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By John Helmer in Moscow

Silvinit, until now a second string potash producer, challenges Uralkali, with state help.

Until recently, Silvinit, a major Russian potash miner, appeared to be playing second-fiddle to its larger, and financially more powerful mining neighbour in the Urals, Uralkali. But in the hungry Russian resource market, with potash’s accelerating value multiples in the commodity and share markets, the fiddler can wind up being on the menu to be eaten — and that appeared to be the direction in which Silvinit was headed.

One takeover candidate was Uralkali, which listed its shares in London in October, and has since seen its market capitalization rise to $11.4 billion — more than double its listing target. Uralkali is controlled by Dmitry Rybolovlev. In October 2006, Uralkali had announced an IPO plan for the sale of 21% of its shares, offered at the time at $2.05-$2.45 per share. This past October, the company placed 12.75% of its stock at $3.35/share. The current price ranges between $5.35 and $5.75.

For Silvinit, the second apparent bidder was the state-owned Gazprom spinoff, Sibur-Mineral Fertilizers, a unit of the Sibur chemicals group. Mineweb reported their strategy in September:

http://www.mineweb.com/mineweb/view/mineweb/en/page675?oid=27244&sn=Detail

Since then, however, sources at Gazprom and Sibur-MF have acknowledged they must pull in their horns; that is to say, they are re-aiming their asset acquisition plan at targets they can afford. For the time being at least, this means sticking to nitrogen fertilizer assets, which process natural gas and convert ammonia. Even they have been expensive, difficult, and slow to pick these off. This month, Dyed Moroz (“Father Frost”, the Russian Santa Claus), will be visiting the potash and phosphate miners with a reprieve, not with an offer they can’t refuse.

This has taken some of the heat off Silvinit, but not all. For it remains vulnerable to takeover pressure from Uralkali’s direction. The accumulating cash reserve and borrowing capacity of Uralkali is one form of pressure. Silvinit’s dependence on the Russian railway company RZD to build a new spur line, avoiding ground subsidence near its mine, is another. And then there is the contest with Uralkali and others for new potash mine prospects and licences, to be awarded soon by the federal Ministry of Natural Resources.

To ward that off, Silvinit has struck an alliance with a powerful state business figure, Sergei Chemezov. He controls Rosoboronexport (“Russian Defence Export”), the multi-billion dollar arms export monopoly. The first announcements of their alliance indicate that ROE subsidiary Oboronimpex has agreed with Silvinit to form a joint venture for the production and processing of carnallite, the main raw material for magnesium production.

Carnallite is a mineral usually found in combination with potassium (potash). It derives its name from a Prussian mining engineer, Rudolf von Carnall, who first described it at a potash deposit in Germany in 1856.

Oboronimpex is the controlling shareholder of Russian titanium and magnesium producer VSMPO-Avisma, which consumes carnallite from Silvinit. After Uralkali lost its Mine-1 to flooding in 2006, Silvinit remains the only Russian producer of carnallite, which is used for titanium sponge, as well as magnesium production. But stocks of mineable carnallite at Silvinit’s current mine will run out shortly. Silvinit has a 45% stake in the new JV with Oboronimpex, called Kamskaya Mining Company (KMC).

KMC plans to produce carnallite at the Polovodovsky site of the Verkhnekamskoye deposit. Polovodovsky has estimated carnallite reserves of 600 million tonnes. But for Silvinit to mine and deliver the carnallite Oboronimpex needs for VSMPO, it must win the government’s auction for Polovodovsky — and that’s where Uralkali and other rivals step in.

And it’s not the carnallite that really counts in this contest. Carnallite is designated as a strategic mineral for titanium production, which in turn is strategic for the country’s military industrial and aerospace complex. Carnallite prices are regulated by the government, as Silvinit is the monopoly producer in Russia; and revenues from carnallite sales were worth just $9.2 million to Silvinit last year. “We do not believe there will be any significant increase in this part of revenues,” reports Marina Alexeenkova, an analyst with Renaissance Capital in Moscow.

Revenues for Silvinit this year, calculated according to Russian accounting standards, are projected to be $900 million, and $1.3 billion next year. These numbers compare with $675 million reported in 2006. Costs are rising more slowly. Net profit is expected to jump 49% this year to $178 million, and 96% in 2008 to $520 million.

The company’s recorded shareholding structure indicates that 86% of the common stock is controlled by 7 shareholders. Most are controlled in turn by chief executive Pyotr Kondrashov. A 20% stake in Silvinit is controlled by Uralkali’s Rybolovlev. Alexeenkova reports a free float of Silvinit shares amounting to 10.5%; an identified management stake of just 4%, with German and other offshore nominee holders of 77.5%; and a stake of the Acron holding, a multi-chemical fertilizer rival, of 8.1%. This is reported to be in negotiation for sale to Silvinit’s controlling shareholders. According to Alexeenkova, Acron has proposed to management the provision of support for an international listing by Silvinit. This includes the production of IAS figures and management participation in investor meetings. “However, management states that there are no plans to sell shares in Silvinit, nor any plans to undertake an international listing.”

A report, just released by Rencap, suggests it is backing the Silvinit alliance to win over Uralkali for the new mines. It recommends that it’s time for punters to start buying Silvinit on the expectation of victory.

By contrast, Alfa Bank analyst Royel Stewart warned in September: “stronger firms with closer political connections pose a risk to Silvinit. Competitor Uralkali is determined to obtain the licenses for the remaining plots in Solikamsk, and Sibur Fertilizer is interested in acquiring Silvinit outright, possibly at below market value. We are not convinced that Silvinit can overcome these troubles.”

According to Alexeenkova, the upside for Silvinit’s market capitalization, currently at $5.4 billion, is almost 40%. She reports: “Silvinit remains one of the cheapest of the top-six producers globally. Silvinit has performed strongly, adding 109% to its market capitalisation since the beginning of the year. Performance has been driven by potash price upgrades in Silvinit’s key markets. The main reason for the relatively high discount of Silvinit to international peers is the company’s low level of transparency. Silvinit does not disclose its ultimate shareholders or its export prices with customers, and does not consolidate its marketing unit. The stock remains illiquid. The lack of IAS figures and a transparent business model make Silvinit a less attractive play on the potash market from an investment point of view. At the same time, the exclusive club of potash producers is very restricted. Accordingly, we expect the company to increase its market value, due to the unique demand/supply situation in the global potash industry. We expect the sector – and Silvinit in particular – to show positive dynamics.”

But the key assumption powering the RenCap forecast is that the Silvinit-Oboronimpex alliance will win the new licence auction. And with those new resources, Alexeenkova argues, Silvinit’s increased potash production capacity will be assurred for years to come. Its share price can thus comfortably ride on the back of the potash commodity price, just as Uralkali’s is doing.

Yury Trutnev, the Natural Resources Minister, who previously ran the Perm region as governor, where both Silvinit and Uralkali mine, announced the auction in November. But he didn’t set a date. Silvinit has tried to limit open bidding, proposing instead a state review of rival project plans which it expected Chemezov to dominate.

That option has been rejected. Andrei Belokon, a spokesman for the regional licensing agency Permnedra told Mineweb: “There are three areas: Polovodovsky, Talitsky and a third, which has two areas – Palashersky and Balakontsevsky. The documents for the auction were sent to Rosnedra [in Moscow], and now it is for them to issue the auction. We have also already formulated the contest rules – it will be an auction, not a contest of projects.”

Alexeenkova is skeptical of the Silvinit group’s project proposal. “The founders of KMC plan to build a 0.5mnt-capacity plant at Polovodovsky over the next two years, with a potential investment of $1.5bn. The volume of investments seems very high.”

Uralkali has been building a rival bidding alliance with Kama, a regional oil company affiliate of LUKoil, whose controlling shareholder is Vagit Alekperov. Alekperov is the figure generally credited with lobbying Trutnev from his regional seat to his chair in the federal cabinet.

Several other Russian bidders from the chemical sector have an interest in the bidding, but there is as yet no sign of a Gazprom candidate, or Sibur-MF. There is also talk that BHP Billiton might compete. From the preliminary skirmishing among officials, it is evident that the contest will be driven to the level of the prime ministry, or the Kremlin, before it is decided. That means that the licence award is likely to be deferred until after the presidential election in March.

President Vladimir Putin’s decision to endorse Dmitry Medvedev, his former chief of staff, and currently deputy prime minister, was announced on Monday afternoon. Putin’s future role, and the future of the current Prime Minister Victor Zubkov, remain unclear.

When the political smoke clears, it is uncertain that Trutnev will remain at the Natural Resources Ministry. More certain it is that Chemezov will continue at ROE. Sources at Oboronimpex have told Mineweb in the past that their strategy is to protect their titanium refining and fabricating capacity by acquiring upstream mineable ore assets. These include carnallite, ilmenite, and molybdenum.

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