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By John Helmer in Moscow

A new ratings report by Fitch has declared Alrosa, the state-owned Russian diamond miner, to be twice as profitable — as measured by Ebitda margin — than global leader, De Beers.

Alrosa doesn’t issue production figures for its mines by carat, but claims a 25% share of global diamond mine output by value. Diamond sales in 2008 have been reported at $2.8 billion. Anglo American, a part-owner of De Beers, reports that the latter produced last year about 48 million carats, and holds a 40% global mine market share. De Beers’s sales in 2008 were $6.9 billion.

According to the report issued by Fitch on May 21, Alrosa’s advantages include its lower rouble cost structure and state financial backing. “The company’s EBITDA margin is 30%, on average, ” according to Fitch analyst Sergei Grishunin, “which exceeds the EBITDA margin of market leader De Beers, which had an EBITDA margin of 17% in 2008 and 2007.”

According to Grishunin, the value of the Kremlin’s financial support for Alrosa this year will include Rb45 billion in procurement of rough diamonds for the state stockpile agency Gokhran in the first half of the year; and Rb44 billion in financing from the state VTB Bank for covering some of Alrosa’s maturing obligations to foreign lenders. At the current exchange rate, these inputs are worth $1.5 billion and $1.4 billion, respectively.

Notwithstanding, Fitch claims that Alrosa lacks the product diversification of other mining companies that make them less vulnerable to the current diamond price cycle. These constraints, according to the Fitch report, “include high indebtedness which exceeds that of Commonwealth of Independent States’s metal and mining companies rated by Fitch (average FYE2008 gross debt/EBITDAR of 1.2x). Fitch estimates Alrosa’s FYE2008 gross debt/EBITDAR in a range of 4.1-4.2x, and FYE2008 net debt/EBITDARn in a range of 3.5-3.7x. As of H108, Alrosa had breached covenants (net debt/EBITDA less than 2.5x) for some loan agreements, but it received a waiver from creditors until the next half-year covenants testing in July 2009.”

This makes heavy pressure on Alrosa to generate additional cash on its balance-sheet. Alrosa issued its annual financial report for 2007, audited according to international financial reporting standards (IFRS), on July 8, 2008; PriceWaterhouseCoopers was the auditor. There has been no successor report for 2008 as yet. The IFRS report for the year, and the Russian standards financial report prepared by auditor FBK, do not provide a clear statement of the conventional Ebitda measure — earnings before income tax, depreciation and amortization (Ebitda). Long-term debt as of December 31, 2007 — according to the PWC report — was the rouble equivalent of $3.33 billion (Rb82.8 billion); of which the short-term debt was reported to be $2 billion (Rb49.5 billion). The reports indicate that while the company’s long-term debt had been shrinking over time, in 2007 the short-term debt doubled. As of 2007, all debt was unsecured, except for Rb1 billion ($41.9 million) in short-term obligations.

The latest Fitch analysis “notes that Alrosa’s debt measured in USD has increased in the last three years by 2x from USD1.5bn to USD3.3bn as the company has continued to implement a significant capex programme of conversion of open-pit mines to underground mining and engaged in M&A activities.” It is believed by sources close to the company that some of these M&A transactions have been the focus of recent Accounting Chamber inquiries.

Fitch reports that it “expects that the company’s FY09 sales will be 20%-25% below that of FY08, including volume off-take by the Russian State. The agency estimates FY09 gross debt/EBITDAR at 3.8-4.0x and net interest/EBITDAR at 2.7-3.0x.”

Fitch has concluded with the “concerns that Alrosa will again breach covenants under some debt facilities at half-year testing for FYE08 and 2009. Fitch expects to resolve the RWN [Ratings Watch Negative] once the issuer has addressed this matter by either renegotiating its covenant level or by improving its capital structure, for example, by using proceeds from the sale of non-core assets for debt repayments.”

Sergei Vybornov, Alrosa’s chief executive, is to confirm the divestment of oil and gas exploration assets this week, according to an interview cited by Finam, a Moscow investment house and brokerage. “We regard these [ownership rights to oil and gas fields] as noncore assets and fully intend to get rid of them,” Finam quotes Vybornov as saying. “I expect the transaction to be completed by the end of the month [June]. These O&G assets are to be sold to a Russian company, but not to Gazprom. This concern is registered in Russia, not state-controlled…not under full control of the state, I would say. I’m not talking about Gazprom or Rosneft.”

In March, according to Finam, Vybornov had said that Gazprom would take over Alrosa’s gas subsidiaries – Geotransgaz and Urengoi Gas Company, but no transaction has subsequently been announced. Alrosa also has an oil-producing subsidiary, Irelyakhneft. In March, again according to Finam, the diamond company had valued the assets together at between $600 million and $700 million.

Some of these assets were held by a subsidiary in Cyprus called Rolant Investments Ltd., which in turn had been acquired earlier by Alrosa in a complex transaction chain with Morgan Stanley for more than $300 million.

Sources close to Vybornov have complained that recent gossip regarding his job tenure is inaccurate and damaging. A source inside the company adds that the internal problems should be solved by the scheduled date of the annual shareholders’ meeting on June 20.

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