While looking at the valuations of Russian companies internationally, it has to be borne in mind that while Russian company share prices have been going mostly up, their risk profile has been coming down, allowing more room for price appreciation. After all, valuations are meaningless before they have been compared to growth rates and risks, as measured by WACC.

The single largest change to the WACCs of Russian companies came from the significant reduction in the country risk, as measured by the basket of Eurobonds. The yields of Russian Eurobonds, both sovereign and corporate, have seen a considerable decline in the last 12 months, on average by a 3—3.5 percentage points. To a large degree, however, this is attributable to a significant decline in US dollar yields – the tightening in EMBI spreads was far less steep than the decline in yields. Also, Russian debt yields have been declining in line with peers, as emerging market debt has performed quite well in the low interest rate and low economic growth environment.

However, there are also some Russia-specific factors behind the great performance of Russian debt over the past several months. These include a significant current account surplus, forex reserves nudging the $60 billion mark, a state budget surplus, a growing economy, significantly improved political stability, and some hesitant progress in structural reforms. This is all in sharp contrast with 1997—1998, when the decline in yields was driven by foreign «hot money» rather than fundamentals. In contrast now domestic investor demand in the Eurobond market is more stable than foreign demand. For these reasons, and due to the relatively low chance of rising dollar interest rates this year, we think that Russian debt yields, however ridiculously low they might appear, are sustainable in 2003. And Russia is still trading some healthy 100 basis points (bps) wider than Mexico, which is one investment grade higher, and about 200 bps wider than Poland, which is now trading as a quasi-EU country.

As an example of corporate bonds, the yields of MTS and Vympelkom dollar debt instruments have also declined in the past year. It should be noted, though, that Vympelkom has closed the gap with MTS in terms of the cost of debt, which is due both to an improvement in Vympelkom’s financial results and MTS’ increasing leverage. MTS’ Eurobonds maturing in 2008 now probably serve as the best proxy for the cost of debt for both companies, which we would see in the tight area of around 8%.

Despite the decreasing macro risks, we do not think that there have been many changes, which would allow us to consider Russian equity as any less risky than we did previously. Legislation has not changed much, the corporate governance risks remain the same, the dealings in shares of UES and Surgutneftegas over the past six months have proved that the market remains an «insider’s» place, and the overall breadth of the market – if anything – has worsened. Thus, we do not see any reasons to decrease our six percentage point equity risk premium.