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By John Helmer in Moscow

LSE regulators and US government investigations trigger strategy differences on getting Rusal to market.

US and European banks are fighting among themselves over the terms of the proposed initial placement offering (IPO) of shares of United Company Rusal, the Russian owned bauxite miner and world’s no.2 aluminium producer.

The conflict between the bankers, and between shareholders in Rusal, is so intense, the Financial Services Authority (FSA), regulator of the UK market and the London Stock Exchange (LSE), has already appointed a team of specialists to analyse the disclosures, litigation, and lobbying documents that have been presented by advocates for and against Rusal, and its controlling shareholder, Oleg Deripaska.

A source with access to recent meetings in London between Rusal advisors and UK regulators told Mineweb that this month there was a discussion of a multi-billion dollar set-aside to assure investors that the legal contingencies Rusal is facing can be met, if the company and its shareholders lose out in court.

The set-aside or contingency reserve is proposed to be reported in its IPO prospectus by Rusal, and booked in its financial accounts, to cover the company’s liability for a multi-billion asset claim by Michael Cherney. Last November, in the UK High Court, Cherney lodged an initial claim that he owns 20% of the older Russian Aluminium company, which merged with others to form UC Rusal in March of this year.

With a target market cap of $30 billion, the proposed Rusal IPO is one of the London market’s largest; no date has been announced yet, and a November target date appears to be slipping.

Wholly owned by Deripaska (66%), Victor Vekselberg and his partners (22%), and Glencore, a share placement of about 25% is the target. Deripaska is not selling any of his shares, according to one of the IPO planners; but no decision has been reached yet on whether the full 25% placement will be through issue of new Rusal shares (which would dilute Deripaska to just above 50%); or whether Vekselberg and Glencore will sell part of their shareholding.

Morgan Stanley is advising Deripaska to list Rusal as a general depositary receipt (GDR); legally, this requires a relatively low level of disclosure, and limits the bank’s liability to new shareholders if asset problems are proved in court. Other banks engaged favour a mainboard LSE listing. Mineweb has already reported a bitter conflict over this issue; it is one of the clues to conflicting ambitions over whether Rusal will be preserved as the Russian national aluminium champion; or pass out of Russian control, allowing Deripaska and Vekselberg to become minority stakeholders of internationals like Xstrata, in a fresh round of global aluminium consolidation.

In addition to Morgan Stanley, banks participating include Goldman Sachs, JP Morgan-Cazenove, Deutsche Bank, and Credit Suisse. Goldman Sachs is quietly claiming credit for lobbying in Washington for the US government to lift the revocation order on Deripaska’s visa to enter the US. After a decade in which Deripaska was barred, the visa was issued in 2005, and then revoked in 2006. Goldman Sachs has told US officials that Deripaska plans to invest billions of dollars in North America, notably through a tie-up with Magna, a Canadian auto parts supplier to US car companies. Goldman Sachs boosters in the Deripaska camp claim the visa ban was the result of an FBI investigation, and this will be lifted shortly. There will be special conditions, Mineweb was told, including a multi-billion dollar investment commitment. “What’s so strange about that?”, commented a source close to the situation. “US visas cost money — everyone has to pay for them. Oleg Deripaska is promising to pay more.”

The US Government investigations of Deripaska to date have helped confirm allegations in the Cherney case that he was the initial owner of the aluminium smelters which have been consolidated in several stages into the new Rusal. The evidence of an ongoing business relationship between the two, Deripaska’s indebtedness to Cherney, and UK legal jurisdiction for disputes arising out of shareholding and loan agreements the two men have signed has been reviewed by US law enforcement officials. They are also being considered by the UK Listing Authority (UKLA) at the FSA.

Deripaska denies a business relationship with Cherney, and claims he owes nothing to him. This person,” Deripaska told the Financial Times recently, “had no relation to my business.” Rusal claims that, whatever the position may be between Deripaska and Cherney, the company is not liable. Cherney’s lawyers contend that Rusal chief executive Alexander Bulygin is as tied to Cherney as Deripaska, and that Rusal is liable in Deripaska’s schemes of arrangement.

New court filings in the London High Court are expected, extending Cherney’s claim against Deripaska and the Rusal group of companies. Altogether, counting Cherney’s 20% stake of Deripaska’s holding in Rusal, plus past-due dividends, his share of the proceeds of a Rusal plant sale to Alcoa (2005), and repayment of a $150 million loan, Cherney is owed more than $5.1 billion. Bank advisors to Deripaska, led by Morgan Stanley, have reportedly proposed to ease the complications of the Rusal listing by establishing a reserve fund of between $3 billion and $4 billion to cover the legal contingencies facing Rusal. A source privy to the discussions said the reserve figure was originally set at about $1 billion, and it may be raised again to $6 billion.

Rusal said this week it expects to boost aluminium output 65% over the next five years through capacity expansion. Alumina output by Rusal will grow 66%, a company executive added. The firm currently turns out 4 million tonnes of primary aluminium per year and 11 million tonnes of alumina.

Analysts have told Mineweb that at the current spot price of $2,458, the aluminium should fetch about $10 billion, while the alumina should contribute another $3 billion to annual revenues; the estimated total for revenues in 2007 is between $12 and $14 billion. In a presentation to investors in London in June, Rusal provided limited financial data. It claimed sales in 2006 amounted to $13 billion, and Ebitda $5 billion. In 2005 Deripaska’s wholly owned Rusal, the company claimed, revenues were $6.5 billion, Ebitda $2.2 billion.

As purely private companies, however, the old and the new Rusal are black boxes. The old Rusal, according to evidence gathered in Swiss, US, and other litigations against it, was a shell controlling mines, refineries, smelters, and the shipment of metal through dozens of companies, controlled by Deripaska, but legally separated from him and from Rusal itself. A banker to the IPO has told Mineweb that when the prospectus is issued, the financial reports will show consolidation of all these production, transport, and trading companies.

The same banker also told Mineweb that after consolidation, Rusal will be marketed to investors unencumbered. If there were to be a claim, such as Cherney’s, the source argues, then it will be against Deripaska, not against Rusal. No matter what Deripaska’s financial liability may be, the argument is that Rusal has no exposure or risk of liability. The banker told Mineweb he knows of no discussions, proposals, or agreements with UK regulators over a legal contingency set-aside. Lawyers in London familiar with Cherney’s case say the averred evidence indicates that consolidation of Rusal was financed by Cherney, and Rusal’s current and future shareholders are liable.

Putting distance between Rusal and Deripaska is also politically problematic for Deripaska at home. For Kremlin support of the merger between Deripaska’s Rusal and Vekselberg’s SUAL last year was contingent on preservation of the new Rusal as a Russian aluminium company, paying taxes to Moscow, even if it is registered in Jersey. Financial advisors to Vekselberg have told Mineweb that he, and his US-based partner Len Blavatnik, may sell out entirely.

That would leave Cherney, who is as Russian as Deripaska; sources have reported President Vladimir Putin as commenting that he can’t see the difference between the two. Deripaska himself said recently about his shareholding: “If the state says we need to give it up, we’ll give it up.” If Deripaska thinks he has negotiated a concession deal with Putin to retain a 50%-plus stake in Rusal, after the IPO, and that will suffice to ward off Cherney, as well as a change of Kremlin-favoured proprietor, his bankers’ strategy for reassuring foreign sharebuyers should have set off alarm bells in the Kremlin, where there are suspicions of the promises that have offered the US in exchange for Deripaska’s visa. In the past, Deripaska has managed to beat or buy off government or parliamentary attempts to end the use of Rusal as an empty Russian shell, while its profits were transferred offshore. An LSE listing, along the lines advocated by JP Morgan, or the GDR strategy favoured by Morgan Stanley, lead offshore in the same direction.

Mineweb has already reported on efforts the IPO advisors and lawyers are making in Moscow to secure a written undertaking from the Kremlin, assuring investors that Deripaska will not be displaced. An assurance like that is unlikely. But if it is granted, and then circulated in the market, it would confirm the very link bankers are trying to deny between Deripaska and Rusal. A link as solid as the bankers are asking the Kremlin to confirm makes the liability of Rusal and Deripaska to Cherney jindissolubly joint.

If the Rusal listing materialises, it will generate fees for the participating banks of at least 40 million pounds. The inducements are blindingly large for the investment bankers involved. For Morgan Stanley, however, the risks of being judged at fault by the market are growing. According to a joke circulating among bankers in the City of London, “when I say no, Morgan Stanley says no problem.””

Two well-known Russian IPOs in the City – the Evraz steel company’s listing in June 2005, and the PIK real estate company listing in June 2007 – have exposed the fact that Morgan Stanley either did not know, or omitted to disclose, that key assets, on which the two companies were valued and shares sold, were problematic. Mineweb reported in detail on the problems at Evraz, where shares were sold by the controlling shareholder, Alexander Abramov, although as High Court filings alleged, these were held in trust for someone else. Bankers involved, including sources within Morgan Stanley, have told Mineweb that the bank quietly withdrew from the Evraz share sale. Abramov settled the claim out of court.

More recently, Morgan Stanley helped draft the prospectus for PIK, in which the most valuable asset in the company’s real estate portfolio turns out to be the subject of criminal prosecution, initiated by the Mayor of Moscow, with action suspended subject to a range of covenants that do not permit PIK to develop the site. Morgan Stanley’s London office was asked this week: what did the bank know of the transaction history, prosecution files, and city covenants relating to the land and development assets of the Krasnopresnensky Sugar Refining Factory (KSRZ), the single most valuable asset in the PIK portfolio issued with the circular and included in the accompanying asset valuation report by CB Richard Ellis (page 33 — No. 7, Matulinskaya Street). How does Morgan Stanley explain non-disclosure of this information material to investor assessment of PIK?” The bank refused to answer.

Morgan Stanley was also asked about its role in promoting the Rusal sell-off and its assessment of the Cherney claim on Rusal’s assets. Michael Wang, executive director for Morgan Stanley’s corporate communications, was asked: “Will you confirm that Morgan Stanley has now accepted the requirement for a set-aside in relation to the ongoing litigation, and what value Morgan Stanley believes is appropriate?” He said the institution will make no comment.

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