Is Rosneft too risky to invest in - or just too expensive?
The latest Russian company to come to London, oil producer Rosneft, is carrying plenty of baggage. But investors are less worried about legal risk - they're more concerned by the price of the company's shares.
The fourth-biggest initial public offering the world has ever seen is set to hit the London Stock Exchange in less than a month.
Russian oil giant Rosneft (ROSN) is pressing ahead with its flotation in London and Moscow, despite recent stock market turmoil. It hopes to raise at least $8.5bn, which would value the firm at between $60bn and $80bn.
The move has been shadowed by controversy. Rosneft's main assets are oil fields that were taken from rival group Yukos by the Russian authorities. Rosneft paid $10bn for the fields in 2004 in a less-than-transparent state "auction" they are now thought to be worth $40bn.
But the main question on investors' minds isn't so much "is it legal?" as "is it worth it?"
Rosneft became the country's third-biggest oil producer using assets seized from rival Yukos Oil.
In 2004, the Russian government confiscated Yukos's Yuganskneftgaz unit to cover back tax claims of $30bn against the firm. Rosneft snapped the oilfields up for $9.3bn, tripling its oil output practically overnight.
In light of the asset snatch, Yukos has asked the Financial Services Authority to prevent the float, to no avail. "If the FSA allows the Rosneft IPO to go ahead, it would be allowing the sale of stolen goods, as well as a rather convoluted process of money laundering," Yukos spokeswoman Claire Davidson said to Reuters.
But theft or otherwise is the last thing on investors' minds. They are focusing on the more prosaic fact that Rosneft's mooted listing price simply doesn't seem to offer good value for money.
At the top of its float range, Rosneft would have a market capitalisation of about $80bn when trading begins in mid-July. Compare that to Russia's second-largest oil producer, Lukoil (LKOH), which has seen its market capitalisation fall from over $77bn in May to around $59bn now.
And Rosneft has a p/e ratio of 12, twice that of Lukoil. That would seem like a pretty hefty premium, even if Rosneft was a better firm than Lukoil.
The trouble is, Lukoil is actually widely seen as the better company. It has slightly more proven oil reserves and pumps more oil. So why is Rosneft asking for more?
As Jeremy Batstone of Charles Stanley pointed out in a piece he wrote before the float range was announced: "Rosneft will have a superior production growth profile to most Western oil companies with plans to double its production by 2015. Also, it has enviable reserves on its doorstep providing lower development costs than Western oil companies." (you can read the rest of Jeremy's take on Rosneft here: Should you invest in Russian gas?)
The company is also hoping to benefit from snatching the remaining assets of the ill-fated Yukos, which is struggling to fend off bankruptcy. And meanwhile Russia's president Vladimir Putin has said that the company would enjoy state support in getting access to new large oilfields.
But all of this and more is already in the price, according to Robert Cyran on Breakingviews.com. In fact, the entire Russian oil sector is looking expensive.
Five years ago, Russian oil companies "traded at 2.5 times earnings, while big Western firms such as BP and Exxon traded at 17 times earnings. Now the Russians trade at about a 5% premium." Given the controversy in the background, and general political risk in Russia "the validity of such a premium is questionable."
Investors are understandably reluctant to buy the most overpriced company in an overpriced sector. Emerging markets specialist Mark Mobius told Reuters: "The question is why get Rosneft when I have Lukoil. If the price comes down we might look at it."
Glen Finegan of First State Investments was even less equivocal. Talking to Bloomberg he called Rosneft "a poorly run, state-owned companythey will struggle to get a premium to Lukoil."
With investor sentiment still extremely wobbly, emerging markets like Russia remain vulnerable to any further corrections. If you're keen to get more exposure to the oil sector, we'd suggest looking at FTSE 100 stalwarts such as BP (BP) or Royal Dutch Shell (RDSA).
MoneyWeek's James Ferguson wrote recently about why the UK's blue-chip oil companies still represent good value for money - and he also recommends a few listed outside of the UK too. Subscribers can read the piece by clicking here: How to profit from soaring oil prices
Turning to the wider markets...
The FTSE 100 ended lower, down 10 points at 5,681 on Monday. The mining sector made gains as merger hopes were boosted by US firm Phelps Dodge agreed a three-way $56bn merger with Canadian miners Falconbridge and Inco. Retailer Marks & Spencer was the main gainer, up 2% to 578p on hopes that it will beat market hopes when it reports on its first quarter next month. For a full market report, see: London market close
Over in continental Europe, the Paris Cac 40 shed 16 points to 4,801, while the German Dax fell 15 to close at 5,514.
Across the Atlantic, US stocks made gains, helped by news that new home sales rose 4.6% in May, against expectations for a fall. However, sales are still down 5.9% on last year. Merger activity also helped stocks - on top of the three-way mining sector deal mentioned above, drugs giant Pfizer sold its consumer products unit to Johnson & Johnson. The Dow Jones Industrial Average rose 56 to 11,045, while the S&P 500 closed 6 points higher at 1,250. The tech-heavy Nasdaq rose 12 to 2,133.
In Asia, stocks advanced. The Nikkei 225 gained 19 points to 15,171. Steelmakers such as Nippon Steel were again among the main risers, as Mittal Steel sealed the deal for rival Arcelor. But exporters such as Toyota and Sony lost out again ahead of the Federal Reserve's interest rate decision due on Thursday.
This morning, oil was higher in New York, trading at around $72.15 a barrel. Brent crude was up too, trading at around $70.70.
Meanwhile, spot gold was on the rise, trading at around $590 an ounce while silver also made gains, rising to $10.34 an ounce.
And in the UK this morning, newsagent group WH Smith has confirmed plans to split its retail and news distribution units into two separate listed businesses. Shareholders will receive one share each in the respective companies.
And our two recommended articles for today...
Is London property really booming again? - Press reports and housing market pundits are proclaiming a resurgence in London property prices - but if there really is a new boom forming in the capital, then MoneyWeek editor Merryn Somerset Webb can't find it. And a new report on house price growth confirms her suspicions. To find out why the current UK economy just isn't a healthy environment for house price growth, click here: Is London property really booming again?
The truth behind the stock market slump- The recent slump in global stock markets wasn't caused by fear of inflation, despite media reports to the contrary, says Martin Spring in the On Target newsletter. The real reason for the fall was Japan's decision to slash monetary growth in preparation for raising interest rates. And with rates set to rise by at least a quarter point in the next couple of months, it looks like there will be further turbulence ahead. But that could create great opportunities for smart investors. To find out the best time to pick up sound assets at cheap prices, see: The truth behind the stock market slump