Russian stocks sold off after a deadly explosion at Moscow’s Domodedovo Airport, and while this is certainly a tragic event, it is not likely to have any damaging long-term effects on Russian investments. In fact, this weakness should be treated as a buying opportunity for those looking to invest in this dynamic emerging market.
In 2009, I wrote a piece about investing in Russia that was critical of their attitude toward foreign investors — “Russia Will Always Be Cheap” — and a link even made it to the defense site of jailed oligarch Mikhail Khodorkovsky. Meddling in the Yukos affair was not one of my goals; I wrote it out of frustration that a country with much unrealized potential had alienated foreign investors at precisely the wrong time.
The economy had just begun to pick up steam after the 1998 debt default and commodity prices were rallying, giving Russia the capital to develop a vibrant economy. Yet, it became clear over the past decade that the natural resource sector, where Russia’s largest potential is, was not a place where foreign capital was welcome. However, developments in the past couple of months show this is changing in a major way, which is why I’m changing my attitude toward investing in Russia.
First, PM Putin allowed Pepsico (NYSE: PEP) to take total control over Russia’s largest dairy and fruit drink maker Winn Bill Dann (NYSE: WBD). Pepsi had been a big investor in the country for many years and this was a natural step to gain a bigger market share in Russia and the FSU. And we just learned that BP (NYSE: BP) took a huge stake in state-controlled Rosneft, Russia’s largest oil producer.
We have my favorite U.S. producer ConocoPhillips (NYSE: COP) cutting its stake in Lukoil (OTC: LUKOY) from 20% to 10% — the overhang of shares this summer was one reason why Lukoil’s valuation of six P/E stayed at depressed levels — while BP is increasing its Russian exposure. What is more important, Rosneft is state-controlled and BP’s CEO had huge political problems with the BP-TNK joint venture he ran until 2008 in Russia, causing him to leave the country. Now he is making a deal between BP and the Russian state, which is the first of its kind. This shows the willingness of Russia to attract investment in its resources sector, even if it comes with a cross shareholding status.
The BP-Rosneft deal is a rare fit for both sides. BP replaces all reserves that it lost in the fire sales to pay for the oil spill in the Gulf at less than half the price, while Rosneft receives drilling expertise — no pun intended — that will help recover oil that otherwise will be difficult to develop on its own. BP is making a $7.8 billion share swap with Rosneft, which gives it 10.8% of the company; Rosneft will own 5% of BP.
Rosneft’s market value prices its oil and gas reserves at $5.33 a barrel, the fourth-lowest among the world’s biggest oil producers, according to Bloomberg. That’s a 60% discount to the $13.20 average price BP received for fields sold last year holding 1.7 billion barrels. BP’s 10.8% stake in Rosneft represents 1.6 billion barrels of proved reserves. The fields that they will develop in the Arctic hold 5 billion tons of oil.
There have been numerous promises for changes on the foreign investment front from President Medvedev over the past two years. The chatter from both the president and the prime minister was increasing towards the end of last year, but I had dismissed it as not much had followed previous such statements before. Now, we have several big deals in a row and the Russian market is clearly starting to outperform many other emerging markets.