Research Notes

Russian electricity monopoly UES has approached the first phase of its restructuring and in less than 12 months the energy holding's restructuring, which has so far given investors a run for their money, will be finalized. Even the first stage gives rise to a myriad of questions. For example, not all investors yet realize that holding UES stocks on September 3, 2007 – the preliminary spin-off date for WGC-5 and TGC-5 – they will gain stakes in these concerns and retain their status of UES shareholders. As a matter of fact, this is the gist of the first stage of reorganization which will make it possible to work out the mechanisms for executing the second (final) stage of restructuring that is scheduled for July 2008.

Within the second stage, which is more difficult to understand, all other assets will be spun off from UES. These assets will be structured in quite a non-trivial manner. According to UES representatives, the holding's separation balance sheet occupies “half of a big room” – only a part of all quantitative information has been made available, so far. It is known that UES shareholders, who vote against the restructuring at an October 26 EGM, by law, will get stakes in all 28 spun-off businesses, while the other consenting shareholders will be assigned equity stakes in only 23 companies.

The proportions in which companies spun off from UES in the course of the second restructuring phase will be divided among shareholders, still remain unknown, but the primary principle of distributing UES assets that calls for pro-rata receipt by all the holding's shareholders of spun-off concerns will be observed when it comes to assets for one and the same amount on the separation balance sheet regardless of whether or not a shareholder votes. However, the actual composition of these assets will differ, and the liquidity and upside potential of equity stakes assigned will depend on how a shareholder votes.

To take part in the final distribution of assets a shareholder will have to own UES shares as of the cut-off date in order to participate in the second phase of restructuring (expected in June 2008). The Russian electricity monopoly will notify its shareholders and stock market participants of the cut-off date beforehand. By the time the second restructuring stage comes to a close, system-wide functions which are carried out by UES will have been fully assigned to the state, infrastructural and self-regulatory concerns. Measures within UES' final restructuring procedures involving the establishment of concerns making up the final industry structure are to be wrapped up by July 1, 2008.

As part of this research note we described the main details of UES' restructuring program. Overall, the assets which UES shareholders will receive next July will depend on a number of factors; there are numerous nuances, and later on in our further research notes at www.finam.ru we will keep investors informed about all details once the situation becomes clearer.

We believe that UES stocks have not yet exhausted their upside potential and are confident that the holding's securities are still an alluring opportunity to buy into the Russian utility sector. In line with our valuation model for UES, which we described in our desk note dated July 19, 2007, we updated our valuation of UES's fair market cap. After WGC-5 and TGC-5 (which account for 6.3% of UES's capitalization, according to our calculations) are spun off from the energy holding, the fair value of UES equities, even after WGC-5 and TGC-5 turn into standalone businesses, is $1.84 per common and $1.66 per preferred shares. We reiterate our Buy recommendation on the power holding's securities.

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Simon Birg

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