The Mobile TeleSystems Paradox

| About: Mobile TeleSystems (MBT)

Summary

In an odd twist, it might be in Mobile TeleSystems' shareholders' interest that relations with Russia remain cool.

This is so, because if those relations improved, Mobile TeleSystems shareholders could suffer a one-day setback.

This article explains this weird paradox.

I have been, and continue to be, positive on Mobile TeleSystems (NYSE:MBT). I made this clear in my three articles on it, titled "How About A Sustainable Dividend Yield Over 10%?," "I Disagree With The Bear Thesis - Mobile TeleSystems Is A Tremendous Opportunity" and "Just How Cheap Is Mobile TeleSystems? A Comparative Study."

However, there's an angle which I didn't explore, which poses a risk to MBT shareholders, and which gives rise to the title in this article. The angle makes us believe that relations between the U.S./EU and Russia stay cold for MBT shareholders not to suffer an instant loss. In this article will explain the weird thesis.

ADR

MBT is an ADR to the Mobile TeleSystems stock trading in Moscow under the ticker of MTSS. The ratio between MTSS and MBT is 2:1, meaning 1 MBT share represents 2 MTSS shares.

MTSS trades at RUB 236.80 as I write this. At the present exchange rate, you need RUB 77.5 to buy 1 USD. This means 1 MTSS share is presently worth $3.05. Since you need two of those to make one MBT, this means two MTSS shares go for $6.10.

This is where the problem starts: MBT is trading at $7.31, not $6.10. So MBT is trading at a large premium to MTSS. A 20% premium, to be exact.

Usually, when such thing happens, I'd be here jumping up and down telling you that it isn't smart to buy MBT under such conditions, like I did with iPath S&P GSCI Crude Oil TR ETN (NYSEARCA:OIL) versus United States Oil (NYSEARCA:USO) in my article titled "Do Not Buy OIL; Sell OIL Instead; Or Put OIL Into A Pair Trade."

However, in this case there are a few things to consider:

  • Nearly no investor will be able to buy MTSS in Russia.
  • The Ruble is, itself, undervalued versus the USD.
  • If relations between the U.S. and Russia were to improve, this would also likely mean an higher Ruble, thus potentially wiping out a good part of the observed premium.
  • The reason for the disparity (to be discussed next) is likely to be lasting.
  • And importantly, when I calculated valuation metrics for MBT, I used the market capitalization based on MBT, not MTSS (though the premium was lower when I wrote my bullish articles on MBT).

Even then, it's important to know this risk. Were relations between the U.S./EU and Russia to warm up, it would be possible that this premium could disappear.

In the event that the premium disappeared, it would mean MBT would go down and MTSS would go up, in relative terms. MBT wouldn't take most of the damage, though, because the stock trades around 2x more in NYSE than in Moscow (volumes are nearly identical, but each MBT share represents two MTSS shares).

How And Why Does This Disparity Happen?

I've already written on how a similar phenomenon happened with National Bank Of Greece, in my article titled "Be Aware Of This If You're Investing In National Bank Of Greece," and how it got eliminated, in my article titled "Notice Today's Compression In The National Bank Of Greece Arbitrage." The reason is always the same, something makes the cogs which allow for conversion between the ADR and the underlying equity grind to a halt (and "books be closed").

The conversion mechanism is what ensures a perfect arbitrage between the markets of an ADR and its underlying equity. When that mechanism is working, you can buy the underlying equity and convert it to ADRs to sell, and vice-versa. When it grinds to a halt, you can't, and the markets start diverging.

In the case of MBT, the same thing happened. On January 27, 2015, the ADR issuance was closed on account of "Foreign Ownership Limit" (Source: JPMorgan's ADR.com, search for MBT). Thus, there's a pressure by foreigners to buy which can't be satisfied except through MBT trading at a premium.

The foreign ownership limits were tightened by Russia back in October 2014, from 50% to 20%, hence the closure of issuance of new ADRs.

It's likely that this would only change if relationships between the U.S./EU and Russia were to warm up significantly, so until that happens there's a very low likelihood the arbitrage mechanism/ADR issuance (books open) will be reestablished. So, while there's a large premium in buying MBT in the U.S.:

  • The premium is likely to persist and could even go higher if owning assets in Russia becomes more attractive.
  • The MBT valuation multiples are attractive even when calculated with the more expensive MBT equity.

Still, were these limits to be lifted and ADR issuance to resume, and MBT shareholders would likely get a 0%-17% instant haircut.

Conclusion

MBT is an ADR that actually trades at a significant (~20%) premium to its underlying equity. However, it seems likely that the reason for this premium won't go away unless the relationship between foreign powers (U.S., EU) and Russia improves a lot. If the relationship was to improve, MBT would probably trade higher on account of higher valuation multiples and an improved Ruble exchange rage, but the reinstatement of the ADR arbitrage would lead to a one-day negative effect on the stock.

That said, this is still a risk which MBT shareholders should be aware of.

Disclosure: I am/we are long MBT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.