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By John Helmer in Moscow

The share price of Canadian-listed, Russian-owned goldminer High River Gold (HRG:CN) has shot up by 65% since December 4, and last week hit 89 Canadian cents – its highest level since August of 2008. There has been no news to speak of, but there was a meeting, a month ago, with Prime Minister Vladimir Putin. Does he have the Midas touch?

The Prime Ministry isn’t saying how much time metals and mining oligarch Alexei Mordashov, who controls HRG, spent with Putin when they met in the latter’s office on December 4. But Mordashov has made so many mistakes, incurred such debts, and lost so much money, since the two of them last met intimately in May of 2006, there was plenty to talk about. “Good. Let’s talk in more detail”, said Putin, the instant before the public transcript was cut off.

According to the understanding that Russian oligarchs have of the terms under which they hold their resource concessions from the state, they must ask permission to make new transactions putting at risk the cashflow generated by their concession agreements. They are also obliged to plead for forgiveness, when their concessions lose big money, or cause unpopular scandal (e.g., mass layoffs, budget shortfalls, mine fatalities). In both cases, they must pay for the privilege of walking out of the room and back to their counting-houses.
 

Severstal and the Prime Ministry are not giving details of their conversation. Mordashov’s spokesman said: “All we can say is what the site of the government reports”. For Putin, Alexander Smirnov asked for a fax and did not reply. If Putin’s face and body language indicate he’s far from happy with Mordashov, that’s only a guess.

Ten days later, Severstal tipped Bloomberg off that Mordashov is thinking of spinning his goldmining assets out of the group, and giving it an independent share listing outside Russia. Such a transaction might create marketable equity value as high as $4.3 billion depending on how market analysts judge the value of the group’s principal mining unit, High River Gold (ticker HRG:CN), which is already listed in Toronto; plus the group’s Russian gold assets Mordashov’s subordinates reportedly overpaid for, when he first started collecting gold. If Mordashov asked Putin to give him the Sukhoi Log deposit, whose mining licence is currently retained by the state, then the spinoff would more than triple its gold reserves, and be worth much more. If, on the other hand, Mordashov asked Putin’s permission to sell the lot to a Chinese mining company, then the valuation and the transaction price might go even higher.

The formula Bloomberg uses when it is given Russian company placements, and wishes to avoid informing readers of the provenance, is — “two people familiar with the situation.” Accordingly, on December 16, Bloomberg reported: “Severstal may hold an initial public offering late next year or in early 2011, said the people, who declined to be identified because the deliberations are private. Severstal created a separate company, OOO Severstal Gold, in October to manage assets including a controlling stake in Toronto-based High River Gold Mines Ltd., one of the people said. The location for a potential IPO hasn’t been chosen, the people said.” A Bloomberg source says his agency knows who its sources are, but doesn’t want to tell its readers. “Unidentified means anonymous, which means the report won’t identify — that’s all,” said the Bloomberg source who asked not to be named.

But the December Bloomberg report wasn’t news, because a Severstal executive had already said it publicly on October 22. At an investment conference in Moscow that day, the chief financial officer of the Severstal group, Alexei Kulichenko, said the company might divest its gold business in the first half of 2010. This was then reported by Alfa Bank to investors, with the comment that “the divestment will occur earlier than we anticipated. Previously, the management planned the divestment for 2011. We understand that the company still has to do a lot of preparation work for the divestment by consolidating financials and auditing and publishing reserves, etc.” A day after Kulichenko’s remark, Severstal issued a formal denial of its intention to sell its gold business.

The important difference between what Kulichenko had said in October and what Bloomberg’s “two people familiar with the situation” said two months later, was the timing. Until Mordashov went to Putin on December 4, he didn’t dare admit publicly what he was saying privately. And even then, whatever Putin told him left the Mordashov spokesman with the caution of keeping the announcement as anonymous, and as deniable, as possible.

Sources close to HRG and to Severstal Gold in Moscow say that three end-game options are being considered by Mordashov. The first is to secure enough shareholder votes to sell the entire kit and caboodle to a Chinese goldmining concern. Instrumental in arranging this are Troika Dialog’s joint-venture partner and shareholder, Standard Bank of South Africa, and its joint-venture partner and shareholder, Industrial and Commercial Bank of China (ICBC). HRG has completed the first step – a deal between Mordashov and Troika for the latter to buy 150,000,000 HRG shares at a price of C$0.38 per share, for a total of C$57 million.

The deal announcement was issued on October 27, when the share price was 38 cents. At its high this week of 89 cents, the market capitalization is C$711 million. Troika, which is controlled by Reuben Vardanyan (right figure in the picture), has been able to book C$76.5 million, or 134% in gain over the 10-week interval. Minority Canadian shareholders have complained to the Toronto Stock Exchange that the Troika transaction was undervalued to Troika’s benefit. The shareholders also requested stock exchange action to rule that the deal wasn’t arm’s length; that Troika was a concert party with Mordashov the controlling shareholder; and that its new shareholding should not be allowed to be voted in favour of further deals Mordashov might have in mind, but has yet to disclose to the market.

Igor Klimanov, the new chief executive of HRG, insisted: “Troika is a non-related party, and everyone who says otherwise is a liar.” On the option of a sale of Severstal’s gold assets to a Chinese buyer, he said: “As to Chinese stuff I have no idea what you are talking about.”

With the completion of the Troika transaction, there are approx. 798.9 million shares outstanding. Severstal will own approx. 400.7 million (50.16%). Troika’s 150 million will amount to 18.8%, while unaffiliated minority shareholders will hold 248.2 million shares (31.1%).

The Ontario Securities Commission (OSC), which regulates the Toronto exchange, has told HRG minorities that it cannot rule on whether to nullify Troika’s votes on a new transaction proposed by Mordashov until the proposal is actually tabled. “The application of Multilateral Instrument (MI) 61-101 Protection of Minority Security Holders in Special Transactions to any future going private transaction of HRG,” the OSC has written, “cannot be determined until the time of the proposed transaction. To view MI 61-101 on the OSC website at www.osc.gov.on.ca, from the homepage:”

On the latest financial data available, HRG makes up about two-thirds of the gold division revenues for Severstal Resources. So, either Mordashov offers the minorities a premium to buy full control of the company for his end-game, so that the sellers believe they are sharing in the upside; or else Mordashov squeezes them out. For Mordashov to do this and neutralize the minorities, he needs to construct a new transaction worth at least 100 million shares, so that, combined with the Troika bloc, the Mordashov allies would have a majority of the minority ready to approve his scheme of arrangement.

The second end-game option is aimed at this 100 million new shares. It has been in discussion at Severstal Resources and with Mordashov for some time, according to a source who was involved. The idea has been to build an additional majority of the minority shareholders at HRG by acquiring a Russian gold company or asset in a swap for HRG shares. One of the candidates, which independent Russian sources say is being marketed for sale elsewhere, is GV Gold, whose controlling shareholder is Sergei Dokuchayev of the Lanta Bank group. GV Gold has already made several abortive efforts at public listings in Canada and London, falling short of its target valuation each time. In the meantime, it has been steadily lifting gold output at its principal producing deposit of Golovets Vysochaishy, near Sukhoi Log in the Irkutsk region.

Nine-month results reported by GV Gold indicate production in 2009 to September 30 of 87,200 ounces, compared to 99,300 oz in the same period of 2008. Gold sale revenue this year amounted to Rb2.5 billion (C$88 million), up 19% on the revenue figure of Rb2.1 billion a year ago. Current reserves for Vyoschaishy and other deposits for which GV Gold holds licences amount to 2.3 million oz counted according to the C1 + C2 Russian classification of reserves; with an additional 3 million oz in resources counted as P1, P2, and P3.

In comparison, HRG’s production in the first 9 months of 2009 was 241,781 ounces with C$263 million in gold sale revenue. HRG’s gold reserves are reported to be 6.4 millon equivalent ounces classified as ‘Proven & Probable, Measured & Indicated, and Inferred’, according to the corporate presentation on the company website. On the 2008 production standings, GV Gold ranks 8th largest goldminer in Russia and. Severstal Resources, including HRG’s Russian output, ranked 5th.

GV Gold’s last semi-public share transaction was by BlackRock in 2007, but at a deep discount that valued the company between $150 million and $200 million. GV Gold denied the reported transaction price at the time, and BlackRock refused to say. BlackRock’s current stake is reported to be 20%.

In comparing GV Gold’s and HRG’s production, you come up with a value ratio of 73.5% in HRG’s favour. It is more difficult to compare the reserves of each company’s mines, as Canada and Russia have a different reserve classification system (described in this document http://www.imcinvest.com/pdf/Russian_reserves_8.pdf). However, if no system differences are taken into account, you come up with a value ratio of 55% in HRG’s favor. In comparing these ratios, it may be difficult for Mordashov and Dokuchayev to reach agreement There is also this hitch in the Toronto exchange rules: “TSX listed issuers will be required to obtain security holder approval for public company acquisitions that will result in the issuance of 25% or more of their issued and outstanding securities (on a non-diluted basis).”

The Canadian minorities have so far demonstrated considerable staying power against Mordashov. During last summer’s minority buy-out attempt, the institutions currently holding about 120 million shares said publicly they will not sell for less than one Canadian dollar. Retail minority shareholders with 57 million shares indicated their average sale price would be C$1.47. If Mordashov tries a new share swap, and follows with a reorganization of HRG to the exclusion of the Canadian minorities, they threaten to sue . “The litigation lawyers have sent a warning letter to HRG stating we will be extremely vigilant to ensure that any transactions, if done, are carried out at fair value and for a proper purpose.” said Chris Charlwood, an HRG shareholder with significant minority support. Severstal can announce an amalgamation at any time without a prior bid. The majority of the minority wins this vote. Severstal can’t vote any of its shares. Troika and GV Gold (if a transaction were completed) may not be able to – subject to the qualification OSC has issued.

An unpleasant variant of this scheme, says one suspicious stakeholder in HRG, would be for “Troika and other friendly parties to be bought out by Severstal Resources at a pre-agreed price. You can guess after that, there would be a mandatory buy-out at a ‘fair price’, which is unlikely to be lower than 50 cents if they do it within 6 months after the [October 28] Troika sale.”

What is suspected of Mordashov and Severstal is thus an extension of the game that was played in 2009 to consolidate the entire HRG at an ouster price for the resisting minorities that would be well below what they think HRG is worth. So what is HRG worth? Last month, a Canadian business newspaper combined with a Russian brokerage to revalue HRG shares to a target of C$2.48 – more than a fourfold increase on the present price – and a total market capitalization of C$1.98 billion. “We believe High River Gold has now become a secure asset which carries substantial investment attractiveness,” the Moscow report from the Olma brokerage was quoted as saying in the Canadian media.

Charlwood circulated this valuation in November, as HRG began to move. “With the recent closing price at $.44,” Charlwood reported at the time, “HRG’s market cap would be approx. 2.7 times cash flow from operations (post Troika deal closing). Since Russian companies only report every half year, for this communication, a different Global mid-tier peer group is used for the third-quarter comparison. Historically, the numbers have been in the same ballpark as the West Africa-Russian peer group. HRG’s global peer group of mid-tier public gold companies (Randgold Resources, Northgate Minerals, Centerra Gold, Golden Star Resources, Red Back Mining, Eldorado Gold, Semafo Inc., Gammon Gold, New Gold Inc., Alamos Gold, Aurizon Mines, Jaguar Mining) is trading at an average of approx. 18.2 times Q3 Operating Cash flow on an annualized basis. If HRG were trading at this average multiple, the share price would be C$3.00 (after Troika dilution). HRG was trading at $3.40 early last year.” At this estimated share price,, HRG’s market cap would become C$2.4 billion.

A third option for Mordashov is the spinoff — with or without Sukhoi Log’s 60 million oz on the balance-sheet. Without them, Severstal Gold has been estimated by an Alfa Bank report in November to have about 14 million oz in reserves. Output this year for the group, including HRG, should come inabout 550,000 oz, according to public remarks by Kulichenko. The company has been valued by Barry Ehrlich of Alfa at about $1.6 billion.
Severstal paid €300 million ($437 million) in October 2007 for Siberian gold assets belonging to investment company Arlan, according to Rob Edwards, metals and mining analyst for Renaissance Capital in London. Sector sources in Moscow say this price was highly advantageous to those involved in the transaction, but unrealistically high as a benchmark for future transactions. Severstal also overpaid, the sources claim, when it spent US$325 million in 2007 and 2008 to acquire and delist London-based gold miner Celtic Resources. Using the Olma valuation for HRG alone at C$1.98 billion and considering HRG’s percentage contribution in production and reserves , the estimates for Severstal Gold may well fall in the range between C$3.2 billion and C$4.3 billion.

In a recent report for clients of Unicredit Securities, gold analyst George Buzhenitsa said: “we believe the structure of the transaction could resemble the [2006] spin-off of Polyus Gold, where shareholders of Norilsk Nickel received one share in a new entity for each share owned in the parent, giving current shareholders a free option. We value Severstal’s gold business at roughly USD 2.5-2.7 billion, based on our gold price forecast of USD 1,150/oz for 2010E, 2010E output of about 600,000oz, average cash costs of USD 550-600/oz, and a target 2010E EV/EBITDA of 7.5x, in line with the closest peers.”

If Mordashov and Dokuchayev can’t agree on merging GV Gold into HRG and Severstal Gold; and if the proposed spinoff doesn’t look like achieving a high enough target valuation to suit Mordashov, there is an alternative scheme,, according to Edwards of Renaissance Capital. This would involve Severstal selling the Arlan and Celtic assets to HRG at a valuation precisely equal to the number of shares required to strike the majority of the minority, and topple the holdout Canadians. The question such a tactic is bound to provoke is – if that triggers a Canadian lawsuit, what would happen to the Severstal Gold IPO?

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