By John Helmer in Moscow
Alrosa’s chief executive Fyodor Andreyev (right image) briefed Moscow investment banks last week on the company’s strategy in an attempt to raise demand for a domestic bond issue, to be followed by a eurobond issue in November. Alrosa’s target for the two issues is $1.84 billion.
The unsecured bonds are needed to cover the company’s debts of $2.2 billion which must be repaid or refinanced by the end of the year. According to a report of Andreyev’s claims by Renaissance Capital, Alrosa’s total debt at the start of this month was $3.7 billion. The bulk of this debt, $2.2 billion, is owed to the Russian state bank, VTB; $1.8 billion of this is due to VTB. Andreyev told Renaissance Capital that Alrosa intends to sell Rb26 billion ($84 million) in domestic bonds, and then follow with a eurobond issue of $1 billion. Andreyev has been evasive about the eurobond plan, saying just a few weeks ago: “It’s too early to talk about the eurobonds, it’s a plan”.
Alrosa’s debt took off as a result of a plan to diversify into non-diamond mining, including oil and gas, coal, iron-ore, and gold. This was approved at the time by the Alrosa board chairman, Russia’s Finance Minister Alexei Kudrin; Vyacheslav Shtirov, the President of the Sakha Republic, where the diamonds are mined and Alrosa based; and the chief executive appointed in February 2007, Sergei Vybornov (left image); he had previously headed Investment Group Alrosa, an asset diversification subsidiary of the parent company. Total debt at the end of December 2006 was the equivalent of $2.4 billion. It rose by 38% to $3.3 billion at the close of 2007. At the end of 2008, the debt had jumped almost 40% to $4.6 billion. Vybornov was replaced in July of 2009 by Andreyev; Shtirov was replaced in Sakha this month by his former deputy, Yegor Borisov.
Kudrin was asked why as the Alrosa board chairman, he had approved the runup of the company’s debt, and who had benefited from the acquisition strategy. He did not respond.
Andreyev’s appointment — he had been the financial strategist of the state-owned Russian Railways Company before — was assigned the priority of cutting Alrosa’s debts, and enabling the company to resume a normal pattern of development. In April of 2009, Standard & Poors (S&P) had suspended Alrosa’s rating. This was reinstated in February of this year, though its stand-alone credit profile — without state financial backing — remained “weak” and “highly leveraged”, according to an S&P report.
This report points out that if not for VTB, Alrosa would be on the brink of bankruptcy. “Cash balances as of Dec. 31, 2009, are relatively low for a company of its size, and, in our view, are largely tied to operations. The company doesn’t have substantial available committed lines. This is only partly offset by expected government support including the track record of access to financing from Russian banks, notably state-owned VTB, which currently account for about 75% of Alrosa’s debt. Traditionally, the company has relied on short-term debt, including commercial paper. We understand, however, that management plans to increase the share of long-term debt to about 70% by year-end 2010 through long-term issuance. Its ability to do so would depend on credit market conditions, however.”
One of the most important figures in directing Alrosa’s asset acquisition strategy, and the flow of state cash to support it, has been a little-known executive of VTB named Otar Marganya. His role as advisor to Kudrin, Shtirov, and Vybornov appears to have vanished when Vybornov was replaced by Andreyev. VTB says he is no longer an office holder at the bank.
Last week Andreyev told investment bank analysts in Moscow that selling Alrosa shares in an initial public offering (IPO) is an option after the bonds have been placed, but he claimed an IPO is unlikely to happen for another two years. In briefing the Sakha region parliament on May 24, Andreyev did not disclose this timetable. Sakha republic officials and deputies are reluctant to accept any market sale of Alrosa shares that may threaten the 40% bloc which Sakha controls, unless Moscow gives iron-clad guarantees of Alrosa’s revenue contributions to the regional budget. There is little trust in Yakutsk, the Sakha capital, in Moscow’s promises.
Raising another $1 billion in new funds will be required to finance underground mining for diamonds, Andreyev reportedly told the investment banks last week. He said that Alrosa had spent $1 billion on capital charges, including mining equipment, in 2008, and will now spread out the remaining sum in equal tranches over three years, as the company completes construction of the underground mines at Mir, Aikhal, and Udachny. Maintenance of the mines will cost around $500 million a year, he added. According to one of the reports of what he told the banks, the operating costs for underground mining will be less than those for open-pit mining, but Andreyev did not provide details.
A month ago, Alrosa reported it was expecting to produce 33.54 million carats this year. “Such a level of planned output is based on the operating capacities of the company and its subsidiaries. Besides, the Mir and Aikhal [underground] mines will be brought to their design capacity. The Udachny Mine will also be launched and it will become one of the largest underground diamond mines in the world capable to produce up to 4 million tons of ore per year,” the company said. The design capacity of Aikhal is 500,000 tonnes of ore per year, that of the Mir Mine is one million tonnes of ore per year, and they are scheduled to reach their design capacity in 2012. It is also expected that the Udachny Mine will turn out its first 25,000 tons of ore in 2012. In 2014 ALROSA plans to launch the first stage of Udachny with an operating capacity of 500,000 tons of ore in a year, while its design capacity is scheduled to be reached in 2016.
In a production release for the first quarter, Alrosa says its diamond output in the three months to March 31 was 8.6 million carats; this was down 7% from the 9.2 million carat figure for the first quarter of 2009. Then all stones sold went to the state stockpile agency Gokhran; this year Alrosa claims all diamonds sold have gone to the market.
Andreyev claimed in his remarks to the bond broking banks last week that Alrosa expects sales revenue this year of Rb130 billion (currently $4.2 billion). If achieved, the result would be 66.5% higher than the sales result for 2009, and 42% higher than in 2008. Earnings (Ebitda) are projected to reach Rb51.6 billion ($167 million), double the pre-crisis result in 2007. The chief executive, who has been in office for a year without having given a press conference, also lifted his output projection for this year, telling the banks that Alrosa plans to produce 40 million carats, up about 30% on last year’s production volume. Renaissance Capital’s analyst Andrei Markov expressed skepticism, reporting to clients that Andreyev’s assumptions about diamond pricing this year, on which his revenue and earnings projections are based, “has yet to be tested, in our view… The company’s forecast looks somewhat optimistic to us and we would like to see it confirmed by the company’s IFRS reporting.”
If — and Andreyev has yet to respond to questions on the point — the financial results meet the projections by year’s end, and the bond issues go as planned, Markov reports that Alrosa’s debt will be reduced to Rb100 billion ($3.2 billion), a reduction of $500 million from this month’s level. That ought to translate into a significant improvement of the ratio between debt and earnings from a multiple of 6.1 in 2009 to a multiple of 2. This in turn would open up commercial lending for the balance of Alrosa’s debt.
Markov suggests that Andreyev is under-estimating the interest rate Alrosa will have to pay to sell its bonds, noting that despite its semi-sovereign guarantee and full state ownership, it will be obliged by the market to pay bond interest rate that is higher than it has paid before, and equivalent to the most heavily indebted of Russia’s steel companies, the publicly listed, oligarch owned Evraz group, which has been loss-making since the 2008 crash. “In our view,” reports Markov, “the fair yield of Alrosa’s rouble bond should be within Evraz’s curve minus 25-75 bpts,” Markov reported to bond buyers. “Therefore, we estimate it at 9.25-9.75% for the three-year issue and 9.85-10.35% for its five-year issue (company guidance is 8.51-9.04% and 9.04-9.58% respectively).”
Company releases indicate that the coupon paid on Alrosa’s $500 million eurobond between issue in 2003 and redemption in 2008 was 8.125%. The subsequent $500 million in eurobond issues in 2004-2005, maturing in 2014, are paying 8.875%.
In a report in April, Renaissance Capital cited Alrosa as claiming to have reduced the cost of its borrowing from 12.4% in 2009 to 7.85% as of 31 March 2010, on the assumption, which Andreyev has yet to confirm, “that VTB agreed to reduce the interest on its loans to Alrosa.” According to Markov, “given that Alrosa’s debt was $3.8bn as of 2009 [estimated], in our view an interest rate reduction would be a rather important driver of an improvement in Alrosa’s financials this year. Last year the company paid RUB17bn [$562 million] in interest expense (non-consolidated RAS data).” In the reporting of Andreyev’s briefing to the Il Tumen (Sakha parliament) last month, Alrosa’s interest payments last year were reported as Rb15 billion ($496 million).
Andreyev made much in last week’s presentation to analysts of his success at divesting the non-diamond mining assets of the company, which had been part of the acquisition strategy of his predecessor Vybornov. The balance-sheet impacts of Vybornov’s transactions in energy, iron-ore, and gold have not been disclosed since his departure in July of 2009. Silent as he has been on Alrosa’s debts, Kudrin has actively promoted the bailout in which state banks have paid high prices to take the assets off Alrosa’s books. Last year Alrosa sold Geotransgas and Urengoy Gas Company to VTB for $620 million. Last week, the company told the bond brokers it will soon close the sale of Irelyahneft, an oilfield property, for $120 million.
In May of last year, in the final weeks of the internal conflict over who was to blame for Alrosa’s financial condition, Vybornov disclosed that he was close to an agreement with a buyer for Irelyahneft. According to Vybornov, that, plus the other oil and gasfield assets, should fetch between $600 million to $700 million. Irelyahneft’s assets included reserves esrimated at about 4 billion cubic meters of gas and 12 million tonnes of oil. The state bank intervention to pay Alrosa for the energy projects has been a holding action, because state-owned Gazprom and Rosneft, as well as oil company Surgutneftgas, had indicated they were not prepared to pay market price for the reserves, because they have no intention of developing production for at least five to ten more years.
Alrosa is now saying that its Timir iron-ore company — which holds rights to four deposits in the southern part of the Sakha region, Tayezhny, Desovsky, Gorkitsky and Tarynnahsky — will be sold off, or offered on concession to a strategic partner, instead of developed by Alrosa. Earlier plans had called for Alrosa to start mining at two of the deposits, and build an ore concentration complex there. Development of the other two deposits, together with an iron and steel mill to consume the output, were also on the drawing boards. Andreyev told the Sakha parliament last month that the capital cost of the iron-ore projects would be $3 billion.
Markov for Renaissance Capital reports that “Alrosa has abandoned its previous strategy of trying to be a diversified mining and energy company, and has shifted its focus back to its main area of operations, namely diamond mining in Russia. We view this as very positive for the company, as its attempts to diversify resulted in an increase in leverage and large capex requirements, and did not improve its cash flow generation capacity.”
Alrosa has also been hinting that it has resumed its effort to find a foreign mining company willing to bring the Arkhangelsk region, Lomonosov diamond deposits into production. Originally acquired by De Beers when the field was privatized as Severalmaz (“Northern Diamond”), the property was sold to Alrosa when De Beers concluded that the costs and risks of starting up a new Russian diamond mine outweighed the likely profits. De Beers since tried to develop the nearby Grib diamond pipe, through subsidiary Archangel Diamond Corporation, only to abandon that under pressure from raiders led by LUKoil; the affair is still being litigated in the US courts.
Early this month, according to a cryptic report from Alrosa, Rio Tinto paid a visit to the Severalmaz project, and inspected the drill site and pilot ore-treatment plant. Rio Tinto, BHP Billiton, Beny Steinmetz, Lev Leviev, and several Indian diamond groups have all been invited to assess the Lomonosov deposits for prospective joint development, and all have refused. According to Alrosa’s announcement of the latest Rio Tinto visit, “during the meeting a productive exchange of experience on issues of technology and organization of diamond production took place.”