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By John Helmer in Moscow

Open warfare declared at Russia’s largest gold miner exposes Lord Gillford, and starts a run at Polyus assets.

On their annual day of atonement for a year of sinning, the biblical Hebrews used to beat a goat over a cliff; or drive him into the desert to be devoured by the demon Azazel, carrying their sins with him.

From this substitution come our term, scapegoat; and the Hebrew exclamation, ‘lekh la-Azazel’, meaning ‘Go to hell’. This week Russian gold mining executive Pavel Skotvich discovered what it’s like to be the former, while Polyus shareholders discovered what it feels to be in the latter.

It has cost Polyus shareholders already this year $133 million in share options value to see off Chief Executive Officer Yevgeny Ivanov, Chief Financial Officer Alexei Osenmuk, and another executive, German Pikhoya, a few weeks ago. Ivanov took about $100 million; the others divided the balance.They had been insisting on the payoff, after counting how much Polyus Board Chairman Mikhail Prokhorov had been gathering from gains on his shares, as well as transactions.

The one man who didn’t share in the feast was Pavel Skitovich, the chief executive brought into Polyus by co-controlling shareholder Vladimir Potanin to replace Prokhorov’s man Ivanov.

Mineweb has been reporting since January the steady deterioration of relations between Potanin and his holding Interros, on the one side; and Prokhorov and his Onexim holding, on the other. Potanin and Prokhorov each hold 22% in Polyus, and share in an additional 7.4%; this gives them, together, control of the company they spun off from Norilsk Nickel in 2005.

Prokhorov and his men confirm they are trying to sell out. But since Potanin won’t meet their price, they have tried to find another buyer. Alrosa, the state diamond miner, has been in negotiation for the purchase, but the financial demands proposed by Alrosa Sergei Vybornov have stymied Prokhorov for the time being.

In frustration, Prokhorov has moved to swing board members of Polyus, who, until now, have been loyal to Potanin, into backing a fresh management takeover. A switch of votes and of loyalties on the board generated a simple majority at the board meeting on October 16 in favour of Prokhorov’s scheme to return himself to the chairmanship, and Ivanov to the chief executive’s seat. The change has been explained in terms that have scapegoated Skitovich.

Prokhorov is cited on the Polyus website as claiming: “Polyus Gold has huge development potential. To ensure that this potential is fully and efficiently realized, I have agreed to head up once again the company’s Board of Directors.

Since the Moscow market knows Prokhorov is selling, and doesn’t intend to be around for the “huge development potential” of the company, his fight over the board seats appears a desperation measure to lift Polyus’s share price, and generate fast cash return for himself. On the first day’s trading after the news, the price rose 1% to $43.50, but it remains 1.6% down on the price three months ago, and down 12% on the year to date. The share continued to gain on the second day of trading.

According to a Russian gold miner close to the battle, “Prokhorov has gone too far this time. By declaring war against Potanin, he has exposed his vulnerability to a wide range of counter-attacks.” Mixing maxims, another source described the situation as one in which “Pokhorov cut off a goat to spite his own face.”

Moscow newspaper coverage of the board shoot-out reports a source close to Prokhorov as saying: “I am disturbed that, in contrast to the growth of the Russian share market and the gold market, the value of the Polyus share does not grow in proportion.” The RTS average is up 12% in the year to date; the gold price up 20%.

Scapegoating is primitive wishful thinking; not even the ancient Hebrews believed their God fell for it.

From the charts, the market is well aware that the first serious downturn in the Polyus share price this year occurred in January, following Prokhorov’s arrest by French police. A more prolonged collapse in the share price followed between February and May, when the evidence of infighting between Prokhorov and Potanin became too obvious to ignore, and when Prokhorov and Ivanov lost their seats. If Skitovich is to be blamed for something, it is for the improvement of the share price since he took over.

But now Ivanov is back, with $100 million of share value in his pocket, and Skitovich has been obliged to sign the half-year report to shareholders on the company’s loss-making.

A company announcement, issued on October 16, explains that “at a meeting of the Board of Directors of OJSC Polyus Gold (RTS, MICEX and LSE – PLZL), held earlier today, a decision was taken to re-elect Mikhail Prokhorov as Chairman of the Board. The Board also took a decision to terminate the position of Pavel Skitovich as chief executive and re-instate Evgueni Ivanov, as General Director.

The newly elected General Director Evgueni Ivanov noted: “I am pleased that the Board has demonstrated its confidence in me, and I relish the opportunity of contributing my dynamic energy to the company’s operations once more. Polyus Gold’s unique competitive advantages, when employed effectively, will, I am sure, guarantee successful achievement of our impressive production and financial growth targets.”

Last week, it became clear what has been sparking some of Ivanov’s “dynamic energy”. But the company had trouble explaining why, in the current boom of gold prices, its profit in the first half of the year dropped 21%. The official explanation is that the fall was due to increased stripping costs required at the Olympiada mine, the principal source of the company’s gold production and revenue.

In July 2007, Polyus released preliminary first-half production figures, indicating production of 470,000 ounces of gold, a decline of 6%, compared to the same period of 2006. The average gold price received for the period was $660 per oz, up 11% on the same period of last year. With higher current spot prices of gold, the likelihood is that Polyus’s second-half results will be susbstantially better, no matter who manages the company.

Sales in the first half were $309.4 million, up 4%; but costs rose faster at 23% to $204.4 million. A huge increase of $151.1 million in “selling, general and administrative expenses”, tipped the entire balance-sheet into the red by $92 million, compared with a gross operating profit of $92 million in H1 2006. After counting tax and other items, the net loss for the first half of the year was $93.4 million.

What is referred to as a “share option plan”, costing Polyus $132.6 million, is the reason for the reported loss. A source close to the company says that this has been calculated on the difference between an exercise price of $14 per share, and the average traded price of the share in the report period. As a public company, Polyus has never actually traded as low as $14.

Who profited? Polyus told Mineweb that Skitovich was not a beneficiary in the option plan. All that the company’s report (note 18, bottom of page 14, “Liabilities under share option plan”) reveals is that on April 3 the Polyus board “approved an option-based executive compensation plan under which certain members of management and directors of the Group were granted options to buy up to 9,513,380 shares of the Company at the price of USD 14 per share. Subsequently, the number of shares for the share option plan was reduced to 4,765,693 ordinary shares.”

A source close to Polyus’s financials told Mineweb it looks like Prokhorov and his allies decided to take the cash before Potanin and his allies could prevent them. On April 2, for example, Polyus announced that Potanin’s man, Dmity Glotov, was coming across from Norilsk Nickel, to become chief financial officer for Polyus. He replaced Osenmuk, Prokhorov’s man, who was appointed to a new company called Polyus Explorations.

Then on April 14, Prokhorov, still chairman of the board, waved adieu to Ivanov, and Potanins man Skitovich took his place, effective May 29. But it wasn’t adieu — it was au revoir; Prokhorov’s French has improved since his January vacation in the French Alps. Eighteen weeks after Ivanov announced “I am excited to be starting a new business,” he is back in the old one.

On July 6, another Potanin placeman, Sergei Batekhin, followed Skitovich to Polyus, and replaced Prokhorov as chairman of the board. The independent director, Lord Patrick Gillford, was named chairman of the board’s audit committee. Now, three months later, Prokhorov has taken Batekhin’s chair, while Gillford is the sole international independent on the Polyus board, as the two other named independents, Russians, don’t qualify.

An old Etonian, Tory advisor, and career PR agent, Gillford took his Polyus seat before the company’s London float in 2006. He runs Policy Partnership Ltd. at an address in southwest London. According to the firm’s website, “we provide expert advice and sound judgement to help our clients anticipate and respond to regulatory, policy and communication challenges, both domestically and internationally.”

Gillford was asked by Mineweb if his firm represents Polyus in London; whether he himself had been a beneficiary of the share option scheme; and what he thought of the board shenanigans this week. He did not respond.

Gillford’s role as an independent director of the Russian- controlled gold miner is a test for other, western shareholders of the contribution independent directors can play, when Russian shareholders dominate; especially when they are oligarch-sized. Suspicion that this independence counts for nothing was a factor in the recent failure of JP Morgan-Casenove to arrange the planned listing of aluminium maker Rusal on the main board of the London Stock Exchange.

Russians do not believe that Gillford could make a stand against either Potanin or Prokhorov, let alone both, even if he wanted to, believing that public shareholders of Polyus were being disadvantaged. Sources in the London market told Mineweb that Gillford has been representing Interros (Potanin) interests in London for several years, but that he has been “ineffectual.”

The problem Gillford and Polyus’s international shareholders, must now wrestle with is that warfare between Prokhorov and Potanin can lead to unexpected, ill-considered sallies by one side, or another. These may trigger loss of confidence in the value of Polyus’s assets, and hence the share price. Among the vulnerabilities–which Prokhorov’s past management of the company now opens up–are tax problems associated with the record of its asset acquisitions.

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