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By John Helmer in Moscow

Negotiations are close to a deal announcement for the takeover of the Donetsk Electrometallurgical Works (DEMZ) by Russia’s Mechel group, controlled by Igor Zyuzin (right figure).

A report today from George Buzhenitsa, steel analyst at Unicredit Securities, discloses that Mechel is “in the final stages of completing the acquisition”. He noted that Mechel has already been active in taking over operating rights of several other steelmills which, like DEMZ, had been owned by Vadim Varshavsky (left figure) until last year. Then he lost them in regional court bankruptcy actions, after he defaulted on about $3 billion worth of loan obligations – considerably more than the steelmills he mortgaged were worth. The four Varshavsky steelmills transferred to Mechel so far are Nytva, Zlatoust, Rostov, and Gurievsk: http://johnhelmer.net/?p=1772 and http://johnhelmer.net/?p=1501

Announcement of Mechel’s takeover of those mills falls short of asset acquisition, because the conditions in which Mechel can spend its cashflow on new assets are strictly regulated by Mechel’s international and Russian banks. Mechel currently owes these banks almost $6 billion, and it is seeking to stretch out the repayment periods, relax some of the loan covenants, and lower the interest rates. Current loan covenants are believed to make new asset takeovers, like DEMZ, subject to bank approval.

There have been hints that Zyuzin hasn’t wanted to take over Varshavsky’s mills at all, but is being obliged to do so by a combination of regional governments, desperate to keep the mills in operation and employment; and the Kremlin, which through state bank bond support, is financing Zyuzin’s new coalmine projects in the equally desperate fareastern republic of Sakha.

Since Varshavsky is the only billion-dollar defaulter in Russia whom the Kremlin has allowed to go bankrupt, the question of why others in the metals sector with even bigger debts than his, contracted with equal folly, are being protected. Having failed to secure financial rescue on commercial terms from his friends or former friends, Varshavsky has hinted in public that he may yet arrange his comeback, and a buy-back. But that is about all Varshavsky has been heard to say in public since his financial crash began.

According to Mechel’s spokesman, Alexander Tolkach, the DEMZ sale “information is false”. He declines to say anything more. However, a source close to the negotiations over the Ukrainian mill confirms that the deal is in negotiation right now between Mechel and A1, an asset management unit of Mikhail Fridman’s Alfa Bank group.

Formerly controlled through a holding called Istil, the management of DEMZ was replaced in August last by A1, which installed Andrei Saltanov as the new chief executive. Earlier, Saltanov had been the chief executive of Varshavsky’s Moscow-based Estar holding. Varshavsky had bought DEMZ in January 2008 from Mohammed Zahoor, an Anglo-Pakistani based in London, who had acquired the asset himself through shareholding transactions in 2000.

Varshavsky’s acquisition, and the loan Varshavsky took from Alfa Bank to pay for it, were well below published industry source estimates of up to $1 billion. This number continues to appear in print. But a year ago an Alfa Bank source told CRU Steel News that the transaction and borrowing were below $300 million.

Prior to the sale to Varshavsky, the Donetsk plant was producing about 1 million tonnes of crude steel, 990,000 tonnes of rolled products. Stemcor, the London-based steel trader, traded much of this steel, and was involved in the securitization arrangements at the time of the Alfa Bank loan to Varshavsky.

In today’s deal negotiations, according to Buzhenitsa, “no details on the valuation of the possible deal were available, and we believe this would influence the market’s reaction to the news, given Mechel’s highly leveraged balance sheet. However, if the deal goes through, the valuation is unlikely to be low, as A1 is a portofolio investor with sufficient financial support from its parent company, Alfa Group, implying that the disposal of the investment is not urgent.”

What Buzhenitsa means by Mechel’s leverage has been reported by Mechel itself, as it has arranged the kind of state guaranteed refinancing that is unavailable to Varshavsky.

Mechel confirms that it is currently in negotiations with 27 foreign and local creditors to extend payback periods and cut interest payments for $2.1 billion in outstanding loans. They include $500 million from a foreign banking syndicate led by ABN Amro and Merrill Lynch, with which Mechel acquired its ferroalloy unit, Oriel Resources, in 2008; and $1.6 billion that helped pay for the acquisition of the Elga coal deposit, in the Sakha region, in 2007. The new talks are aimed at improving the terms last agreed with the bankers in 2009, which extended the repayment deadline beyond December 2012, and lowered the interest rate previously agreed of Libor plus 7%. As of last September, Mechel reported debt of $5.6 billion.

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