OREANDA-NEWS. August 12, 2011. 17 into 1. Rostelecom’s 17 common share classes are trading under a single ticker on MICEX. This event represents the completion of Rostelecom’s reorganisation and signals the creation of a new telecom blue chip, in our view. The company’s free float in common shares is now 45% or USD 7.5bn.

Prerequisite for MSCI Inclusion. The merger of the common shares was set by MSCI Barra as a prerequisite for the inclusion of Rostelecom’s common stock into the MSCI Index. This is expected to occur on 1 Sep. We estimate its potential weight at 2.9% subject to other companies’ MktCap fluctuations and MSCI policy. We believe inclusion in the MSCI Index will foster the rebalancing of Rostelecom’s overall shareholder structure in favour of international institutional clients.

LSE listing is next on the agenda. MSCI Index inclusion should facilitate an LSE listing. We believe the latter is likely to materialise in 4Q11 after 1H11 IFRS results are released (scheduled for October). The current instability in the financial markets should not necessarily reduce the listing’s likelihood as the company does not plan to conduct an SPO or raise money in any other way. In fact, we think Rostelecom’s current shareholders are likely to welcome GDR conversion due to higher liquidity prospects and the need to stay within the 25% limit legally allowed in Russia for foreign trading. If the government is serious about its privatisation plans it should also be interested in an LSE listing in order to enhance Rostelecom’s capitalisation, in our view.

The stock underperformed the market during the correction… Overall, Rostelecom’s shares outperformed the market before the major sell-off, but started losing ground ahead of the recent market collapse. Indeed, announcement of the conversion (on 26 July) of Rostelecom’s shares exacerbated the hypothetical risk of share overhang and from 25 July to 1 Aug, Rostelecom lost 5%. We think uncertainty over Rostelecom’s privatisation was also taken negatively by investors. Since 2 Aug (the start of the market sell-off) Rostelecom has dropped another 22%, while MICEX has lost 13%. In our view, potential overhang worries are widely discounted by the market.

…although it is essentially defensive in nature. Telecoms are a relatively non-cyclical business and are essentially a utility service. Telecom consumption could only deteriorate significantly in the case of severe unemployment in our view, which is not a real risk at the moment. We believe slower?than?expected economic growth dynamics could position Rostelecom as a defensive stock. Aton’s strategy team highlighted Rostelecom as a defensive stock in its note RUSSIAN EQUITY STRATEGY: Where to Hide in a Market Downturn: A Look in the Rear-View Mirror, released on 8 Aug.

More expensive on the RTS than on MICEX. Trading in separate share classes limited the stock’s liquidity, cutting into its market price visibility. That said, the discount on MICEX yesterday between Rostelecom’s new and old shares (price: RUB160.5) narrowed on average to 1%. On the RTS, Rostelecom’s stock traded yesterday at USD 6.7/share, implying a 24% premium to the old Rostelecom shares on MICEX.

Rostelecom is particularly cheap following the correction. Rostelecom looks undervalued at a FY12E P/E of 9.4x vs the EM average of 11.7x and an EV/OIBDA of 4.1x vs EM peers’ 4.3x. A mix of technical (MSCI, LSE) and fundamental triggers (providing service to the state’s IT programme, fibre-to-the-building roll-out, staff cuts) favourably differentiate Rostelecom from other Russian telecom stocks, in our view.