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By John Helmer, Moscow

Over the weekend, Ukrainian reports indicated that the Donetsk steelmaking assets in Ukraine, which went into bankruptcy in 2009, have been bought by Russia’s Mechel group, owned by Igor Zyuzin. The deal cost is reported to have been $537 million, including assumption of debts.

Confirmation of the sale appears in publication last Thursday in Ukraine of the agenda for a shareholder meeting scheduled on June 6, at which a vote is proposed on a purchase by Psarko Investments Ltd from Daveze Ltd. for $537 million.

The Donetsk Electrometallurgical Works (DEMZ) had been the property of the Anglo-Pakistani Istil group, before it was taken over in January of 2008 by Vadim Varshavsky and his Estar group. The original proprietor of the plant was London-based Mohammed Zahoor. The deal value between him and Varshavsky was well below published industry source estimates of up to $1 billion. An Alfa Bank source said at the time that the transaction and borrowing to finance it were below $300 million, secured by trade receivables. UK steel trader Stemcor handled the steel trade for the plant at the time.

Prior to the sale to Varshavsky, the Donetsk plant was producing about 1 million tonnes of crude steel, 990,000t of rolled products, most of which was square and round continuously rolled billet.

Varshavsky had borrowed from Alfa Bank in Moscow to make his takeover. But in August of 2009 he defaulted, and Alfa’s liquidation unit, called A1, took over, putting Andrei Saltanov, former chief executive at Estar, in charge at Donetsk. DEMZ spokesman Irina Ramazanova declined to confirm the latest transaction, and there has been no official announcement from Mechel. It is reported that the Ukrainian stock register confirms that DEMZ has been wholly owned since March 10, 2020, by Daveze Ltd. Daveze is thus the Alfa Bank vehicle for the sale of DEMZ to Zyuzin and Mechel.

A Mechel source released a document from DEMZ, announcing an agreement between Mechel as borrower, DEMZ as guarantor, Psarko Investments Ltd (Cyprus) as lender, and Daveze as the transferor of shares or seller. The number of shares is identified as 1,999, and the transaction value $537 million. The term of this sale, purchase and borrowing is three years — until May 14, 2014.

Mechel has been publicly listed on the New York Stock Exchange since 2003, one of the few Russian companies to be subject thereby to the disclosure rules of the US Securities and Exchange Commission (SEC) — the other two are Norilsk Nickel and Vimpelcom, with Yandex about to list on NASDAQ. On May 12, the same day as the Donetsk deal was being disclosed in the DEMZ documents for DEMZ shareholders, Zyuzin filed a collection of share sale documents with the SEC. Here they are.

The transactions appear to be share transfers between Cyprus registered front companies all owned by Zyuzin – Calridge, Bellasis Holdings, Amolink, MetHol, ActionDeal, and Cyberwood. There is no reference to DEMZ or anything remotely resembling a steelmaking asset. The purpose of the transaction series, as reported in the SEC filing, is this: “In connection with certain financings, Bellasis has pledged 27,070,500 Common Shares, Armolink has pledged 4,058,442 Common Shares, Cyberwood has pledged 17,193,750 Common Shares and Calridge has pledged 25,298,756 Common Shares.” That sounds like an agreement by Zyuzin to pledge his shares in Mechel to secure the $537 million purchase of DEMZ. But there is also this reported disclaimer: “As the chairman of the board of directors and controlling shareholder of the Issuer, at any given time, Mr. Zyuzin may be involved in discussions, plans or proposals which relate to or, if effected, may result in any of the matters referred to in paragraphs (a) through (j), inclusive, of the instructions to Item 4 of Schedule 13D.”

Mechel’s US shareholders might think their equity in Mechel would be adversely impacted if Zyuzin is busy pledging his shares to secure a $537 million loan, but Mechel’s official silence on the transaction and the SEC filing give nothing away.

The latest deal is also confirmed by Alfa Bank steel analyst Barry Ehrlich in a report today. He adds that the mill debts amount to $29 million, cautioning that the purchase price may also include other assets not publicly acknowledged to date. “We cannot rule out that the company may also have other steel making-assets in its structure. The main asset is an electric arc furnace with a nameplate capacity of 1mt.”

When Varshavsky bought DEMZ from Zoor, the assets included the re-rolling mill in Wales, Alpha Steel, as well as port facilities in Odessa, and the trading company MRHK Ltd in Hong Kong. What has become of those is not known.

According to Ehrlich, A1 handed operational control of the DEMZ plant to Zyuzin, who has headed DEMZ’s board. In the nine months to September 2010, earnings reported according to Ukrainian accounting standards amounted to just $1 million – too little to warrant a sale price 537 times larger. However, trading profits on DEMZ exports may have been registered elsewhere.

Reporting from Ukraine today, the pricing of the deal is said to have been kept off Mechel’s balance-sheet because bankers to the heavily indebted group may not allow the additional outlays, and Mechel’s new $537 million debt, to violate current loan and debt repayment covenants.

According to Ehrlich, “As of the end of FY10, Mechel’s net debt was about $7b and net debt/EBITDA ratio was 3.5x. According to our estimates, this acquisition together with $2b planned CAPEX in 2011 will inflate net debt to over $8b by EOY11. Mechel’s overall debt level is becoming a substantial risk factor, in our opinion, and should an unanticipated downturn in coking coal prices occur, Mechel could be forced to reduce CAPEX and slow the development of Elga and/or face liquidity issues. Given the unconvincing value of this acquisition, we view this news as NEGATIVE.”

Before that report appeared today, US trading in Mechel’s shares cut the price by 7% for the week. In today’s Russian stock trading, the stock price is down 1% already.

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