Analysis: Rising state meddling in EM companies irks investors

LONDON Fri Apr 15, 2011 1:06pm EDT

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LONDON (Reuters) - Investors in emerging markets are increasingly exasperated with government interference in big state-run companies -- potentially bearish news for stock markets and future share listings.

Across the developing world, governments facing inflation are turning to food and energy subsidies as an alternative to raising interest rates, especially if elections loom.

State-run firms, which according to Deutsche Bank account for over a third of the emerging corporate universe, often bear most of the subsidy burden. That means profitability -- and share prices -- will take a knock, more so when the emerging markets environment is looking choppy.

"This is one of the key topics of the next few years -- can we trust governments in the way they deal with corporates?" said Marten-Jan Bakkum, portfolio strategist at ING Investment Management's $3 billion emerging markets fund in The Hague.

"There is an increased level of state interference and investors don't like that," he said, adding ING has gone neutral on Brazil because of growing pressure on big state firms.

China's success in deploying the resources of its own giant state-owned firms is tempting other countries to try to emulate it, especially after the economic crisis gave their faith in the free-market model something of a knock.

Brazil most recently hit the news by ousting the head of $180 billion miner Vale for resisting state efforts to push it into low-return, labor-intensive, activities.

The move came months after a $70 billion share offering in oil firm Petrobras angered minority shareholders.

The concerns are reflected in share prices. Vale shares are valued now at half the average for global steelmakers.

Credit Suisse analysts note Brazil has historically traded at a 25 percent discount to emerging peers on a forward basis -- possibly because the state has stakes in a disproportionately large share of listed stocks.

And Russian oil firms, among the most vulnerable to state meddling, carry a 40-50 percent discount to emerging peers.

Will Landers, who runs $10.5 billion in Latin American stocks at Blackrock, said the Petrobras issue had eroded its status as a state firm that still treated shareholders fairly.

"(Petrobras and Vale) are reminders that we do have the government as a partner in the company, and from time to time we will get caught up in situations which are not good for shareholders," he said. "All this increases our concern to a certain extent."

SHARE SALES

But Landers still has Petrobras among his top 10 holdings though he remains underweight on the stock. Because big state-run companies make up a large part of the local market, it can be tough for portfolio managers to ignore them entirely.

That's especially so during the ongoing commodity boom as these firms usually have huge reserves of energy or metals.

Some investors see state backing as broadly positive as governments can push companies' agenda overseas or step in if they need financial assistance. But in a tougher emerging market environment, the issue will weigh more heavily on prices, especially as many countries are preparing for big stake sales in state companies.

Russia for instance has kicked off a three-year $35 billion privatization plan while India hopes to raise $9 billion in 2011 by selling stakes in oil firm ONGC and steelmaker SAIL.

Some of these IPOs will fly as state-run firms tend to list at lower valuations than private ones.

But some predict problems down the line.

John-Paul Smith, Deutsche Bank's chief emerging equity strategist, points out state-run firms suffer from heavy capital expenditure which will hit future return-on-equity (ROE).

A Deutsche study found net capital invested in emerging markets rose 53 percent from the 2006-08 period to 2009-11 but economic earnings -- the cash flow a company expects to generate in perpetuity -- grew just 7 percent. Russia, China and Brazil, countries where state control is highest, fared worst.

The same analysis showed investment and economic earnings growth of 10 and 6 percent respectively in the United States.

Emerging stocks valuation discount shows some of this is already priced in. But Smith predicts worse is to come.

"I think the ROE in emerging markets will be hit quite hard in coming years ... over time we should see some erosion of EM earnings growth versus DM, mainly due to over-investment -- that's the reason I'm relatively bearish on emerging markets."

But there are some positive signs. In Russia, where political risk is viewed as extremely high, President Dmitry Medvedev has ordered the removal of ministers from the boards of top companies such as Gazprom and Rosneft.

The move is timely, says John Lomax, HSBC head of emerging equity strategy "If Russia want to get this issuance away, they must create conditions in which investors want to take part."

(Editing by Stephen Nisbet)

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