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By John Helmer, Moscow

There are three golden rules for valuing Russian initial public offerings (IPOs) in the international market.

The first is whether the Russian owners of the shares are taking all of the cash they raise for themselves. The more they take, the greater the business risks for the company they leave behind, and so the less their shares are worth. The other way of putting this is – if the Russian owner or owners of the shares for sale has (have) so little confidence in the future of their business (profits, dividend stream, capital gains, etc.) that they want an immediate cash-out, why should incoming non-Russian share-buyers toss their precious money at them as they wave goodbye? So far this year, Russian IPOs introduced in the London market, whose prospectuses disclose the selling shareholders are not investing any of the proceeds in their company, have either been withdrawn, because the share price has collapsed; or else the selling shareholders have accepted a discount of at least 30% off their target valuation.

There is one peculiarly Russian exception to this particular golden rule. Because ownership is a sometime, somehow thing in recent Russian commercial history, it can happen that those who appear to be the control shareholders of Russian resource companies actually share their stakes with silent partners. The latter are often instrumental in lending the control shareholders money, or protecting them from raiders, or securing them from trouble. And so it sometimes happens that these silent stakeholders are the ones who insist on the IPO, and also demand their entire silent stake in cash. The control shareholders may thus appear to be the sole beneficiaries of the IPO, but they aren’t. Sometimes they are the victims of something that’s quite legal in Russian corporate practice, but might be termed early warning in meteorological parlance, or a shakedown in patois.

The second golden rule is whether the Russian owners of the shares own all of the assets on which enterprise value and share price are based. If the state or a rival Russian (they are often the same thing) owns a large chunk of the equity either directly, or through collateral pledged to Russian banks for heavy debts, then there is a solid chance the prime owners may not be able to hang on to their property. In that outcome, the incoming minority shareholders may be the victims in a sub-market priced takeover. The cleverest of these shareholders may rightly figure that the only investment worth risking in such shares at the outset is to bet on the mendacity of the underwriters and the gullibility of their clients, and go short, betting on the fall of the share price after the IPO.

And the third golden rule is whether the Russian share-sellers are capable of speaking in public and answering a regular factual question in the normal way. Russian share-owners who invite public markets to invest in their businesses but hide their prospectuses, refuse to answer relevant questions, or – if they are members of the Russian parliament – never speak in public do not earn trust, so they don’t deserve it.

In the case of Andrei Guriev (image left), the senator for Murmansk region in the Federation Council, and Vladimir Litvinenko (right), the Rector of the Plekhanov Leningrad Mining institute (aka St. Petersburg State Mining Institute), the control shareholders of phosphate miner Phosagro, the golden calculus adds up to three zeroes.

Today in Moscow Uralsib Bank has posted the following warning: “Funds raised by Phosagro through the IPO will go to the current ownership, as additional shares will not be issued, nor will any treasuries be placed. Such a cash-out is usually perceived as a negative sign by investors, as the business receives no additional funds for development; it can also reflect the owners own uncertainties for the business’ prospects.”

The underwriters engaged by Phosagro for this IPO were disclosed on May 11. They are: Citigroup, Credit Suisse, Deutsche Bank, Morgan Stanley, Merrill Lynch, BMO-Nesbitt Burns, and BNP Paribas for the internationals; and for the Russians, Renaissance Capital (through its Cyprus affiliate); VTB and Troika Dialog. The presence of VTB in the lineup suggests that state bank money may be used to anchor this share sale in the event that international market demand falls short.

One of the underwriting banks has issued this notice, revealing that Guriev and Litvinenko are selling out of private companies registered in Cyprus; note the wording claims the sellers “may include” this group of five. The notice also reveals that no new shares are being sold by the company, so that means all shares sold will come from the control shareholders, and all proceeds will go back to them.

WARNING: DO NOT FORWARD

The information is provided to you because you are either a qualified
non-U.S. purchaser and a permissible recipient (a “non-U.S. person”)
under Regulation S of the U.S. Securities Act of 1933, as amended (the
“Securities Act”) or a qualified institutional buyer (“QIB”) as defined
under Rule 144A of the Securities Act. This communication must not be
forwarded to others.

ISSUER: OJSC Phosagro
SECTOR: A vertically integrated global leader in the phosphate
fertilizer industry

OFFER STRUCTURE: Initial Public Offering
LISTING / TRADING: MICEX, RTS, London Stock Exchange
SECURITIES OFFERED: Ordinary shares and GDRs (30 to 1 ratio, GDRs to
Ords)

INDICATIVE TERMS
DEAL SIZE: Min.US$500m. 100% secondary

SELLING SHAREHOLDERS: A group of the company’s shareholders, which may
include Chlodwig Enterprises Limited, Miles Ahead Management Limited,
Adorabella Limited, Dubhe Holdings Limited and Fornido Holding Limited
LOCK-UP: 180 days for the Company and Selling
Shareholders

CS ROLE: Joint Bookrunner

SELLING RESTRICTIONS: Sales to QIBs pursuant to Rule 144A in the US
Sales to institutional investors under Reg S
outside of the US
Sales to “permitted clients” who are also
“accredited investors” in Canada
Japan: List of 49

INDICATIVE TIMETABLE
INVESTOR EDUCATION: Starts today, 14 June
ROADSHOW/BOOKBUILD: 29 June – 14 July
PRICING: 15 July

On June 14, Phosagro also released this Intention to Float (ITF) document. There is the same coyness in explaining to potential share buyers who is – as distinct from who may be – selling shares.

Phosagro’s financial report for 2010, issued on June 9, is even more reticent. It claims that “the Company’s key shareholders are several Cyprus entities holding between 5% and 10% of the Company’s ordinary shares each. During 2008-2010, the majority of the shares of the company were ultimately owned by trusts, where the economic beneficiary is Mr Andrey Guriev and his family members”.

This wording has not addressed speculation in the London media that Guriev himself may be, or may have been, the trustee for another shareholder; and that the remnants of the old Yukos group, which had once privatized and controlled the Apatit company, the phosphate miner at the heart of the Phosagro group, may remain in the background. There is no corroboration for this. That it is unlikely, given the recent political history, has not eliminated investor curiosity which Guriev has yet to address.

There is also no reference in these releases to Litvinenko’s 10% shareholding. This was not confirmed officially by the company until last week, although there are reports of earlier Phosagro prospectuses identifying Litvinenko as the owner of preferred shares. Litvinenko was chairman of the Phosagro board of directors until last month, when a Norwegian executive, Sven Ombudstvedt, was appointed chairman to pilot the IPO. Litvinenko remains on the board.

The lock-up period revealed for those who are selling now is just 180 days. When United Company Rusal listed in Hong Kong, the control shareholder Oleg Deripaska agreed to a two-year lock-up period for his bonus shares, and the same restriction was applied to others rewarded with bonus shares. Rusal’s IPO underwriters were allowed to bail out more swiftly at 180 days; as were the cornerstone shareholders led by the Russian state bank VEB. A more recent comparison of owner confidence and lockup period is the Yandex IPO on the US Nasdaq exchange. When Yandex offered its shares for sale last month, the control shareholders accepted lock-up periods of one year for one class of their shares, two years for another.

The financial reports of Phosagro are posted on the company website. They make clear that as a group, with output of phosphate and nitrogen fertilizers and related products, 90% of the group revenues (Rb77 billion in 2010, or $2.5 billion) came from phosphates. Phosphates also generated 93% of the group’s total profit figure for 2010 of Rb28.2 billion ($925 million). And of total phosphate sales, 20% in revenue terms – that’s roughly one bag in five — went to a single customer.

Export sales, according to Phosagro’s documents, are not channelled through its own onshore or offshore trading companies. This is unusual in the Russian fertilizer sector. Instead, the company claims, “the group sells its fertilisers outside Russia through large and well-known international traders and distributors. Export sales accounted for 81.9 per cent. of the Group’s fertiliser and feed phosphate sales in 2010, with the Group’s fertilisers and feed phosphate exported to more than 60 countries…. Overall, export sales accounted for 65.1 per cent. of the Group’s total sales in 2010.” Two subsidiaries registered in Switzerland, NW Nordwest AG and PhosAsset GmbH, and one Cyprus company, PhosInt Ltd., are identified in company documents as 100% owned. Their functions are described in group reports as holding “financial assets, including equity and debt instruments of Russian issuers, loans issued, property and cash”. They do not appear to be profit centres for export trading.

The principal source of Phosagro’s phosphate production is the Apatit joint stock company. This is the foundation of the company’s business and profitability. Company documents say Apatit “mines apatite-nepheline ore and produces phosphate rock and nepheline concentrate. Apatit has four operating apatite-nepheline ore mines and two beneficiation plants which process ore from Apatit’s mines and produce phosphate rock and nepheline concentrate.” Company documents also show that Phosagro’s effective shareholding in Apatit is just 58%.

The state owns a 20% stake in Apatit. One of the reasons for selling shares now which Phosagro has given analysts, according to the Uralsib report, is “that such an IPO is needed by the company to get a market valuation of Phosagro’s share capital, so that the holding can participate in privatization of the government’s stake in Apatit through a share swap, or participate in other M&A activity. Besides that, the group currently has no need to raise finance and its debt leverage is negligible.”

This isn’t the place to re-tell the Apatit saga which includes some of the most painful infighting in Russian corporate history. Enough to say that the ownership of the asset is controversial and contested. In April a year ago, one of Phosagro’s Russian rivals, Uralchem, failed to make a convincing case in the London market that the shares it was offering for sale had a stable asset base, and thus a stable value.

Accordingly, Phosagro was asked to say if its place in the Russian phosphate sector is stable, and what the Kremlin’s strategy for the future of the sector may be. Timur Belov, spokesman for Phosagro, replied: “In general the state’s strategy for the mineral fertilizer sector, as well as other key sectors of Russian industry, is aimed at creation of conditions and incentives to encourage their development and modernization. At present, the [Russian] fertilizer industry sees the beginning of the consolidation process. Phosagro is constantly analyzing various options of mergers and acquisitions on the fertilizer market. At the moment, we are not planning such deals, but if we receive proposals interesting to the shareholders and if they are focused on the company development and increase of shareholder value, we will certainly examine and discuss them. The company’s shares, whose market assessment is expected to emerge during the planned IPO, can be one of the payment instruments in such transactions.”

Asked if Phosagro might be a target, or a beneficiary, of a state-directed consolidation of producers of phosphates and nitrogen fertilizers, along the lines of the recent potash consolidation, Belov said: “Phosagro is a phosphate company, and first of all we are interested in the phosphate fertilizer segment. At the moment, Phosagro, as we have already noted, does not discuss mergers and acquisitions, but we need to be fully prepared if there is an opportunity to make a deal profitable for the shareholders and the company development.”

Phosagro’s ITF release itemizes the “key strengths” of the group, including: “the Group’s vertically-integrated business model provides it with significant advantages over its competitors – PhosAgro’s phosphate-based fertiliser production is integrated with mining of apatite-nepheline ore, production of high-grade phosphate rock and production of key feedstocks, including phosphoric acid, sulphuric acid and ammonia.”

The IPO prospectus should also present the risks the group is facing. The June 9 financial report documents (at page 39) tax claims from the federal government totaling Rb13.5 billion ($483 million), but disposes of these as future threats on the ground that rulings of the domestic arbitration courts have been favourable to Phosagro. “In view of the positive court decisions, Group management has concluded that no provision is required.”

But what of the risk that in the privatization of the state stake in Apatit, the Kremlin may opt for another asset consolidator, not Guriev and Litvinenko? Belov said the risk section of the IPO prospectus is still in draft, and for the time being cannot be released because it has not been finalized.

Guriev and Litvinenko have not concealed their concern to boost Phosagro’s chances of winning this privatization and combating domestic rivals. The bid Phosagro made in November of last year for Potash Corporation of Canada didn’t last long; it may never have had the financial capacity to compete. But the announcement of the ambition signalled on the part of Guriev and Litvinenko that they believed they had the backing of Deputy Prime Minister Igor Sechin and the state banks to be the Russian national champion for phosphates.

They fell short of success, at least in Canada. So now in London potential sharebuyers might ask why the attempt was made in the first place – and how the Canadian government overseeing the bidding for Potash Corporation assessed it. For Uralsib, the valuation of Phosagro in a market dominated by the likes of Potash Corporation requires a hefty discount:

The Uralsib report presents several metrics of comparative value for Phosagro, based on an initial target price range of $16 to $21 per General Depositary Receipt (GDR), each ordinary share to represent 30 GDRs. By valuing Phosagro’s assets in a sum of parts, Uralsib claims the company is worth $7 billion. Again, the biggest part of that is represented by Apatit, with a target market capitalization, according to Uralsib, of $3.8 billion in total – making Phosagro’s share worth $2.1 billion. Added to that is the Ammophos unit, the phosphate processor, which is 94% owned by Phosagro. Its target valuation is $$2.9 billion; its share of Uralsib’s consolidated valuation of Phosagro, $2.9 billion.


 

What this means, according to Uralsib, is that “investors previously had access to the phosphorus fertilizer market only through illiquid and nontransparent Phosagro subsidiaries: Ammofos and Apatit. The IPO will provide an opportunity to invest in a more transparent, major, vertically-integrated phosphate holding that covers the whole value chain from apatite extraction and ammonia production to the processing of compound phosphate fertilizers, transportation and distribution. According to our multiples-based valuation, the fair value of Phosagro is $19/GDR, which is in the middle of the announced pricing range.”

At that price, the ratio of the target GDR price in relation to Phosagro’s estimated earnings this year of $844 million (P/E) comes to more than 44. Uralsib’s calculation of the ratio of enterprise value to earnings (EV/Ebitda) turns out to be between 9.6 and 12.7, with a “fair” midpoint of 11. These numbers apparently outweigh the international peers.

As the selling shareholders, Guriev and Litvinenko stand to make between $500 million and $1 billion from the IPO, depending on how many shares are sold and at what price. The numbers have been trimmed back from the 21% bloc of shares originally applied to the Russian regulator for permission to sell. Just how transparent and accountable are the selling shareholders?

This may become clearer when the IPO is released. In the meantime, to supplement the corporate strategy questions answered by the company spokesman, Guriev was asked this test of Golden Rule #3: “as a public officeholder, what do you consider to be have been your most significant act, including vote in the Federation Council, to benefit the public welfare and your region.”

At first, Guriev’s assistant Zinaida Artemyeva said the senator was occupied in St. Petersburg and would need four days to consider his reply. When that time had expired, she was asked to say if Guriev was refusing to reply. She said: “If there hasn’t been a prompt answer, it probably means Andrei Grigoryevich [Guriev] didn’t find the request interesting enough to answer to.”

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