By John Helmer, Moscow
Igor Zyuzin (right) is almost entirely dependent on the Russian government for the solvency of his Mechel steelmaking and coalmining group. With between $9 billion and $10 billion in debt, Zyuzin, who owns 65.49% of Mechel’s shares and controls the company as chairman of its board, is now the steel and coal sector’s most heavily indebted proprietor. If not for a series of cash loans, bond purchases and guarantees from state-controlled banks – Sberbank, VTB, Gazprombank, Eurasian Development Bank (EDB), and Transcreditbank – he would be bankrupt.
That is, Mechel, with a bottom-line loss last year of $1.7 billion, would be as bankrupt as the Estar group of steelmills, which Zyuzin took over in 2009, when Estar’s proprietor Vadim Varshavsky went bankrupt. Varshavsky was consigned by state officials and the state banks to go belly up for debts of about $3 billion. Zyuzin has been preserved in his place for three times that debt. He has also been permitted to buy Varshavsky’s old assets at a fraction of their value, using tolling schemes which may be considered asset stripping, a form of larceny, outside Russia — if their terms were known. In other words, Varshavsky’s insolvent steelmills appear to be paying Zyuzin to take them over for Mechel.
The more state debt Zyuzin racks up, the richer in assets he seems to grow. The company admits there may be a conflict of interest in this arrangement.
Mechel, one of the very few Russian companies to be listed on the New York Stock Exchange and subject to the US regulator, the US Securities & Exchange Commission (SEC), acknowledges in its latest SEC filing: “We have also engaged and will likely continue to engage in transactions with related parties, including our controlling shareholder, that may present conflicts of interest, potentially resulting in the conclusion of transactions on less favorable terms than could be obtained in arm’s length transactions or transactions that may expose us to risks outside the ordinary course of business…Thus, our controlling shareholder can take actions that you may not view as beneficial, and as a result, the value of the shares and ADSs could be materially adversely affected.”
By keeping details of related-party, especially Zyuzin’s transactions with Mechel from public report, Mechel shareholders are obliged to take this risk – in the dark. Mechel’s bankers are also invited not to look too carefully. But they reckon they don’t have to, so long as the Kremlin guarantees to cover Zyuzin’s mistakes and pay Mechel’s obligations.
In order to ward off default notices from its lenders, Mechel agreed with VTB earlier this month on a 5-year Rb40 billion ($1.3 billion) credit, the terms of which allow for an initial 15-month grace period in which nothing has to be repaid. In other words, the state is giving Mechel the cash to pay the debts its commercial lenders insist on receiving this year, and postponing the time Zyuzin must repay the state in return.
This is difficult to explain to shareholders who watched as the price of their shares fell 6% this week, on release of Mechel’s Form 20F annual report  to the US Securities and Exchange commission (SEC).
Since Mechel shares hit this year’s peak of $7.40 on January 7, they have fallen 49%. The market value lost has been $1.5 billion. At the moment, the New York stock market thinks Mechel is worth $1.57 billion. It’s obvious that with debts of almost six times that number, Mechel is worth much, much more to its banks than to its shareholders. But because most of the Mechel debt is held by state-controlled banks, and they control the repayment terms, the reality is that Mechel has been nationalized.
6-MONTH SHARE PRICE TRAJECTORY FOR MECHEL
According to the latest Mechel financial report released this week, the five state banks hold about 53% of Mechel’s rouble debt equivalent to $5.4 billion; 50% of its dollar debt of $3.3 billion; and 17% of its Euro-denominated debt equivalent to $639 million. The proportion of Mechel debt held by the state-controlled banks is in fact higher, because the calculation should include the credits contributed by VTB subsidiaries in Austria, Germany and France which are participating lenders in the $2 billion syndicated loan of September 2010. Rouble bonds worth about $2.4 billion also benefit from state bank underwriting and repayment guarantees.
Varshavsky’s tale was told here . Whatever has persuaded state officials and state bankers that Zyuzin is more honest and competent than Varshavsky is, however, not an issue that is permitted to be examined in public, no matter how much in state money is committed to keep Zyuzin in full control of Mechel.
Zyuzin, with approval from the federal government in Moscow, regional governors, and state banks, has loaned large sums of money to Estar steelmills for raw materials like coal, iron-ore, ferroalloys and scrap, along with semi-finished steel, all produced by Mechel, the book cost of which has been exaggerated in tolling agreements. In practice, Zyuzin has been slowly taking over the Varshavsky assets by creating debt beyond the capacity of the mills to pay. As the small print of Mechel’s Form 20F, the SEC’s required annual report filing, explained for 2011: “According the loan agreement, in the event that the loan is not repaid at maturity (September 30, 2012), the Group is entitled to enforce the pledge over the pledged related metallurgical plants assets and thereby take control of these assets subject to approval from the Russian Federal Antimonopoly Service.”
In November 2011, when the receivables or debts owed by the Varshavsky mills to Zyuzin came to $1.06 billion, Mechel loaned $944.5 million, and then extended the maturity date for repayment (aka takeover) to June of 2013. Varshavsky’s assets have so far paid off $213.4 million, so the default amount is about $731.1 million.
Another example of the way Zyuzin adds assets to the nationalized Mechel, but keeps secret how the transactions are funded, and who pays, is the purchase last December of Vanino port, on the Sea of Japan. After years of controversy  over the privatization of the state’s control stake in the port, and competition from oligarch groups including Vladimir Lisin’s United Cargo Logistics Holding and Oleg Deripaska’s EN+, Mechel emerged the victor.
Mechel’s report to the SEC this week says: “On December 7, 2012, the Group won an auction to acquire 74,195 common shares (73.33% of the total common shares or 55% of the total shares) of Vanino Sea Trade Port OAO (“Port Vanino”), the largest seaport in Khabarovsk Krai, located in the Tatar Strait in Russia, for 15.5 billion Russian rubles ($501,444  as of the auction date).”
But Mechel, which didn’t have $501.4 million in cash and wasn’t allowed by its banks to borrow the money, managed to pay for the port acquisition by selling it to somebody else. Again, according to the Form 20F disclosure, “on January 9, 2013, the shares of Port Vanino were transferred and the Group made a cash payment of 15.5 billion Russian rubles. On the same date, 72,780 of the acquired shares were sold to several Russian and foreign investors (“Investors”).”
This took care of the state stake in the port. The minority shareholder in Vanino, Deripaska, was then bought out, according to the following scheme. “On January 28, 2013, the Group acquired additional 21,892 common shares (21.64% of the total common shares or 16.23% of the total shares) and 16,039 preferred shares (47.56% of the total preferred shares or 11.89% of the total shares) of Port Vanino from a minority shareholder. The aggregate consideration for the preferred shares was 275 million Russian rubles ($9,152) and was fully paid. The maximum aggregate consideration for the common shares is 4.77 billion Russian rubles ($158,817) which is to be paid by October 2013. The Group has an option to sell and to require one of the Investors to buy 22,707 common shares and 16,039 preferred shares for the maximum aggregate price of $174,611. The option can be exercised by October 2013.”
End result, for the record: “The purchases resulted in 23,307 common shares and 16,039 preferred shares being held by the Group. These shares represent 29.2% of the total share capital of Port Vanino, or 23.04% of the total common shares, which enables the Group to have significant influence over the operations of the investee. This acquisition will be accounted for using the equity method of accounting and will be included within long-term investments in related parties as of January 28, 2013.”
End result, in practice: Mechel has operational control of Vanino, and formal control of 29% of its capital, 23% of its shares. But it hasn’t paid the $669.4 million price tag. Instead it paid a handful of cash, and arranged with “Russian and foreign investors” to pay the rest.
If it turns out that these investors are Zyuzin and his Cyprus companies, whose assets are Mechel’s, and they are in turn pledged to secure state loans, then the scheme is a subterfuge, and the port privatization was an elaborate fake. If it turns out that some of the foreign investors are South Korean or Japanese coal buyers and traders, whose interest in the port is in getting more coal cargoes at a discounted transportation tariff and perhaps at a discount to the coal price benchmark, then Mechel’s future revenues are being charged for the asset. Either way, Mechel is in effect borrowing to buy the asset with trade receivables from related parties.
Such a scheme looks like a loan covenant breaker for the banks, and a charge against future net income from which shareholders have been hoping to be paid dividends. In short, a secret worth Zyuzin’s while to keep to himself. Mechel’s disclosure to the SEC is this: “In addition to the information disclosed with respect to this acquisition, ASC 805 requires the Group to disclose the amounts to be recognized at the acquisition date for assets acquired and liabilities assumed. It is impracticable to disclose this information because the Group has not completed the purchase price allocation as of the date when the financial statements were available to be issued.”
When the deal for Vanino was first announced, Barry Ehrlich of Alfa Bank, a leading steel analyst in Moscow, acknowledged that having the port under control for its expanded coal exports was a good thing for Mechel, but the extra debt would be a bad thing. “Overall payment for Vanino may total RUB21.1bn (~$650m). As of the end of 2Q12, Mechel had $8.7bn of net debt on the balance sheet and net debt to EBITDA ratio of 4.4x. Leverage is a major concern for the company, and we believe the news is NEGATIVE for Mechel if the acquisition would result in cash outflow from the company and further inflate its stretched balance sheet.”
“The news suggests that Mechel already has certain arrangements to sell the 25% stake in Mechel Mining and that it may finance the Vanino acquisition from that cash flow. The news may also suggest that one of the conditions for the MM [Mechel Mining] stake acquisition was acquisition of the port in order to secure shipping capacity to facilitate Elga coal exports to Asian markets. The buyer of the mining stake may provide long-term financing for the Vanino acquisition.”
In retrospect , it can be seen that the Mechel Mining sale has yet to materialize – not to the Koreans, Japanese or Chinese. Another Russian state entity, Vnesheconombank (VEB), may turn out to substitute for the foreigners and by another loan to Mechel the government will nationalize the asset, rather than let it go.
So has Vanino port been sold to anyone in particular? Who are these Russian and foreign investors?
Privately, Mechel management has been explaining to its bankers the benefits of the Vanino deal, and the strategic relationship between expanding the flow of coal for export from the Sakha republic (Yakutia) mines, adding to the capacity of the state railroad to carry the coal to port, and enlarging Vanino itself for the extra trade. According to one bank analyst, “the management has been highlighting a number of tangible benefits for Mechel of ‘sort of’ owning Vanino, such as the volume guarantee (there is a high competition from coal exporters to access Far East ports); plus Vanino is the end destination of BAM [railroad], and in this capacity acts as a regulator of the cargo traffic, which makes the entire eastern bit of this railroad more flexible to Mechel’s traffic needs; plus Mechel will be saving on port loading charges. Even if Mechel may have agreed on some discount for its coal as part of the Vanino deal, this has to be considered in the context of the benefits they are gaining. Last, but not the least, by buying Vanino Mechel is also saving on its own capex which would go otherwise to expand the capacity of Posiet [port, already owned by Mechel]. Vanino Bay is still better than Posiet as it allows to load larger capacity ships. Expansion of Posiet would have been a must (until they had Vanino) in order to ship all the new coal coming from Elga mine. [Without the Vanino acquisition] to allow expansion of [coalmine] output and target export markets, $2 billion plus in investments in the Sakha mines would be a waste.”
This sounds reasonable. But has Zyuzin told the banks by whom exactly the deal is being paid for?
The five state bank lenders to Mechel – Sberbank, VTB, Gazprombank, Transcredit Bank, and Eurasia Development Bank – were asked the question. They refuse to answer. The following banks, listed in Mechel Form 20F filings as well as in announcements of Mechel loan syndicates, were also asked the question: Unicredit, Raffeisen, ING, BNP Paribas, HSBC, Nordea, Société Générale, Morgan Stanley, Credit Suisse, Royal Bank of Scotland and Natixis. Nordea was the only one to respond. It claims it is no longer in a Mechel loan syndicate.
Analysts at the banks acknowledge there is a blanket of secrecy around Zyuzin’s dealings, which isn’t worth their jobs to probe. According to one, “in the market there are quite different rumours of who the buyers are, starting from a number of Russian names, from [Gennady] Timchenko [for Gunvor’s expanding coal operations] and ending with some Asian companies. And it is possible more than one person, but several. And it is said that it can be Zyuzin himself. But there is no consensus. Mechel itself keeps it in great secrecy; there is apparently no leak.”
Another bank source claims the banks have not been let in on the secret. “In one of the presentations which they [Mechel] showed to banks from whom they take credits, there is no such information. That is, it was written that they are buying a port in the consortium, that they do not require any funding, it does not affect either the covenants — nothing else. But just who exactly [is paying] was not written in the presentation. It may be that [Mechel] opened it to the banks in a private conversation. But it was not in an open presentation for the bankers-lenders. Even there they have not disclosed it.”
A Russian expert on ports says, also off the record: “My sources say that Zyuzin took his money out of the thrift box. That is, it is not the money of Mechel, it is money of Zyuzin’s by almost 100%.”
A well-informed Moscow bank source says he is confident the deal was done by “related party receivables.” He concedes too that there is genuine fear among bank analysts and newspaper reporters to open up what this means. He suspects that Mechel has written down receivables from related parties, meaning Zyuzin companies, and the corresponding amount has then been paid by the Zyuzin companies offshore to acquire the Vanino port shares.
In short, Mechel is lending (or giving) Zyuzin $669.4 million. “The [accounting report] dots”, claims this source, “connect to Vanino”.
Mechel wasn’t asked to disclose what it is keeping secret about the transaction. Instead, it was asked to explain the company’s reasons for not disclosing to the New York stock market and to shareholders the identities of the Vanino port investors, Russian and foreign; and to clarify Mechel’s purpose in the withholding and how it should be understood as compliance with normal corporate transparency standards.
The company promised to work on the request and reply. It hasn’t done so.