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19.06.2008 - MDM Comment: High yield opportunity - TCS Bank

For those with a high risk appetite, we recommend having a look at the short-dated ruble bond issue of the Bank Tinkoff Credit Systems (not rated), which offers some 18.5% to a put in October, 2008 (Bloomberg ticker TINCRE).
This bond issue has piqued our interest given TCS Bank’s announcement yesterday of an agreed sale of 15% of its equity (through a new share issue) to private equity investment fund Vostok Nafta for USD 30 million, as well as a completed sale of EUR 70 million in 3-year unsecured bonds with an 18% coupon and a call option after 12 months.
To put all of this into context, some quick background information on TSC Bank is needed.
TCS bank is a recent project which was launched at the beginning of last year by Russian entrepreneur Oleg Tinkov. Mr. Tinkov is famous for successfully developing a beer business, including a premium local beer brand Tinkoff. Core assets in that business included a brand new brewery, construction of which was almost entirely debt-financed. The beer business (with the exception of a restaurant chain) was sold at a favorable price to InBev group back in 2005, when the beer market in Russia was living through a period of intense consolidation. We estimate that Mr.Tinkov may have receieved some USD150m from that deal net of related debt repayments.
In 2007 Mr. Tinkov decided to bet on Russia's financial sector, specifically on underdeveloped credit card financing. He bought a small bank, re-branded it into Tinkoff Credit Systems and made it a mono-product institution focusing only on credit cards, referring to US-based Capital One as a model. To run the business, Mr. Tinkov invited a chief executive from the Russian part of Visa, Mr. Oliver Hughes. Unlike most of its Russian competitors, TCS is offering credit cards via direct mailing and only to individuals it chooses (one cannot ask for a card). To determine potential cardholders and their ability to pay, the bank is buying databases from various companies that provide services to a large audience of people and have information on payment track record. We understand that effective interest rates charged by TCS are around 35-40%. Another feature of the bank's business model is that it doesn't have front offices, so that all client communication is taken care of via a large call-center.
At a very early stage of the project Mr. Tinkov sold 10% of the bank for USD 10 million to Goldman Sachs, so the entire bank was valued at USD 100m vs a new valuation of USD200m in the  most recent deal with Vosok Nafta.  Back then Goldman Sachs had to rely only on a thoroughly prepared but untested modelThen the liquidity crisis arose, making fund-raising exercises very difficult for start-ups like TCS. For instance, ruble bond placement done in October 2007 (the same bond we now recommend to look at) was not very successful, with the coupon set at 18% and still only a part of the RUB 1.5 billion offering going into the hands of investors unaffiliated with TCS (some paper still on balance sheet of the bank).
Based on the information provided by the bank, its quick and dirty "snapshot" now looks as follows: loan portfolio of around USD 100m, equity of approximately USD 33m (without newly announced injection), loan performance in line with the model and operational break-even point within a close reach.
Now coming back to the news announced yesterday - we think that arrival of EUR 70m in long-term debt funding along with USD 30m in additional equity significantly improves TCS's financial flexibility and reduces its short-term credit risk. Therefore we think it makes sense to buy the ruble issue of the bank, which has a put in just 4 months and yields over 18% to a put date. Also, the ruble issue is looking more appealing vs the newly placed EUR bond from a spread-over-swaps perspective (approx. 1400bp vs approx. 1300bp).
Finally, as we have learned, the bank intends to publish its first IFRS statements as soon as next week. They will cover both 2007 and 1Q 2008. We assume that greater transparency and the likely assignment of first-time credit ratings will add to the appeal of TCS bonds.

19.06.2008 15:40
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