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By John Helmer in Moscow

A lion, who copies a lion, is an ape.

That is Victor Hugo, France’s 19th century poet hero, talking of the difference between writers and hacks. If Hugo had lowered (or raised) himself to think of steelmakers, his remark might inspire sceptical reflection on what is really happening in the deal, proposed last week, for Russian steelmaker Evraz to buy a 79% control stake of Highveld Steel and Vanadium.

According to the official announcement by Evraz, and seller Anglo American, the transaction has been arranged in several parts and several stages, so that the buyer is exposed to the risk of deal failure at a rate of only $169 million at a time, instead of having to put the full deal value of $678 million in Anglo’s bank at the outset. Evraz is understandably sensitive. It is the most heavily indebted of Russia’s steelmakers with obligations totaling $2.5 billion; its profitability this year has been shrinking; and its estimated cash position at end-2005 was $665 million. In addition, Evraz suffered two significant deal failures last year in attempts to purchase manganese assets in Ukraine and the former Soviet republic of Georgia; not to mention rejection in its bid to buy a Ukrainian steelmill; and a near-miss in the bidding to buy a Czech one.

The deal announcement says that Evraz and Credit Suisse will each acquire 24.9% of Highveld’s share capital from Anglo American, and Evraz will have two options of increasing its stake in Highveld if, and after, South African regulators approve the purchase. Assuming regulatory approval, Evraz would be entitled to purchase Anglo American’s remaining 29.2%, as well as the 24.9% held by Credit Suisse through separate option agreements. Should Evraz increase its interest beyond 35% — as the announcement clearly signifies — the company will have to make an offer to all Highveld shareholders. To secure regulatory approval, Evraz is also bound to have to pay for a black empowerment stake in the new scheme of shareholding. However, the price of the first stage suggests that the price on offer to the minorities could be as low, or even lower, than the discount to market which Evraz and Anglo American agreed last week.

Evraz spokesman Nikolai Kudryashov has said the only reason for structuring the deal in this fashion is that it covers the risk of rejection by SA regulators. “If and when we get [approval], we will definitely exercise our stock option,” Kudryashov is quoted as saying. “Then we will be obliged to make an offer to all shareholders.” It has also happened that, immediately after the details of the deal were disclosed, Highveld’s share price collapsed, and more than R1 billion ($138 million) was wiped off Highveld’s shares; the share closed 13.% below the level of the day before the announcement. In Moscow, the reaction was almost as negative. From the day before the Highveld deal was announced to close of business on Monday, the Russian market has wiped 9%, or $841 million, off Evraz’s market capitalization. That is roughly what Highveld is worth; and $163 million more than Evraz is offering to pay for its stake. What do the Johannesburg and Moscow markets suspect about the takeover which remains for SA regulators to investigate?

The South African review is not the only one. The Highveld deal may also trigger a European Commission review in Brussels, although Evraz sources say they are not certain this will be required.

Also, a US government review is currently in progress of Evraz’s proposal to buy a 73% control stake of the US vanadium producer, Strategic Minerals Corporation (Stratcor). That deal, announced on May 1, bought out the management, which had taken Stratcor out of Union Carbide 20 years earlier. The price of Stratcor to Evraz is reported to be $110 million. What might have been an uncontroversial deal for Washington anti-trust regulators may appear in a different light, if Evraz takes control of both Stratcor and Highveld. The last occasion when US Department of Justice regulators analyzed a Russian bid for a US mining asset was Norilsk Nickel’s bid for the Montana palladium producer, Stillwater Mining, in 2003. Norilsk Nickel told the US regulators that, while it controlled about 47% of the global mined output of palladium, Stillwater had just 4%. The acquisition, it argued, would have negligible impact on global competition, and by subjecting Norilsk Nickel to US disclosure requirements, would enhance transparency. The deal was approved.

Expert estimates differ on the size of the global market in vanadium which Evraz is cornering. The estimates differ, depending on the unit of measurement, or the stage of production from ore to slag, and from slag to ferrovanadium, and other products of vanadium pentoxide. Michael Kavanagh, a metals analyst with MDM Bank in Moscow, estimates that Evraz is moving toward a 50% to 60% share of “raw” global vanadium production. Leonid Smirnov, director of the Urals Institute of Metals and the all-Russia expert on vanadium, told Mineweb that measurement is difficult, but he calculates that, if Evraz succeeds in both acquisitions, its global share of the vanadium market will be between 30% and 40%. Irina Kibina, spokesman for Evraz, told Mineweb that whatever methodology of calculation is used, the company believes that the two deals will produce a global market share “not greater than one-third”.

The vanadium market is currently dominated by South Africa, which is far ahead of the others with about 43% of the aggregate in vanadium pentoxide equivalent; followed by China and Russia, with about 20% apiece; all other producers share the balance. US production, including Stratcor’s, has been growing fast. During the recent steel boom, both globally and in China, demand for vanadium jumped ahead of demand for steel, in large part because of its value in hardening steel reinforcement bar (rebar), a key ingredient of the steel used in building construction. From a pre-boom price of around $25 per kg for ferrovanadium, Russian customs data for 2005 indicate that exports of this product to the Rotterdam market were declared at a price of $37/kg. Market reports indicate that the spot price for ferrovanadium reached $70/kg during the year, overtaking the boom pricing of the mid-1980s.

The price is highly volatile, however, and spot has fallen sharply this year. Robert Bunting, a Stratcor executive, described the past quarter-century for vanadium as “a market which has seen long periods of over-supply with uneconomic pricing – together with a few rare spikes driven by strong demand, and production cutbacks forced by uneconomic pricing.”

That Evraz appears intent on playing vanadium roulette is bound to raise questions for shareholders and regulators curious to know who owns the Russian group’s assets; how the current shareholders came by them; and what they intend to do with them. These questions are also being tested in court cases in London, and in two states of the US, where Alexander Abramov, the former chairman, CEO, and principal shareholder, has been accused of asset theft, fraud, and breach of trust. Abramov denies all the charges, and no court has yet adjudicated the claims.

The Evraz group combines three mills in Russia, one in Italy, and one in the Czech Republic; plus three iron-ore mines, as well as coal mines and prospects, and a Pacific seaport. Last year’s results — issued in April — weren’t as rosy as 2004, with revenues up by 9.7% to $6,508 million, but earnings before interest, tax and depreciation (EBITDA) down by 7.8% to $1,860 million year-on-year, and after-tax profit down even more sharply by 23% to $905 million. In the first quarter of 2006, net profit was down 35%, compared to the first quarter of 2005, at the lead mill, Nizhny Tagil Iron & Steel; and down 10% at West Siberian Iron & Steel (Zapsib).

Standard & Poors reports that Evraz is Russia’s most heavily indebted steelmaker, with obligations — before the Highveld sale — totaling $2.5 billion.

According to the IPO prospectus, prepared in London for Evraz a year ago by Morgan Stanley, Evraz “was established by a group of Russian scientists and engineers led by Alexander Abramov.” Three steelmills — Nizhny Tagil, Zapsib, and Novokuznetsk Metallurgical Combine — were bought out of bankruptcy by a group of creditors, who had supplied raw materials like iron-ore and coking coal to the mills; and by traders of its metal, mostly steel bars, rods, rails, and other long products. Squeezed between relatively high prices for inputs, low prices for its products, and pressure from the state railways, the mills fell to new owners. Abramov, according to two other shareholders, was the managerial face of the company. But the two others — Iskander Makhmudov , a copper and coal magnate; and Oleg Boiko, a banker — controlled a majority of more than 60% of the shares. Although they later sold out, and Abramov claimed to have bought their shares, a UK High Court claim, lodged last December, accused Abramov of violating a trust agreement he had with Aidyn Kurbanov, holder of at least 10% in the group. Both plaintiff and defendant remain silent on the outcome of that case.

In a series of parallel court filings in the US and Luxembourg, a group of companies which had owned the Kachkanarsky ore-processing combine — a vanadium-rich iron-ore mine — have accused the Evraz group of stealing their asset. In the IPO prospectus, Kachkanarsky appears to be worth about 20% of the total value of the group, and to be owned directly by Evraz. Its takeover, according to Evraz, was “mediated by an experienced market intermediary, and received from the sellers the limited representations and warranties that are customary in the Russian market.” The court file in the state of Delaware makes more lurid reading. Evraz has responded that “the plaintiffs’ claims against Evraz are without merit.” US judges are still assessing the jurisdictional aspects of the case.

Curiously, when the Kachkanarsky mine’s former owners went to court in Luxembourg last year, lawyers for Evraz claimed their company, registered in Luxembourg and listed in London, was not the owner of the mine’s shares. Rather, they said, it was owned by the mill company at Nizhny Tagil. In a challenge to Morgan Stanley, for apparently misleading IPO subscribers on this point, US attorney Bruce Marks said: “Evraz is either lying to the market or to the Luxembourg court”.

“We believe that these threats are unlikely to lead to serious problems for Evraz. This could be a greenmail attempt by the previous owners,” reported a Moscow brokerage.

One problem which the asset conflicts aroused was the unpublicized loss of interest on the part of Morgan Stanley in running Evraz’s IPO. A source who was involved in the placement told Mineweb that Morgan Stanley effectively withdrew, leaving the share sales to Renaissance Capital, a Moscow investment bank, and Credit Suisse First Boston, the Credit Suisse affiliate. It is noteworthy that Credit Suisse remains by Evraz’s side in the option structure of the proposed Highveld transaction. Morgan Stanley has not commented publicly on what transpired. Privately, a Morgan Stanley source told Mineweb that the bank had relied on what it had been told about the shareholding structure of Evraz and the asset ownership.

In Russia, cornering the market is not quite as illegal as it may be elsewhere. Indeed, cutting off supplies of metal feed or energy to blast furnaces, smelters, and refineries was one of the standard tactics by which today’s Russian metal moguls took over their assets from unwilling managements, workforces, or shareholders. However, these days the Russian government bureaucracy and the Kremlin are not so tolerant. The last attempt by a Russian metals man to use his market clout to cut off iron-ore to steelmakers was aborted last year, after the Kremlin stayed out of the affair, and the steelmills ganged up to beat the attacker off. Evraz has not been so influential that it could be sure of overwhelming similar objections to its use of vanadium supplies to the same end.

Several weeks ago, there were signs of Russian government pressure on Evraz. In February, the group was accused by the independent state auditor, the Accounting Chamber, of tax evasion through transfer pricing schemes involving an offshore trading unit, Ferrotrade. In March and April, the government’s environmental watchdog threatened to close down Evraz’s third steelmill, Novokuznetsk, for violation of waste water disposal rules.

In May, Moscow court proceedings opened against a group accused of fraud in the manipulation of shares of the Mikhailovsky iron-ore mine, one of Russia’s largest. The defendants swore they had not attempted to take over the asset, but rather prevent its sale to Alisher Usmanov, a controversial Moscow entrepreneur. A bank source close to Evraz told Mineweb that Abramov had wanted Mikhailovsky for himself, and didn’t want Usmanov to add a second big iron-ore mine to his portfolio. Abramov has not been named, nor accused of any wrongdoing in the prosecution’s case against the others. In parallel with the Russian developments, Abramov has also been named a defendant in a US court claim, lodged in federal court in Boston, Massachuetts, in March; this alleges that Abramov was party to illegal dealings at the Nikopol manganese processing plant in Ukraine.

Abramov has denied the charge, but it has been acknowledged that his bid last year, along with partner Victor Vekselberg, an aluminium magnate, to capture Nikopol, one of the largest ferromanganese plants in the world, had failed. Another $132 million bid to acquire a source of manganese ore in the former Soviet republic of Georgia was also abandoned, and Evraz’s initial outlay written off. In all, Abramov or Evraz appears to have lost up to $35 million pursuing a corner on manganese, another of the key hardening alloys for steelmaking.

If the Russian group should do better at cornering the vanadium market than it did with manganese, who will benefit? For Abramov has lost his majority control of the group. In an announcement on June 19, Evraz said that a 41.3% stake in the company had been sold to Roman Abramovich’s vehicle Millhouse. Millhouse chairman Eugene Shvidler confirmed the deal, and said the current management, appointed by Abramov, would remain in place. This, and the divided control shareholdings, are unprecedented in the Russian steel sector, and in Russian business practice. The new shareholding lineup will see Millhouse holding 41.3%; Abramov and his associates 41.3%; and a free float of shares at 14.3%. But in Moscow, industry sources believe this is a transitional arrangement, one reason for keeping the management in place. The expectation is that that Abramovich, who benefited richly from selling his Sibneft oil company to the state, is holding the steel asset until the Kremlin decides how it wants to consolidate the Evraz group into a state controlled metals holding.

Thus, noone in the Kremlin, or among Russia’s leading steelmakers, is sure who will turn out to own Evraz within a year or two. The one thing most are confident of is that Abramov, and his chairman of the board, Alexander Frolov, are not likely to be controlling the group for the long term. If they are headed for the exit, however, the future for the vanadium play which Evraz could be as short-lived as last year’s manganese play.

One man who may be able to contribute to the assessment is well-known to the SA business community. James Campbell sits on the Evraz board as an independent director, and following his education in Belfast and Cambridge, he served for 27 years, between 1975 and 2002, with various divisions of Anglo American, ending up as Executive Director of Anglo American plc. Campbell left Anglo in 2002, putting a challenge to his personal credibility, firmly behind him.

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