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By John Helmer in Moscow

Russian multi-mineral fertilizer group calls for investor upgrade ahead of IPO.

Traced on the map, Verkhnekamskoye (“Upper Kama”) looks like a molar tooth, with an unusually deep root. On the ground, in the Perm region of central Russia, it is the second largest deposit of potash known in the world.

About 3.8 billion tonnes of potash ore are estimated to lie at relatively shallow depth of less than 400 metres. Verkhnekamskoye is thus not only the largest undeveloped source of potash in the world; but it is also potentially the cheapest to mine, and bring to market.

Digging into this deposit is an opportunity that third-ranked listed Russian producer Acron acquired at a state auction on March 12, bidding Rb16.8 billion ($704 million). Crossing the Verkhnekamskoye threshold marks Acron’s biggest market move ahead of it’s plans for international public placement later this year.

It also marks a milestone in Acron’s five-year strategy to become vertically integrated upstream for raw materials, and to establish the independence of its complex fertilizer business of rival phosphate and potash mining companies. In October 2006, Acron bought licences for two apatite-nepheline deposits in the Murmansk region of northwestern Russia. In five years’ time, and with an investment of about $300 million, Acron’s North-Western Phosphorus Company (NWPC) is expected to produce 1 million tonnes of phosphates; and another 1 million tonnes of nepheline (for processing into alumina).

In total, $2.35 billion was paid by three Russian fertilizer companies — Silvinit, Acron, and Eurochem — at the March auction for Verkhnekamskoye deposits. Acron’s deposit, Talitsky, has potash reserves estimated at 681 million tonnes. In the southern sector of Verkhnekamskoye, it is adjacent to Mine-2 and Mine-4 of Uralkali, the leading potash producer in Russia. There are interlocking shareholdings between the miners – Uralkali’s controlling shareholders hold a 25.1% stake in Silvinit; Acron an 8.1% stake.

The auguries look good for Acron’s current share price of Rb1,688 ($70.30) – triple the price of last September — to rise again on investor demand for exposure to the Russian commodity play.

The price of potash has been sky-rocketing, as contract announcements from Brazil and India set record benchmarks, ahead of large-volume contract negotiations with China. Russia is the swing producer in the global potash market, and the Belarusian Potash Co. (BPC), international sales agent for Russian and Belarussian potash, has just announced an agreement with Indian Potash Ltd. on a contract price of $625 per tonne of potash. This is up sharply from the price a year ago of $270.

Negotiations with China, Russia’s largest potash market, are under way to lift last year’s price of just $170. In a situation of expanding demand and tight supply, it is only a matter of time, Russian negotiators believe, before China falls into line with the Indian and Brazilian levels.

The impact on the stock market has been to lift actual and brokers’ target prices for shares of the major North American potash producers, who trade through Singapore-based Canpotex. Potash Corporation — at $51 billion, the largest market cap in the global potash market — has tripled its share price of a year ago, and has been at all-time highs through this March.

In the meantime, and despite the good news, the two largest of the listed Russian potash producers, Uralkali and Silvinit, have suffered a serious mark-down of their share prices. Their combined market cap was $28.3 billion on March 5. It is now $24.6 billion, a loss of 13%.

Acron was at its historic high of Rb2,120 ($83.30) on February 29 (market cap of $4.2 billion). Since then, the price has fallen by 13%.

According to Alexander Popov, deputy chairman of the Acron board, this is a reaction to a bout of inflation anxiety on the part of Russian politicians. In the past fortnight, the government in Moscow has announced the imposition of duties on exports of fertilizers, and warned that if domestic supplies are not sufficient to curtail price increases to farmers, quotas on the volume of fertilizer exports may follow.

The government has set a lower rate for potash exports than for nitrogen and complex fertilizers; the latter known as NPK, combines nitrogen, potash, phosphate, nitric acid, and ammonia. The duty for potash will be 5%; for the other fertilizers, 8.5%. This looks irrational to many industry observers, because complex and nitrogen fertilizers have lower profitability, and are subject to rising gas prices. Virtually the whole 5%-8.5% duty will be passed on to consumers through higher pricing of the Russian commodities.

Popov told Mineweb the impact of the duties on Acron will less than 10% of estimated EBITDA for this year. Acron’s financial reports, calculated according to International Financial Reporting Standards, indicate that EBITDA in 2006 was $175.5 million; $205.5 million in the first nine months of 2007. EBITDA margin was running at 25%. Uralkali was at 47%; Potash Corp at 36%.

A March 28 financial report, calculated according to slightly different Russian Accounting Standards, indicates that Acron’s consolidated revenues for the full year 2007 were Rb30.9 billion($1.2 billion), up 28% on 2006; cost of production and sales rose less rapidly by 21% to Rb24.1 billion ($951 million); and EBITDA was up 62% to Rb8.7 billion ($344 million). The new calculation of the EBITDA margin for 2007 is 28%.

The export duty and quota moves “are happening,” said Popov, “because the price of food has grown by two times. The government is reacting to the growth of food inflation.” He estimates that the cost of fertilizers amounts to between 5% and 10% of the domestic cost of farming.

He and most industry analysts doubt that the duty measure will be effective in limiting food price growth. They may be a temporary measure for the presidential and government transition period. Some investment banks are predicting a softening towards the fertilizer companies by June, when a new government will be named and the current prime minister, Victor Zubkov, a strong supporter of the fertilizer price measures, will have been replaced.

“It is paradoxical”, according to Popov, “that the government would introduce a measure slashing the capitalization of the fertilizer companies by billions of dollars, at the same time as it has sought to achieve premium prices for the Verkhnekamskoye licences. Obviously, if you cut EBITDA by one measure, you downgrade the value of the licences to produce the potash. The real economic effect on inflation of the duties will be zero.”

Acron has begun investor presentations with a target to sell between 10% and 20% of its current share issue, on top of the existing freefloat of 16%. Financial advisors and underwriters have been selected, but not yet announced.

If all goes according to plan, Acron will follow the successful London IPO of Uralkali last autumn. But Acron acknowledges that its valuation in the market is hedged by the assessment that a pure potash producer, like Uralkali, is less subject to cost inflation and supply risk than a complex fertilizer (NPK) specialist, like Acron. “There is a discount for multi-mineral fertilizer companies,” Popov told Mineweb. Company data indicate that of annual revenues exceeding $1 billion, 45% is accounted for by NPK sales, 26% by ammonia and ammonia nitrate, and 8% by urea.

To convince the market it can handle volatile gas prices, Acron has a 5-year price and supply agreement with Gazprom, which sets a combination of state regulated and commercial market prices for gas over a 12-month period this year; and then for six-month intervals until 2011, when it is expected that the gap between the state and market prices will have closed. Acron also holds a 21% stake in Sibneftegaz, a Gazprom subsidiary, with 300 billion cubic metres of gas reserves. This asset may be offered by Acron for either cash or an asset swap to fuirther protect Acron’s nitrogen fertilizer supply side.

Does Acron’s dependence on Gazprom for the gas to produce its ammonia and nitrogen fertilizers represent a risk discount? Popov responds: “We consider this as a dependence on the state, and the state is the regulator and stable guarantor of supplies and pricing.”

Acrons is also hedging against over-dependence on particular export markets. Traditionally, and during the 1990s, China was the most important of Acron’s buyers of NPK; roughly 70% went in that direction. Today, Acron operates a plant of its own, the Shandong Hongri Acron Chemical Company, at Linyi, in Shandong province. Sales to China have dwindled therefore to 26% (money terms). The export trade has been reoriented towards Latin America, which now take 15% of Acron’s sales. Brazil and Venezuela lead as the region’s largest consuming clients.

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