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By John Helmer in Moscow

The Severstal steel and mining group, owned by Alexei Mordashov, has issued a prospectus this week for the issue of up to $3 billion in loan participation notes to restructure the group’s current debts. The issue is being underwritten by Goldman Sachs, Barclays Capital, and the Royal Bank of Scotland. Mordashov’s group reports its current long and short-term obligations at $6.3 billion, with $1.8 billion in cash and equivalent on hand, making a net debt level of $4.5 billion.

The surprise in the latest disclosures is in what they fail to say. Mordashov’s prospectus indicates that the long-planned initial public offering (IPO) of the goldmining assets – intended by Mordashov to generate a swift profit from the premiums he has been paying out to buy new gold assets — is unlikely to occur this year. According to the latest disclosure, the spinoff, which had been called Severstal Gold and has now been renamed NordGold, has an uncertain future.

After weeks of egging the London financial media into a state of high anticipation, all Mordashov will say now is this: “On 4 October 2010, the Company issued a press release noting some media speculation with regard to a possible IPO of its gold business. Whilst the Company does not comment on speculation, it repeated its previous statements that an IPO for the gold business is an option under consideration.”

The lawyers for the underwriters have also inserted a revealing footnote on the group’s debt line. In addition to paying an $81 million premium to Endeavour for the takeover of Crew Gold, Mordashov has forced Severstal to accept all $103.9 million of Crew Gold’s debt on to the main balance-sheet. Until now Severstal investors have been wondering where the money has come from for Mordashov’s big gold asset build-up, given the banking covenants and borrowing restrictions which had been imposed on Mordashov’s transaction appetite since the crash of 2008. The footnote, on page 49 of the prospectus, says: “From July 2010, the Group has consolidated Crew Gold. As a result, long-term debt finance increased by US$103.9 million and non-controlling interests increased by US$248.6 million from the amounts reported as at 30 June 2010.”

In slightly larger print, the prospectus carries this uncharacteristic admission from Mordashov that he may have acted with more speed than sense in buying gold assets for the Nord Gold portfolio, especially the takeover of Crew Gold. Here is what happened. And here is how the prospectus puts the position in retrospect. “Most recently, the Group’s controlling interest in Crew Gold, a company listed on the Toronto Stock Exchange and the Oslo Stock Exchange, was obtained through a series of market transactions where the Group was not able to perform the same level of due diligence as it would otherwise be able to undertake in the acquisition of a private company. As a consequence, there can be no assurances that liabilities will not materialise of which the Group was unware or that the target’s operations and asset base are not worse than expected, all of which could have been exposed as part of a more thorough due diligence exercise. Such liabilities could include claims by third-parties to challenge the validity of transactions entered into by the previous owner of the acquired assets, for which the Group had no direct responsibility. Any such liabilities could have an adverse effect on the Group’s operations and the value of the Notes.”

For the full text of the prospectus, click here.

A fresh acquisition to the mining side of Severstal’s non-gold mining business, also revealed in the new prospectus, is a nickel and molybdenum miner called Intex Resources. No sale price or other money data have been disclosed by Mordashov. According to his prospectus, Severstal has acquired a 21.7% shareholding in Intex Resources during last month. This company, listed on the Oslo Stock Exchange, owns the Mindoro Nickel Project, which, according to Severstal’s report, ïs “a substantial nickel laterite deposit in the Philippines. In addition, Intex Resources has two molybdenum assets in Norway, as well as Maniitsoq, a diamond province in Greenland.”

Intex Resources is even less forthcoming, and has so far failed to identify Mordashov as its new shareholder. Instead, the company has released this announcement, suggesting Mordashov had arrived just in time to save the company from being wound up: “In the half year financial report dated 27 August 2010, the Board of Intex Resources ASA announced that an extraordinary general meeting would be called in the near future to decide on the question of a capital reduction and a subsequent repayment of capital to the shareholders. The Board has now made a renewed assessment, and has resolved not to proceed with this matter in light of the changed shareholder structure in the company. As a result, the intended extraordinary general meeting, as announced in the half year financial report, will no longer take place.”

Mordashov’s underwriters warn in the heading to the offer document that “an investment in the notes involves a high degree of risk”. Among those spelled out in the following 425 pages, there is an important warning about the impact of new tax and transfer pricing rules now moving towards enactment in the State Duma Moscow. At this point, Severstal says, ” it cannot be predicted with absolute certainty when these amendments will be enacted, if at all, and what effect they may have on taxpayers, including the Group. If the tax authorities were to impose significant additional tax liabilities as a result of transfer pricing adjustments, this could have a material adverse effect on the Group’s business, financial condition, results of operations and prospects.”

A second risk noted in the prospectus is the role played by Mordashov himself. He is reported as controlling 82.4% of the Severstal shares — 77.4% fully, with an option over another 4.96%. As a result, the prospectus says, “the Majority Shareholder has the ability to exert significant influence over certain actions requiring shareholder approval, including, but not limited to, increasing or decreasing the authorised share capital of the Company (and disapplying pre-emptive rights), the election of directors, declaration of dividends, the
appointment of management and other policy decisions…Although the Group has in the past sought and continues to conclude related party transactions on an arm’s length basis, conflicts of interest may arise between the Group, its affiliates and the Majority Shareholder or his affiliates.”

The new document sets out the strategy for steelmaking which the group is intending to pursue, focusing primarily on its Russian operations. In 2009, the Russian steel division of the group produced about 16% of total Russian crude steel output, and this accounted for 47% of the group’s worldwide revenues. That made Severstal, the fourth largest steelmaker in Russia by volume.

Severstal says it views the Russian market for steel products as “providing significant growth potential. Accordingly, the Group plans to continue to invest in its production facilities in Russia in order to increase production capacity, particularly of long products, pipes, sections and other products used in the construction and infrastructure industries, where the Group expects demand to grow in the long term. In line with this strategy, starting from June 2010, the Group has started operating ZAO Severstal TPZ-Sheksna in test mode. TPZ-Sheksna is located close to the Group’s main Russian steelmaking facilities in Cherepovets and is capable of producing 250 thousand tonnes per year of electricwelded pipes and other profiles.”

Already announced before, Severstal is constructing the Balakovo mini-mill in central Russia, with an expected capacity of one million tonnes per year on completion in 2013. The Balakovo mini-mill is expected to produce long products for the regional construction and infrastructure industries. According to the prospectus, “the plant is well located logistically to benefit from local scrap supplies and to serve the growing steel markets of the Volga region. The Group is planning to construct a new galvanising line and two new colour-coating lines in 2012 and 2013, intended to provide primarily construction-related products.”

After almost two years of attempts to sell off his heavily indebted and lossmaking US steelmills, all unsuccessful to date, Mordashov now claims he is pursuing a new approach, with plans to spend more money on almost all the North American units. At the Columbus, Ohio, steelmill, for example, the prospectus says the strategy calls for fresh investment “resulting in an expected doubling of that facility’s production capacity by the beginning of 2012… In an environment of rising raw material prices, Dearborn [the former Rouge steelmill, Mordashov’s first US steel acquisition] is expected to benefit from its long-term contract with Cliffs Natural Resources. In addition, investments in the pickling line and tandem cold mill in Dearborn is expected to further improve its cost position and enable it to produce advanced automotive steels… Each of Sparrows Point, Severstal Wheeling and Severstal Warren are expected to focus on continuous cost optimisation and restructuring to achieve sustainable profitability levels.”

After a recent review of the costs of this expansion programme, Severstal now says that through 2014 it proposes to spend about $6.4 billion on capital projects. To date, the group says it has had capital expenditures of $2.2 billion in 2008, $978 million in 2009 and US$523.8 million (excluding Lucchini) for the six months ended 30 June 2010.

The commitment to invest a further $2.7 billion in planned capex depends on the operating environment, however, and if profits do not meet targets, the company says it may cut the planned outlays. “The Group plans to rely on cash generated from its operations, and, to a lesser extent, external financing, to provide the capital needed for the capital expenditure programme. However, there can be no assurance that the Group will be able to generate adequate cash from operations or that external financing, if necessary, will be available on reasonable terms.”

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