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By John Helmer in Moscow

Polyus public shareholders in the dark about proposed new gold mine asset sale

Sixty years elapsed between the first US patents issued for the yo-yo, and 1928, when the wooden axle on a string became a fad in California, and then spread across the US. By 1965, the yo-yo was so common, manufacturers couldn’t preserve their trademarks, even while they promoted competitions to popularize demand for the toy.

In yo-yo competitions, a standard routine is called sleeping. That’s when the axle is made to spin without rising up the player’s string. Another is called walking the dog. That’s when the axle is made to spin along the ground, also without rising up or down the string.

In innovative Russian business, as Mikhail Prokhorov has been practicing it, the trick is to keep assets in motion, earning their proprietor cash as they spin. It can be difficult to know what trick Prokhorov intends to pull at the end of his string. Two years ago, when he bought gold mines and prospects to add to the Polyus portfolio, the rationale was obvious – and so was the payoff, if only to count Prokhorov’s 25.5% stake in Polyus’s growing capitalization. (Market reports indicate that Prokhorov may hold as much as 28% of Polyus’s stock.)

But Prokhorov fell out last year with his former co-shareholding partner, Vladimir Potanin, and since then, the duo has been unable to agree on terms for the break-up of their jointly owned assets. , Prokhorov has been playing a number of tricks with Polyus, Russia’s leading goldminer. Mineweb last reported on allegations which Interros, the Potanin holding, and members of the Polyus board have brought, charging Prokhorov and Polyus chief executive, Yevgeny Ivanov, with selling out of the Polyus portfolio as many assets as they can – without shareholder approval, and over board objections: http://www.mineweb.com/mineweb/view/mineweb/en/page34?oid=48197&sdn=Detail

In yo-yo terms, this is more like cutting the string than walking the dog.

But now comes news of the Prokhorov-Ivanov team’s latest trick – this is to spin assets they took in 2005, and sell them back to the original owner. The deal that has been struck, sources close to the negotiations have told Mineweb, is that Polyus is selling to Alrosa, the state diamond miner, the Sakha (Yakutia) region goldmine assets that were bought from Alrosa’s affiliate Investment Group Alrosa for cash by Polyus in 2005 — Kuranakh, Kyuchus, and Nezhdaninskoye.

Kyuchus is an exploration prospect, and Nezhdaninskore is a mine in development; neither asset is shown on Polyus’s books as likely to produce value in the next five years. The company reports current reserve and resource estimates for the two as totaling 13.9 million ozs.

Kuranakh is an important producer in the Polyus portfolio. It currently processes 3.5 million tonnes of ore per annum; this is to be upgraded to 4.5 million tonnes. Production at the mine has been increased from 132,000 ozs in 2005 to 141,000 oz in 2007; this amounts to 12% of Polyus’s aggregate annual output of 1.2 million oz. Kuranakh is growing faster than Polyus’s main mine, Olympiada; by 2009, Polyus planning documents say Kuranakh production will grow 11% to 167,000 oz. Its reserves, reported according to the Russian classification, amount to 4.1 million oz B and C1; plus 3.2 million oz, C2 and P1. On current estimates, these represent 11% of Polyus’s reserve and resource aggregate. The Kuranakh grade is 1.3 grams per tonne. “This is no down-the-road gold project”, a Russian source close to the new transaction told Mineweb. “It is a major producing asset for Polyus right now.”

The value of the sale and purchase transaction for the three Sakha assets in 2005 was officially given as $285 million. Counting associated asset transfers, the effective value of the deal, clear of liabilities, and the price to Polyus, was $450 million.

The sources for the latest news say the deal is moving from in-principle agreement to inventorization required for a detailed contract of sale. It is backed by the President of Sakha, Vyacheslav Shtirov, for it will place the three gold properties closer to his control, which is considerably greater in Alrosa than it was with Polyus.

Potanin’s Interros told Mineweb that it has not been informed about the deal. “We were not informed about this”, a source said. “If this is true, it looks like the usual style of [CEO Yevgeny] Ivanov’s business behaviour – not to inform shareholders on the actions he is taking, or the deals he is putting through.”

Alrosa spokesman Andrei Polyakov told Mineweb that about six months ago, Alrosa had been interested in buying into Polyus, and there were discussions between Alrosa CEO Sergei Vybornov and his Polyus counterpart, Yevgeny Ivanov, as well as Prokhorov, the seller of the proposed stake.

“The decision was left for the shareholders”, Polyakov said, referring to the government board members of Alrosa, headed by Finance Minister Alexei Kudrin. Kudrin said he was not in favour, Polyakov told Mineweb. “I think that price was the issue.” At the time, Prokhorov was reported to be asking $54 to $57 per share.

At present, the Alrosa spokesman added, he has no information and “can’t confirm we are running negotiations” to buy Sakha gold assets from Polyus.

In August 2007, when it was clear that Prokhorov was trying to sell Alrosa his 25% stake in Polyus, the transaction story carried an implied warning to Potanin — if he wouldn’t pay Prokhorov’s asking price, Prokhorov’s stake might be sold at a substantial premium to a state company like Alrosa, while Potanin’s stake might be commandeered by the state at a later discount.

The problem with the deal at the time was that state officials did not have a high estimation of either Prokhorov as seller, or Vybornov as buyer. This stemmed in part from the murky methods, and even murkier asset valuation and tax assessment processes, which accompanied the 2005 deal, in which Vybornov, then in charge of Investment Group Alrosa, had sold Prokhorov and Polyus Alrosa’s control stake in junior gold miner, Celtic Resources, plus other assets. All told, these were Kuranakh, Kyuchus, and Nezhdaninskoye.

Details of the valuations in that deal, and of how the cash was paid and to whom, have yet to be fully disclosed. What appears to have happened is that, in a sequence of transactions, a 30% stake in the Nezhdaninskoye goldmine was sold at a higher valuation than a 50% stake, although title uncertainties should have led seller and buyer to accept a lower one. Tax liability to the Russian exchequer also remains uncertain, but sizeable, if the transaction chain were opened up.

It is no surprise that Alrosa’s state shareholders were reluctant to pay Prokhorov’s price for buying this all back, when Prokhorov hinted publicly that he wanted $54-$57 per share for Polyus; and the share price at the time was $41.30. The year-low had been fixed three months earlier, when it was $36.50. In August, Prokhorov’s asking price represented a 36% premium over market, for a total consideration of $2.5 billion to $2.7 billion.

In the time that has elapsed since Kudrin canned Vybornov’s initiative, neither buyer nor seller has lost appetite to do a deal. And Polyus has clawed back a share price of around $54, with total market capitalization of today of around $10 billion.

But even supposing that Prokhorov is still insisting on a premium, the doubling of the gold price and other calculations recently carried out suggest that Kuranakh and Nezhdaninskoye – without Kyuchus – should be valued at $1.5 billion. This is a tripling of the price Polyus paid two years ago. Such a multiple would be understandably attractive to Prokhorov and Ivanov, and possibly in some circumstances to Vybornov. But would the state board members, and Chairman Kudrin, be agreeable? For them, it may be relevant to note that Alrosa would be obliged for a price less than half of Prokhorov’s previous demand.

The yo-yo question remains to be asked. Why, if Prokhorov owns 25% of a $10 billion company, should he contemplate selling out such valuable assets that give Polyus its market value? “If they sell Kuranakh,” said a source close to the deal, “”there would be the risk of a big drop in the market cap of Polyus. Maybe more than 10%.”

Prokhorov and his financial advisor Dmitry Razumov do not respond to Mineweb questions. But the arithmetic does much of the explaining. If they cannot negotiate the price they want for their shareholding sale, they may be able to generate almost as much cash benefit to themselves by selling Polyus’s assets bit by bit, and still hold 25% of what remains.

Potanin’s Intrerros have already made public their charge that Prokhorov and Ivanov are engaged in an asset-stripping scheme managed by a British Virgin Islands-registered company called Polyus Exploration Ltd. This looks to be the same as the company called Polyus Geologorazvedka, established last May and registered in Moscow. The English appears to be a translation of the Russian in the company title. But they are far from the same company.

Polyus Exploration Ltd. was registered just two months ago at Tortola, BVI, on December 18, 2007. It was created by Prokhorov and Ivanov; the latter was acting on Prokhorov’s orders as chief executive of ZAO Polyus Zoloto (Closed Joint Stock Company Polyus Gold). This is a wholly owned subsidiary of OAO Polyus Zoloto (Open Joint Stock Company Polyus Gold), which is the publicly listed vehicle.

There is a big difference, however, between the open (OAO) and closed (ZAO) corporate structures, which requires a forensic accountant, and not a simple a translator from Russian to English, to unravel. For starters, in addition to its registration in BVI, Polyus Exploration Ltd. has an office in Switzerland. It is wholly owned by Jennington International Plc, which turns out to be registered in BVI also. Jennington was the vehicle used to hold the 20% stake in Gold Fields, which Prokhorov and his then advisers, Leonid Rozhetskin and Dmitry Razumov, acquired in March 2004, beginning what they thought would be a takeover of Gold Fields’s offshore assets, and a reverse listing for Norilsk Nickel. That scheme aborted when the Kremlin vetoed the deal.

Forensically, Jennington is 100% owned by closed joint stock company (ZAO) Polyus, and not by the open and listed parent. But Jennington holds a 9% shareholding in the parent.

ZAO Polyus Zoloto is thus the parent, and indirectly the 100% shareholder of Polyus Exploration Ltd (BVI). In theory, that makes the BVI unit a wholly owned subsidiary of the publicly listed parent, OAO Polyus Zoloto. But in practice, according to the current charter and corporate governance rules of Polyus Gold, Ivanov can make asset purchases and disposals through ZAO Polyus without permission, vote, consultation, or even knowledge, of the board of directors of the parent company. That means Ivanov can sell assets without telling the shareholders of the company – except for Prokhorov.

Mineweb has already reported on recent transfers through this chain of four gold prospects in the Magadan region, around the largest of Polyus’s proven gold deposits, Natalka (Matrosov). At least 7 million oz of reserves or resources, at high grade, are estimated to be at stake. Interros has called on shareholders to block such transfers.

If the sale of Kuranakh and the other Sakha assets goes through, Interros and the public shareholders would be left with a stock of value that is dwindling fast. That would be a yo-yo without a string.

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