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By John Helmer in Moscow

When the Kremlin decides to privatize strategic resource assets, it makes a habit of quietly arranging the buyers in advance. Although such privatizations are always announced as serving the requirement of the state treasury to maximize the asset value and take in the largest amount of cash possible for the newly issued shares, this usually doesn’t happen. The loans-for-shares schemes, which delivered Russia’s most important oil and mining companies into half a dozen oligarch hands in the mid-1990s, is a notorious example. More recent attempts by the Kremlin at genuine auctions of mineral resources have embarrassingly caused the asset prices to go higher than the winning buyers, oligarch-sized though they may be, can afford to pay for, and then develop. Since the crash of 2008 this has produced another round of government financial bailouts for the resource-holding oligarchs, although this time the instruments — state purchases of bonds, state bank loans and share purchases, guarantees, tax relief — have looked less corrupt.

Not since 1997, when Vladimir Potanin and Mikhail Prokhorov, then controlling shareholders of Norilsk Nickel, attempted to privatize a big stake in Alrosa by swapping the Alrosa debt their bank held for shares, has there been a powerful interest in taking Alrosa into a privatization, and thence into a public listing. The Potanin-Prokhorov bank involved, Oneximbank, went bankrupt during the August 1998 crash, and Alrosa was saved.

This week, it has been disclosed in a Moscow newspaper that Deputy Prime Minister Igor Shuvalov and Economic Development Minister Elvira Nabiullina are considering a privatization plan that includes the release of the full federal government stake in Alrosa of 50.9%. According to the leak, Shuvalov and Nabiullina intend to post an open letter to investors, asking them to say what stakes of what state-owned concerns they would like to buy.

A month ago, on January 18, Alrosa’s chief executive, Fyodor Andreyev, proposed publicly a different kind of privatization in a press release, leaving the main mining company intact, but spinning off as separate IPOs three distinct diamond mine assets. The announcement said Alrosa “is contemplating the possibility of raising private investments on capital markets, also through placement of exchange-traded securities of ALROSA mining subsidiaries: OJSC ALROSA–Nyurba, OJSC Severalmaz and OJSC ALROSA-Africa, and by using OTC [over-the-counter] instruments.” According to Alrosa spokesman, Andrei Polyakov, “it’s easier to sell shares of separate mining units as ZAO Alrosa itself has some legal constraints. It currently has a legal form of closed joint stock company, which is not suitable for share sale.”

Alrosa the state diamond-miner — world’s number-2 producer after De Beers — has an authorized capital issue of 272,726 shares, with a nominal value of Rb13,502.50 ($450) apiece. The shareholders include the Russian government, with 50.93% of the share issue; the Sakha regional government, with 32%; eight districts (uluses) of the Sakha republic with a combined 8%; and two other shareholdings — 13,038 shares (4.9% of issue) held by legal entities, and just over 11,000 shares held by Alrosa managers, retirees, and other individuals, amounting to 4.2%.

Because Alrosa is legally a closed company, its shares cannot be traded. This has happened illegally in the past, however. It can also occur legally, though the process is cumbersome and non-transparent. As markets go, the share market for Alrosa is coloured gray to black, and the pricing of the shares is highly artificial.

But this week, in a leak accompanying the one about the Kremlin idea of selling off 50.9% of Alrosa, if an interested buyer can be found, there was a second idea. This was that a valuation of Alrosa’s potential market capitalization by a Swedish investment fund has cut the company’s potential IPO value to a share-buyer by two-thirds — from about $6 billion to less than $2 billion. The newspaper claimed that Vostok Nafta of Stockholm, which currently owns 1,159 Alrosa shares, values them at $6,250 apiece, for a total value in Vostok Nafta’s portfolio of $7.2 million. The numbers are contained in Vostok Nafta’s annual report to its stakeholders for 2009, which was issued on February 17.

Extrapolating from the price Vostok Nafta has booked for its Alrosa shares, the total capitalization of Alrosa, according to this source, is just $1.7 billion. In 2005-2006, when Alrosa’s capital was being reallocated between the federal and Sakha regional shareholders, Russian auditors calculated that Alrosa was worth between $6.1 billion and $6.4 billion. The numbers were then negotiated to a consensus figure by officials of the federal Ministry of finance and the Sakha regional administration. Divided by the number of shares, this represents a share price equivalent of $22,367 to $23,467.

In 2007, Vostok Nafta’s financial report appears to assign Alrosa a modest premium. According to the company’s portfolio tabulation, the fund held 966 shares at a market price of $28,000. The report does not explain from whom it bought the shares, or what it paid for them, though the implication is that it paid $27.1 million for the lot; $28,000 apiece.

Explaining to its shareholders, the Vostok Nafta report said: “We have during the period [2007] invested into the world’s second largest rough diamond producer, Alrosa. The company, which is located in Yakutia [Sakha] accounts for 97 percent of Russia’s total diamond production, and approximately 25 percent of global rough diamond production. Alrosa operates alluvial-, open pit- and underground mines with an estimated explored reserve life of 25 years, and seven primary ore treatment production plants with an estimated throughput capacity of 30 million tons per year. In 2006 Alrosa produced diamonds for a total value of USD 2,332.2 million and manufactured polished diamonds for USD 141.1 million. Rough diamonds are primarily sold to the jewellery industry but also used for the production of industrial abrasives (non-gem diamonds). The company itself cuts and polishes a small share of its production at the subsidiary Brillianty Alrosa. Beside its Russian operations, Alrosa also has a large interest in a diamond production company in Angola. Alrosa currently has the form of a closed joint-stock company, and the largest shareholders are the Russian Federation and the Republic of Sakha (Yakutia). However, plans were recently announced for an IPO in London, Hong Kong or Toronto during 2009, in which the Russian Federation will keep a controlling stake with 50% +1 share. ”

In point of fact, no plan has ever been announced by Alrosa for an IPO, but Vostok Nafta opted to turn Moscow speculation into a speculation of its own, amplifying that for the rest of the market. If Vostok Nafta was hoping to make a hefty gain after an Alrosa IPO, they have been waiting in vain.

In the portfolio listing for 2008, Vostok Nafta said its 966 Alrosa shares had dropped in value to $3,000 each, for a total value of $2.9 million. There was no explanation of this downgrade.

Last week, Vostok Nafta’s 2009 report revealed that over the year it had bought 193 more Alrosa shares to make a total of 1,159. The market value assigned to the lot is now $7.2 million. This makes for a market price of $6,250 per share – more than double the previous year’s share price, but less than one-quarter of the value at acquisition.

Alrosa was asked what it knows of the Vostok Nafta share valuation. Andrei Polyakov, the company spokesman, told PolishedPrices.com: “If Vostok Nafta calculated the price, then we should ask them how they did it. I don’t know where the price came from, and I have no idea who may need to call it. It’s nonsense.”
Sergei Goryainov, a leading Moscow diamond analyst and editor of the Russian journal, Rough&Polished, said he believes the latest Vostok Nafta valuation of $1.7 billion for Alrosa is “an under-estimation.” He suspects the fund is trying to push the price down in order to buy more shares ahead of an IPO. “Perhaps someone wants to buy a stake at a lower price,” he said.

At Vostok Nafta’s Stockholm headquarters, the corporate spokesman and head of investor relations, Robert Eriksson, was in his office all day. He was asked how the fund portfolio managers did their annual valuation of Alrosa shares; how to explain the sharp cut in share value since 2007; and the doubling of share price during the worst year financially the 17-year old Alrosa has had. Eriksson refused to respond to telephone-calls and emails, saying through a secretary he was “too busy”. He also refused to answer the questions.

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