- Net result for the period was USD 157.49 mln (Jan 1, 2007–Jun 30, 2007: 39.52). Earnings per share was USD 3.42 (0.86). Net result for the quarter was USD –3.27 mln (36.11). Earnings per share for the quarter was USD –0.07 (0.78).
- The net asset value of the company was USD 961.75 mln (Dec 31, 2007: 803.95) on June 30, 2008, corresponding to USD 20.90 (12.13) per share. Given a SEK/USD exchange rate of 6.0132 the corresponding values were SEK 5,783.19 mln and SEK 125.66, respectively.
- The group’s net asset value per share in USD increased by 19.63% over the period January 1, 2008–June 30, 2008. During the same period the RTS index increased by 0.52% in USD terms.
- The number of outstanding shares at the end of the period was 46,020,901.
- The net asset value per share of Vostok Nafta as of July 30, 2008 was USD 17.11 (SEK 103.54).
The company will host a telephone conference with an interactive presentation at 16:00 CET (10 am EST) today, Wednesday, August 20. For call-in details, see separate press release issued Monday, August 18 at www.vostoknafta.com.
Background
Vostok Nafta Investment Ltd was incorporated in Bermuda on April 5, 2007 with corporate identity number 39861.
As at June 30, 2008 the Group consists of one Bermudian parent company, one wholly owned Bermudian subsidiary, one wholly owned Cypriot subsidiary, two wholly owned Russian subsidiaries and one wholly owned Swedish subsidiary. The Swedish Depository Receipts of Vostok Nafta (SDB) are from July 4, 2007, listed on the OMX Nordic Exchange Stockholm (previously the Stockholm Stock Exchange), Mid Cap segment, with the ticker VNIL SDB.
The financial year is January 1–December 31.
Group – results for the period and net asset value
During the period, the result from financial assets at fair value through profit or loss amounted to USD 154.46 (1.62) mln. Result from investments in associated companies was USD 0.75 (33.62) mln. Dividend income was USD 4.67 (8.07) mln. Interest income from loan receivables was USD 2.87 (–) mln.
Operating costs were USD –5.22 (–1.59) mln.
Net financial items were USD 0.35 (–1.75) mln.
Net result for the period was USD 157.49 (39.52) mln.
Total shareholders’ equity amounted to USD 961.75 (803.95) mln on June 30, 2008.
Group – results for the quarter
During the quarter, the result from financial assets at fair value through profit or loss amounted to USD 68.14 (4.35) mln. Result from investments in associated companies was USD –69.71 (31.63) mln. Dividend income was USD 1.40 (2.13) mln. Interest income from loan receivables was USD 1.64 (–) mln.
Operating costs were USD –3.72 (–0.69) mln.
Net financial items were USD 0.02 (–1.75) mln.
Net result for the quarter was USD –3.27 (36.11) mln.
Parent company
The parent company finances the Cypriot subsidiary's operations on market terms. The net result for the period was USD 5.07 mln.
Liquid assets
The liquid assets of the group, defined as cash and bank deposits adjusted for concluded but not yet settled share transactions, amounted to USD 182.51 (29.02) mln on June 30, 2008.
Management report
The period covered by this report was one of relative strength for the Russian equity market. This stands in rather stark contrast to the period after the end of the reporting period. July saw the Russian market drop by some 18%. Why? Real fundamental reasons would include the falling oil price and the high level of inflation in the country (although the latter is not a phenomenon that is new to mid-summer). Other reasons that have led to a higher perceived risk premium attributable to Russian valuations include the shareholder conflict in TNK-BP (described in more detail later in the report), the fear that the State’s accusation of Mechel that it is evading taxes would lead to a new Yukos situation and the military conflict in South Ossetia. The worst fears surrounding the Caucasus conflict look unlikely to be realised, but the full repercussions of it are yet to become clear as Russia's relations with the West come under further strain. We are confident, however, that the economic consequences will be small at worst, and the situation effect asset prices only through risk premia rather than results. The situation around TNK-BP and Mechel have been portrayed as signs of the Russian state’s nationalisation of certain parts of these assets which is also a very shallow analysis and which any further scrutinizing proves simply unfounded.
The oil price reached USD 150 in early July before starting a descent which currently has taken magnitude of a 25 % drop. The direction and the momentum of the oil price is negative for the sentiment around the Russian equity market generally and the valuation of Russian hydrocarbon assets specifically. However bar absolute levels going south of USD 80 per bbl the Russian oil & gas universe offer upside of up to 150% above today’s levels. As discussed before we believe the demand destruction created by a USD 150 per bbl oil price environment is a necessity in order to keep up with the supply issues created by geopolitical but most importantly geological constraints.
Macro
Russia has never been strong in its external communications, and recent events made it visible once and again. Prime Minister Putin’s words regarding Mechel Steel Group using transfer prices in its business were taken by the nervous markets as a precursor of another Yukos-type case in the making. Never mind that the Russian government has been trying to put pressure on transfer prices practices that reduced taxable profits in Russia. Both the timing and the wording of Mr. Putin’s public warning could hardly have been more awkward, with visible negative impact on the broad Russian equity market.
The armed conflict with Georgia also cannot claim to be a success of the Kremlin’s public relations. To the best of our knowledge, it is far from being a black and white story that is presented in most of the Western media. The conflict between Georgia and Ossetia has deep cultural and historical roots, which might be only slightly less complex than the conflict between the Palestinians and the state of Israel, or than the case of Kosovo. However, the Russian side while winning the armed conflict has lost in the information war. As a result, Georgia looks like an innocent victim of the Russian aggression, a very questionable perception given that it was Georgia’s bombardment of Ossetia that started the Russian military response.
Of course, poor communication is only partly behind the current tensions with the West. Another factor at play is that Russia started to pursue much more proactively its national interests on different fronts, from consolidation of control over strategic resources to foreign policy. Now it has greater resources to do so than in the past and makes the US, the only world’s superpower much more concerned. On top of that, there is also fundamental distrust by the US and the EU of the current Russian paradigm of ‘managed democracy’ that is no longer pronounced publicly but still seems to be remaining in place.
As a result, tensions with the West are not likely to subside in the near future. However, we should not overestimate their impact on the economy. The US-Russian trade is relatively small, so any worsening of relations is unlikely to have a major impact on both sides. Russia’s role of a leading energy supplier to the EU also leaves the EU with very limited economic power to threaten Russia.
The growing interdependence between the European and the Russian economies is likely to make any tensions shallow and short-lived. More importantly, we believe that the long-term trend of Russia’s social, political and economic evolution continues to be primarily towards Western values. As a step in this direction, President Medvedev’s announced recently a comprehensive plan to fight corruption, news of which went almost unnoticed amidst the events that followed. The plan is first of that kind and envisages a number of legislative and supervisory measures that over time can have a visible impact.
The ongoing difficulties on the global credit markets can have a far greater impact on the Russian economy than any worsening of relations with the West. The Central Bank seems to be well-positioned to cushion any difficulties in the banking system, and recently it expanded the scope of securities that can be used for repo auctions. We think that the difficulties in the banking system should be contained by the Central Bank, however small and medium sized full service banks may experience liquidity problems later this year.
In the corporate sector, a significant number of companies were leveraged for fast growth and many expansion plans might be revised down this year, in particular in sectors not related to commodities. Among those companies that did not manage to attract good management talent, the credit squeeze and rising interest rates are starting to lead to first technical defaults on non-investment grade rouble bonds and on some loans.
How does all this affect our work at Vostok Nafta? We view two things as important for our shareholders. First, scaled down aggressive expansion plans are starting to make valuation expectations of private company owners more reasonable, and we are seeing that in our project pipeline and beyond. Second, there are companies where unreasonable expectations and bad management are starting to be hit hard by reality. Out of such destruction, there may come pieces of substantial value and we are on the lookout for those on behalf of our shareholders and the shareholders of our portfolio companies.
Vostok Nafta’s portfolio development
Vostok Nafta's net asset value/share increased by 19.63% during January 1, 2008 and June 30, 2008 compared to the RTS index increase of 0.52% in USD terms.
(For table see attached file.)
Black Earth Farming
Black Earth Farming Limited (BEF) was among the first foreign financed companies to make substantial investments in Russian agricultural land assets. BEF has thanks to its early establishment now gained a strong market position in the Kursk, Tambov, Lipetsk, Samara, Voronezh and Ryazan areas of Russia. In the first quarter of 2008, BEF completed a strategically important acquisition. The acquisition gave the company direct ownership of 21,200 hectares of land in the central Black Earth region, and also included for example administrative buildings, trucks, planters and a 60,000 tonne capacity grain elevator. The elevator marks the first step towards the creation of a network of elevators, which going forward is planned to have the capacity to efficiently store BEF’s harvests. By using such elevators grain can be stored securely for longer periods, giving the company an opportunity to sell its produce in times of lower supply and higher prices.
In May, 2008, BEF announced the appointment of Michael Schneyderman as its new Chief Financial Officer. Mr. Schneyderman has more than 25 years of experience within strategic financial management, private equity and investment banking in both the United States and Russia.
During the first quarter of 2008 BEF increased its land under control by 36,000 hectares in total. As of March 31, 2008, BEF subsequently controlled around 325,000 hectares of the richly endowed farmland in the Black Earth region. The land under registered ownership amounted to approximately 69,000 hectares, land in ownership registration to around 251,000 hectares and land under long term leases to around 5,000 hectares. During the agricultural year 2005–2006 BEF cropped 5,900 hectares which resulted in a total harvest of 9,000 tonnes of crops. In 2007 these figures had grown to 53,000 hectares cropped and a marketable harvest of over 100,000 tonnes. In 2008, BEF plans to harvest approximately 150,000 hectares and as of May 22, 2008, BEF had seeded 96,130 hectares of spring crops.
BEF is currently focusing more on improving production costs and margins, than on growing its land under control.
Comparative valuation table
The following comparative valuation table compares Black Earth Farming to other listed companies within the agricultural sector. Apart from a series of companies with assets in Russia and Ukraine, SLC Agricola with assets in Brazil is included to provide an international comparison.
(For table see attached file.)
TNK-BP
Vostok Nafta’s third largest position TNK-BP has been subject to intense media coverage over the past six months. The background is a disagreement between the two major shareholders in the company, British BP and Russian Alfa-Access-Renova (AAR). In our view this most likely stems from a newfound interest in the short term returns provided by the company from the side of the Russian shareholders that sprung to life after a failed attempt to sell their stake to another Russian oil company (most likely Gazpromneft). The inability to agree on price led AAR to refocus on the oil asset they owned and assert its rights as a major shareholder on it through the joint venture agreement they have with BP. Whereas AAR are interested in minimizing CAPEX to maximise short term dividends, BP’s interest is to more long term build up the reserve base and production. A normal shareholder disagreement not uncommon in any part of the world like this has been interpreted by the Western press in the most perverse ways. The most common analysis is that the Russian State is pressing for a nationalisation of BP’s assets by using the Russian shareholders and a wide array of pressure forms on the Westerns employees. We believe the, as per above, that the different strategic views of the two shareholders are the reason for the conflict which in itself is normal. Both parties are to blame for not being able to solve these differences before they took a public turn. However it is also our view that they will be solved and that the fundamentals of the company has not in any material way been altered by the conflict. As we have expressed numerous times before in our view the trigger point for a revaluation of company is the exit of the Russian shareholder base, something that we believe is still likely to happen in the not too distant future. In the meantime the Russian major shareholder’s initiative of measure to boost shorter term dividends is not in any way unappealing for us.
Kontakt East Holding
Kontakt East Holding AB (KEH) is a Swedish holding company which invests in companies active within search and guidance media in Russia and associated markets. KEH currently has investments in the business segments Directory Services and Consumer eCommerce. Directory Services offers its customers both online and offline directories and is operated through a number of subsidiaries which together give KEH a leading market position in Russia. Directory Services publishes directories in Moscow, St. Petersburg and nine other Russian regions. Online services are also provided through the web sites www.yellowpages.ru, www.yell.ru and www.perm1.ru. KEH launched its first Consumer eCommerce offering, through the website Avito.ru, in 2007. The site provides an easy and accessible platform for companies and consumers who, through classifieds, wish to buy and sell goods and services over the Internet. In January 2008 online auctions was also added to the product range.
On May 26, 2008, Vostok Nafta and Investment AB Kinnevik announced a cash offer, of SEK 35 per share, for all the shares in KEH through their jointly owned Swedish company Vosvik AB. The total value of the Offer, calculated on the total amount of outstanding shares in Kontakt East, amounted to approximately SEK 493 million. When the acceptance period expired, on June 24, 97.6 percent of the shares and votes in KEH had been tendered and subsequently the offer was declared unconditional. Following this announcement the acceptance period was extended in order for remaining shareholders to tender their shares, and on July 7 shareholders representing, in total, 98.7 percent of the shares and votes in KEH had accepted the offer. On July 4 Vosvik AB called for compulsory acquisition of the remaining KEH shares, and on the same date KEH applied for the shares to be delisted from First North. The last day of trading in KEH shares on First North was July 28, 2008.
Background and reasons for the Offer
Kontakt East was created through Vostok Nafta’s acquisition of Eniro’s Russian catalogue business. The intention was to create a platform for growth on the Russian markets for Internet ads and catalogue services, which were considered to offer great potential. Apart from growth within established segments, the intention was also that Kontakt East should be a driving force in the consolidation of the industry. In conjunction with the listing in November 2006, Kinnevik became a major shareholder in addition to Vostok Nafta. Vostok Nafta and Kinnevik estimate that the potential for Kontakt East is unchanged but that the time horizon until the potential can be materialized is long.
Since its listing in November 2006, the trading volume in Kontakt East’s shares has been far below the average on the stock exchange. A de-listing would allow management to designate all its time to operational issues and allow for savings relating to listing costs. The demand for a long-term perspective, the expected need for financial resources to enable growth and expansion as well as the low liquidity in the share all suggest that Kontakt East’s operations are best suited in a private environment.
Steppe Cement
Steppe Cement is one of the largest cement producers in Kazakhstan, with a sales volume of over 820 thousand tonnes of cement during 2007. In 2008 the company aims to start production from two refurbished dry-line facilities, boosting capacity and as a result making it the largest producer in the country.
The global financial crisis hit Kazakhstan in the autumn of 2007 and construction companies halted launches of new, and the completion of existing, projects – inevitably hurting domestic producers of cement. Cement prices fell considerably from around USD 200 per tonne to circa USD 110–120 per tonne. However, the market has seemingly started to recover during the spring of 2008, and cement prices have again risen gradually. Statistics also point to a significant upswing, of just under 27%, in the Kazakhstani construction sector during the first quarter of 2008.
The future demand and pricing for Kazakhstani cement should be supported by the Kazakhstani state housing program (which is expected to entail over 26 million square meters of housing to be built in upcoming years), accelerating investments in infrastructure and public housing projects along with the overall economic growth in the country. The supply shortage and higher prices in Russia, which we touched upon in our annual report 2007, can also play a part in securing the demand for Kazakhstani cement thanks to well developed transportation infrastructure between the two countries. These export opportunities can also act as protection for the Kazakhstani producers’ margins if domestic cement demand and prices once more start to decrease.
Steppe Cement is in our eyes a well priced opportunity to ride the construction boom in Kazakhstan, and associated FSU (Former Soviet Union) markets.
Tinkoff Credit Systems
Bank Tinkoff Credit Systems (TCS) is Russia’s first monoline bank specializing exclusively on the issuing and servicing of credit cards. Since the launch of its commercial operations a year ago, TCS has issued over 180,000 credit cards to consumers throughout Russia making it one of the fastest growing consumer finance business in Russia. By the end of June 2008, the bank managed to grow its loan book to USD 110 mln.
In December 2007 Vostok Nafta, along with a number of other investors, participated in the syndicated loan arrangement committing RUR 500 mln. At that time Vostok Nafta became entitled to warrants representing 2% of TCS’s equity. In mid 2008, the parent company of TCS has issued a EUR 70 mln bond maturing on June 24, 2011 with a fixed annual coupon of 18%. Issuing a bond of EUR 70 mln under current challenging market conditions confirmed the attractiveness of TCS’s strategy, business model and management team to the broad group of international investors. As a result of the bond issue, TCS has secured financing to grow its credit card portfolio in a rapidly growing and underserved Russian credit card market. Following the bond issue, Vostok Nafta subscribed for USD 30 mln of shares in TCS’ parent company, becoming a 15% shareholder along with the founder Oleg Tinkoff and Goldman Sachs. Altogether USD230 mln of total funds has been raised by the bank.
In terms of operational results by the end of June 2008 the Bank’s loan portfolio has grown almost two fold to USD 110 mln from USD 65 mln as of the beginning of 2008. Quality of the portfolio has improved with the first payment default level declining to 6% from the initial 13%. Response rate measured as percentage of responses from customers who received invitations went to 4–5%, up from 1.5% level. Gross interest yield (annualized monthly interest and fee income earned during each month to the beginning of month balance) was above 75% at each month of 2008.
According to TCS’s IFRS report for the 1H of 2008, TCS’s net interest income amounted to USD 12.5 mln, up from USD 3.65 mln in the 1st quarter of 2008; and fee and commission income totalled USD 2.5 mln, up from USD 0.9 mln in the 1st quarter of 2008. For the 1st half of 2008, TCS posted a net loss of USD 4.46 mln. When taken before loan loss provisions in the amount of USD 6.3 mln, TCS’s net result for the 1H of 2008 was positive, amounting to USD 0.83 mln.
Investments
During the period net investments in financial assets were USD 74.28 (–25.37) mln.
Major changes of listed securities in the portfolio during the quarter were:
Purchases (shares)
+ 95,000,000 Hydro OGK
+ 3,964,000 Steppe Cement Ltd
+ 11,000 RSC Energia BRD
Sales (shares)
– 119,800,000 Kuzbassrazrezugol
– 554,700 Belon
Portfolio structure
The investment portfolio stated at market value as at June 30, 2008 is shown below. Vostok Nafta’s three biggest investments are Black Earth Farming (22.25%), Kuzbassrazrezugol (9.83%) and TNK-BP Holding Pref (8.58%).
(For full report see attached file.)
