many fund managers will be forced to up their stakes, a factor likely to boost both the ADRs and the ordinaries.
Even though he's bullish on Gazprom, Browder adds that it's "riddled with problems" and hobbled by subsidized domestic natural-gas prices.
If the fence comes down, prices of ADRs and ordinary shares should begin to converge. But Russia's a funny place. With Moscow's manhandling of Yukos still a fresh wound among foreign investors, many don't know what to expect.
Buy into Gazprom and you enter a volatile and murky legal, regulatory and corporate-governance world. And Gazprom has recently wandered afield -- not a particularly good sign -- by adding nuclear-energy assets. The idea that Gazprom will narrow its discount to the majors by slowly moving to Western standards of governance, profitability and efficiency makes the shares attractive. But a strong stomach or very long-term investment horizon is a necessity for anyone intending to bet on that.
Change Is Good?
In just two months, Europe will go from a hodgepodge of national accounting standards -- some different in important respects to U.S. Generally Accepted Accounting Principles -- to the new International Financial Reporting Standard, similar to U.S. GAAP. Come New Year's Day 2005, the IFRS will apply to most of Europe's roughly 7,000 publicly traded companies.
Most firms have quietly been working to comply, but accounting rules rarely grab headlines, so it's a good bet that the changes, significant in many respects, aren't on investors' radar screens though companies will adopt them soon.
The IFRS operates on the principle that assets and liabilities, including items like goodwill, pension liabilities and stock options, should be marked to market. Jacques Chahine, head of earnings estimates for FactSet/JCF, expects this to have a significant effect on the volatility of asset values and results, and, consequently, on share prices.
In the long run, the IFRS should lead to more transparency, make company books across Europe comparable. It might even lower the cost of capital by fostering a single financial market. In the short term, however, there will be teething pains, as investors get accustomed to more volatility. The table, Accounting for Change, briefly outlines some of the major modifications.
The biggest effect, says Chahine, will likely be in intangible assets, like goodwill, patents and brand names, which now must be booked at market value rather than historical cost. Here the telecoms and the tech sectors could feel the biggest bite.
At the end of 2003, companies in the Stoxx 50 blue-chip index had €382 billion ($489 billion) in goodwill on their balance sheets, €111 billion ($142 billion) from Vodafone alone, with large chunks also at Deutsche Telekom, Telecom Italia and others. Stoxx 50 earnings before goodwill in 2003, which many analysts and investors tend to look at, totaled €166 billion ($213 billion). After goodwill it was much lower, at €124 billion ($159 billion).
Assets purchased in the pre-2001 boom years might have to be marked down sharply, given the collapse in telecom and tech prices since 2000. So some firms may take a hefty charge to earnings "all in one go," Chahine says, instead of amortizing the purchase price over 20-to-40 years, as before. "The numbers are going to be huge," he warns. The charges could eventually lower book value or shareholders' equity, boosting return on equity, possibly affecting debt covenants that include shareholder equity. Vodafone, for its part, says it regularly conducts impairment tests and that it has never had to impair the value of controlled mobile subsidiaries to date.
On the other hand, media companies like Pearson, VNU and Reed Elsevier might have assets that have stabilized or climbed in value, which means earnings could rise since amortization charges may no longer be necessary.
Pension liabilities will also have to be marked to market. Here deficits are likely, particularly among U.K. companies, since the post-2000 stock-market bust has cut pension fund asset values, in many cases. The shortfalls will have to be made up out of profits.
Similarly, derivatives, hedging contracts, and the like, currently on the balance sheet at original cost, will also have to be evaluated more frequently.
With all kinds of items being marked to market for the first time, "it's going to be a yo-yo," says Chahine of the initial earnings volatility.
Last week, the Dow Jones Stoxx pan-European index finished little-changed at 240.30.
E-mail: vito.racanelli@barrons.com