There are many reasons why investors might avoid the Tehran Stock Exchange (TSE). Chief among them are that US sanctions against Iran’s largest banks have made it more difficult to trade in shares listed on the market, and the availability of good-quality information about the country’s biggest companies is limited.

There is, however, one good reason to invest in the market. While the six GCC markets, and emerging markets worldwide, have fallen over recent months, the main TSE index has soared.

The 320-strong TSE Price & Dividend Index (Tedpix) has gained 56 per cent since the beginning of 2007. In contrast, the Morgan Stanley Capital International (MSCI) GCC index, the most widely used index of the six Gulf markets, has grown by 19 per cent over that time. The MSCI Emerging Markets index, which captures the performance of global emerging markets, has grown by just 8 per cent over the same period.

Bear market

Iranian shares enjoyed their best run early in 2008. Since the beginning of this year, the Tedpix has gained 41 per cent, while the MSCI GCC index has lost 17 per cent and the MSCI Emerging Markets index is down by 21 per cent.

This summer, two key Middle East exchanges dropped more than 20 per cent below their peak levels, putting them in the category of bear markets. The Cairo & Alexandria Stock Exchanges (Case) 30 index of Egypt’s largest floated businesses was 31 per cent below its 5 May peak at the end of trading on 14 August.

The Dubai Financial Market’s (DFM’s) index fell to 20 per cent below its 15 January peak in the same week, and Saudi Arabia’s Tadawul has been a bear market since February 2006.

So far, the TSE has resisted the downturn affecting the region’s other large exchanges. Iran’s ambitious, if slow-moving, privatisation campaign has helped the market along by providing an intermittent supply of major flotations.

On 9 August, the government parted with one of its crown jewels by floating a 5 per cent exploratory stake in Telecommunications Company of Iran (TCI), the country’s monopoly fixed-line operator and its largest mobile phone business.

The market valued the stake at $365m, making the entire company worth $7.3bn less than the $12bn anticipated by some members of Tehran’s broking community, and far below the $16bn valuation established by TCI itself.

Privatisations

The shares climbed a little in the company’s first week of trading, and its valuation of $7.4bn at the close of trading on 13 August made TCI Iran’s second-largest listed company.

Other leading companies on the stock exchange are also the product of recent privatisations. Mobarakeh Steel Complex, Iran’s largest floated company, with a market capitalisation of $9.6bn, came on to the market in 2007, as did National Iranian Copper Company, the third-largest stock on the exchange, with a market capitalisation of $4.7bn.

Other leading listed companies in the country such as Khuzestan Steel and Iranian Shipping - each valued at $3bn - were previously wholly owned by the state. In each case, the government has retained management control and a majority stake in the business.

TCI’s privatisation highlights some unusual practices in the Iranian market. Potential investors were asked to decide whether to buy the shares without seeing an up-to-date set of accounts.

The company’s management published an unaudited set of accounts for the Iranian year ending on 20 March 2008. The accounts, which are also incomplete, show that the company made a net profit of just $100m for the full year.

Part of the reason for the poor performance is Tehran’s habit of levying a 40 per cent tax on earnings on all state-owned companies. This charge alone removed $700m from TCI’s bottom line. TCI will be exempt from paying the tax in future because, following its flotation, it became subject to a different legal code.

The deterioration in TCI’s results since it made $1.7bn in net profit in the Iranian year ending in March 2007 could be a case of the government taking what money it wanted before privatisation, or a sign that the company is failing to compete effectively with Iran’s second mobile phone operator, which launched in the last quarter of 2006.

But TCI will bounce back in the financial year finishing in March 2009, according to Ramin Rabii, managing director of Tehran-based fund manager Turquoise Partners. “For this year, management is forecasting $800m,” he says. “Our forecast is $1.2bn.”

Under TSE rules, TCI will hold an annual general meeting by 11 September, soon after which it must report its first set of financial results as a listed company.

Although TCI’s flotation raised less money than the government wanted, other big privatisations are likely. Three banks - Bank Mellat, Bank Sajerat and Bank Tejarat - are all being prepared for the flotation of minor stakes on the exchange.

However, investors would be foolish to second-guess the Iranian authorities. TCI was originally supposed to list in September 2007, but the flotation was regularly postponed without any public explanation.

One problem for the TSE is its small size. Although the companies listed on the exchange are worth a combined $74.8bn, only 15-20 per cent of their shares are available to private investors, making the value of the free float $20bn at most.

Because the free float is so low, there is not enough money in the market to purchase newly issued multi-billion-dollar stakes, restricting the government’s ability to sell off additional holdings in prize assets such as TCI.

For the same reason, the government cannot list its energy companies in a single block. In March, sources in Iran told MEED that the government wanted to float a $90bn energy holding company on a foreign stock exchange because the TSE was too small to create a liquid market in such a large company.

The sources said the Iranian Privatisation Organisation had been holding talks with the Dubai International Financial Exchange (DIFX) about listing a stake in the holding company in Dubai.

The company would be unable to list on the DFM, the sister exchange of the DIFX, as it only allows the listing of companies that are 51 per cent owned by UAE nationals.

Since then, the DIFX and the Iranian Privatisation Organisation have refused to discuss the proposed flotation. The performance of the Tedpix since March suggests the index has coped well with the potential snub.

Initial public offerings (IPOs) of government-owned companies are driving the market. “If you invested in all the IPOs over the past few years, you would have made more than 100 per cent,” says Rabii.

What is less clear is whether future flotations will increase the overall size of the market to a point where the government can sell multi-billion-dollar stakes in its largest companies on the domestic market.