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By John Helmer in Moscow

Russian specialty steelmaker spins off coal-mining and ferroalloy units to add value, deter asset attack.

A series of new executive appointments, announced this week by Mechel, suggests that the group’s controlling shareholder, Igor Zyuzin, is preparing for the possible, much rumoured sale of the Mechel steel division to the state-owned RusSpetsStal (“Russian Special Steel”, RSS) group.

What isn’t clear yet is whether Zyuzin’s new structure is meant to repel, or absorb, an attack. This structure, comprising separate steel, mining, ferroalloy, and other divisions, is interpreted by some industry sources as a defense against a takeover. Others view it as making Mechel’s steel assets cheaper for a state steelmaking company to acquire, and easier for Zyuzin to let go.

There is no explanation from the company as to why the group’s coal and iron-ore mines are located in the mining spinoff, while chromium and nickel mines are in the ferroalloy unit; nor why transportation and electricity supply have been prized apart from steelmaking, the original function of Mechel, Russia’s fifth ranked steelmaker.

Company statements claim the spinoff scheme will “increase management efficiency,” without diluting group control by Zyuzin. Even after separate listings of the spinoffs, “control of the sub-holdings will always remain with Mechel,” investment relations director Alexander Tolkach has announced.

In all, the Mechel Group — in 2003, the first of the Russian steelmakers to list abroad (and the only one on the New York Stock Exchange) — generated $6.7 billion in revenues last year. Steel sales outside the group amounted to $4.3 billion, or 64% of the aggregate. Mining revenues amounted to $2.4 billion, or 36% of total. Sales of coal and iron-ore inside the Mechel group were worth $712 million for the year; that is 39% of mine revenues. The power generating division reported $599 million worth of revenues, just 16% of which went to other parts of the group. But unlike the other profit-making divisions, power recorded a $13 million loss for the year.

In terms of profitability, calculated as the Ebitda margin, mining is the most lucrative of the group’s businesses with a 39% margin, buoyed by coal and iron-ore prices. Steelmaking generated a margin of 25%; power, just 4.5%.

One clue to Zyuzin’s priorities is the surprise announcement that his chief subordinate is being moved out of the second spot in the group to the top spot in one of the spinoffs. Alexander Ivanushkin — a Mechel veteran since Glencore controlled the Russian steelmaker in the mid-1990s, and the Mechel group’s chief operating officer since 2004 — is being moved to become chief executive of the newly formed Mechel Ferroalloys group, and its management company. This unit consolidates the recently acquired Tikhvin Ferroalloys Plant, the Bratsk Ferroalloys Plant, and Yuzkuralnikel, the mine source for Mechel’s stainless steel production line.

In March, Zyuzin paid $1.5 billion for Tikhvin and other chrome assets of the Oriel Resources group. An independent IPO for the new ferroalloy group is being considered, Mechel says. Notwithstanding, the span of control and value of assets under Ivanushkin are significantly smaller in his new job than in his previous one.

Mechel Mining has also been established as a separate sub-holding of the group. It will consolidate Mechel’s coal and iron-ore mining assets, plus a limestone quarry. A November target date has been suggested by Mechel officials for a London IPO of this group of assets. In 2007 Mechel mined 21 million tonnes of coal, half coking coal, half steam coal. With its new acquisitions in Yakutia, this unit is planning to build production up to about 60 million tonnes per annum, making one of the largest coal sources in Russia. In late 2007, market valuation of the mining division was estimated at between $7 billion to $9 billion.

The new chief executive of Mechel Mining is Igor Khafizov. Most recently, he ran the Yakutugol coalmine in fareastern Sakha. Before that, Khafizov ran Mechel’s YuzhnyKuzbassUgol coalmines, and also the Korshunov iron-ore complex. In Khafizov’s place at Yakutugol, the new chief executive is to be Vladimir Dronov, a coalmining specialist.

The Zyuzin plan also calls for the spinoff of an energy division, incorporating power plants serving the Kuzbass mines. The final spinoff is to be a ports group, which includes Posyet, on the Sea of Japan, two river ports in western Russia, and a coal export terminal in the fareast.

Reports of interest on the part of RSS, headed by Sergei Nosov, in buying the Mechel steelmaking assets have been circulating for more than two years. Mechel is Russia’s dominant stainless steelmaker, with plans to raise the volume of its stainless output to a 50% share of the country’s stainless cold rolled market by 2011.The company produced 36,000 tonnes of hot rolled stainless coil in 2006; about 15,000 tonnes were converted to cold rolled stainless.

The prospect of a state takeover appears to have been one of the factors that encouraged Zyuzin’s former co-partner, Vladimir Yorikh, to sell out his stake in 2006-2007. Yorikh earned $1.5 billion from the sale of his 42% shareholding. Had he not been impelled to exit, and waited for the current market capitalization of the group at $17 billion, Yorikh’s stake would now be worth five times as much.

Although Mineweb has been able to corroborate the negotiations between Mechel and RSS, Nosov has so far been reluctant to acknowledge his plans — or the price his state-owned entity may be able to afford to pay. By creating sub-holdings, and divesting the non-steel assets from Mechel, Zyuzin may be making Mechel Steel more accessible to Nosov, but at the same time stripping out much of its market value as a mining company. An assistant to Nosov said he was unavailable to comment.

Since privatization began in 1991, Russia’s steelmakers have protected themselves from hostage-taking and hostile takeover by vertically integrating control of coal, scrap, and iron-ore supplies, as well as export outlets at the sea. The plan of Mechel’s breakup is thus unprecedented.

Mechel spokesman Pavel Talan refused to clarify Ivanushkin’s job transfer. He declined to comment on whether this represents a demotion; a restructuring of value inside the Mechel asset group; or a defence of the steel group by removing the raw materials and alloys, on which the specialty steel production line depends.

Steel analyst Lev Chesalov told Mineweb: “It is unique for such a structure to be created. It is clear in the case of the mining unit, for it may be traded with higher share and asset value if it is listed and its shares sold as a separate unit. As to ferro-alloys, I simply don’t know. Maybe this is a defensive scheme. Another question is how will the split of the company impact on the market capitalization.”

The Russian stock market cut Mechel’s share price by 7% in Monday trading, after the job appointment notice appeared. The price has fallen 11% in value since it hit its high for the year of $45.80 on May 7.

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