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By John Helmer in Moscow

The Moscow and New York stock markets appear to have been taken unawares by the disclosure that Igor Zyuzin’s steel and coal-mining group Mechel is in court over an unpaid demand by BNP Paribas for $60 million. The share price of the fifth-ranked Russian steelmaker rose 1.3% in Wednesday’s Moscow market trading, and 10% in subsequent trading in New York. However, there is no sign that Mechel has informed the US Securities & Exchange Commission (SEC) of the material change in the company’s financial position and asset value, stemming from the court action in Geneva.

This is the second instance in as many months when Mechel has failed to notify the US regulator and US shareholders of material changes. The first, reported by CRU Steel News on February 26, exposed Zyuzin’s acquisition of the West Virginia-based Bluestone Coal for a cash down-payment of $425 million, and the issue of 80 million Mechel preference shares. As one analyst reported what happened at the time, “the money simply disappeared from Mechel’s balance-sheet, without an explanation.”

Zyuzin’s spokesman Ilya Zhitomirsky has refused to clarify the circumstances of the Bluestone Coal deal. He is also refusing to answer questions about the BNP Paribas claim.

Zyuzin is generally believed in the Russian market to have overpaid for previous mining acquisitions — of coking coal deposits in the Sakha region in January 2005, and again in October 2007, for a combined total of $2.7 billion; and of Oriel Resources, a chrome miner and refiner, in March 2008 for $1.5 billion. Following the Oriel deal, transacted at a 90% premium to the prevailing market price, Mechel’s share price dropped 3%.

Today, Thursday, a note from Alfa Bank confirms that Mechel’s trouble with BNP Paribas is connected to this week’s March 20 deadline for repayment of a $1.5 billion loan. That was issued last year to finance Zyuzin’s premium-priced acquisition of Oriel, whose assets are located in Kazakhstan and Russia. According to the report by Alfa steel analyst Barry Ehrlich, Mechel “had a low cash balance at the beginning of the year, we estimate, and then obtained a three-year $1 bln credit line from Gazprombank in February.” Referring to the BNP Paribas debt, Ehrlich said: “We believe this conflict may be related. We also believe that negotiations with the Oriel Resources loan syndicate are still ongoing.”

According to the company website, “Mechel is committed to observing the highest standards of corporate governance.” In December, a company briefing for analysts reported that, with the inclusion of the $1.5 billion loan for the Oriel takeover, net debt as of September 30 was just under $5 billion. According to chief financial officer, Stanislav Ploschenko, “the strong financial results and healthy cash flow for the first 9 months ensured that despite significant debt-raising to finance acquisitions in the last 12 months we faced the current markets with healthy balance sheet and strong debt-service capacity.”

That was the hopeful news. Then Ploschenko admitted that “the Oriel bridge loan matures in the end of March 2009 and we are currently negotiating its refinancing with a number of Russian and international banks with the aim to reach a solution early in the 1st quarter of 2009.”

The note from Alfa Bank, identified by Mechel as one of its Russian bankers, reveals that, despite the bright spring sunshine flooding over Moscow, no solution has been reached to retrieve Mechel and Zyuzin from their chrome-plated black hole. Ehrlich reports: “The major issues surrounding the Oriel Resources loan, we believe, are whether Mechel can obtain an extension or partial extension of the loan, at what rate, for what time period and with what penalty fees. Also under likely discussion are collateral and covenant restrictions, such as those restricting the sale or transfer of company assets.”

This last sentence is a reference to the unwillingness of Zyuzin, the controlling shareholder and chief executive of the group, to pledge his own shares to secure new loans.

Alfa Bank has been identified by Mechel as one of its lead domestic bankers. Other international banks in the original Oriel loan syndicate include ABN Amro, Merrill Lynch, and the Royal Bank of Scotland (RBS), which has subsequently absorbed ABN Amro’s loan book, and acted as agent for the syndicate. The banks aren’t revealing how much of their initial exposure to the Mechel transaction they have sold to others, and so it is not clear which banks are currently exposed to Mechel for the $1.5 billion, and by how much. Mechel isn’t saying.

Ehrlich reports that Mechel may still have the ability to borrow funds from the state bailout bank, Vnesheconombank (VEB). If the default risk is dire, Zyuzin may have to swallow his objections, and pledge his own shares to secure the bailout. “Since it is possible,” Ehrlich acknowledges, “to default on foreign creditors and continue operations under Russian law, whereas a default on a VEB loan would likely lead to the immediate seizure of collateral and/or control over the company, Mechel (and minority shareholders) would strongly prefer to avoid taking out a VEB loan.”

The danger now for Zyuzin and Mechel is that a combination of Russian forces — including, possibly led by Alfa Bank’s shareholders, Mikhail Fridman, German Khan, and Alexei Kuzmichev — may see the opportunity to press Zyuzin to the wall; compel Mechel with the threat of bankruptcy; and commence a takeover of Mechel’s assets. Zyuzin is no stranger to the tactics. Six years ago, his takeover of the Korshunovsky iron-ore mine took advantage of the latter’s inability to meet its liabilities to the state, and converted that bankruptcy into shareholding and management control. This proved strong enough to fight off a fierce assault by rival steelmaker, Evraz.

Alfa Bank has already demonstrated the new asset attack strategy by defying an international bank syndicate’s standstill agreement with Oleg Deripaska’s holding Basic Element and United Company Rusal. Last month in Jersey, an Alfa subsidiary obtained a court order for assets under the Deripaska group’s control. That, an Alfa Bank executive acknowledged, was just “the first step”. He added; “We are ready to restructure. The options to repay the debt are far from being exhausted.”

As CRU Steel News has reported before, Alfa’s options for Mechel may include acquisition at a distress price, followed by resale at a lucrative margin to the state conglomerate, Russian Technologies, controlled by Sergei Chemezov. For several years now, Chemezov and his subordinates have been eyeing Mechel’s specialty steel units for inclusion in their subsidiary, Russian Special Steel (Russpetsstal). The acquisition was blocked, however, for as long as Mechel’s share price and market value remained high on the price of steel and coal.

For now Ehrlich reports the possibility “that Mechel will be unable to reach an agreement with the Oriel Resources syndicate. While the likelihood of an imminent default situation (syndicate demands repayment and a VEB loan is not available) is probably low, the risk to the stock in this scenario is considerable – the stock could easily fall below $1, in our opinion. On the other hand, Mechel’s stock will probably rally should a significant extension of the Oriel Resources loan be announced.”

If a takeover is under way and Zyuzin’s shareholding is the target, then the readiness of the state lenders to hold back from, or agree to, the Oriel loan refinancing this week should reveal it. In addition to VEB, these lenders have been identified in Mechel documents as Vneshtorgbank (VTB), the state savings bank Sberbank; and Gazprombank.

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