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By John Helmer in Moscow

In the very small world of Russian steelmaking genius, Dmitry Pumpyansky (see right figure) has always been thought a bright bird at managing his pipemills, rather than for picking the right ones to buy, or the right price to pay. As the history books show, the acquisition of the Russian mills comprising the TMK alliance was due in the first place to tough measures by tough men from the Urals, with an altogether different skill set.

Pumpyansky’s big flight test was last year and now, as the full cost of his acquisition of pipemills in the US and Canada has become grimly clear. Just how grim is spelled out by Ernst & Young in unprecedented warnings attached to the TMK financial reports, which were released on Friday. As they read the results, the stock markets chopped 3% off TMK’s share price.

Individually, or with others, Pumpyansky controls 77% of TMK’s stock; 23% is the currently estimated free float. For more background on how high he tried to fly, and how the Russian state banks have been helping to soften the landing for him, read: http://johnhelmer.net/?p=734

That was nine months ago. Now, according to auditors Ernst & Young, after posting a net loss in the first half of this year of $204 million, and an increase in net debt from $3.1 billion in January to $3.6 billion as of June 30, TMK is facing “conditions [which] indicate material uncertainty which may cast significant doubt about the Group’s ability to continue as a going concern.” Don’t look for a reference or citation to this warning in Monday’s reports from the Moscow investment banks and brokerages. Not one of their steel analysts thought it relevant to quote. The share promotion team at Renaissance Capital advised clients that “net losses were not as severe as expected. Of more importance is the current momentum.” For that last phrase, read WAGER. And for UBS, this is a no-risk bet, because “the strategic status of the company being a key supplier for the Russian oil & gas industry helps it in getting state financing from the key state banks — Gazprombank, VTB and Sberbank.”

In a letter accompanying the financial results, the auditors say that TMK’s current liabilities exceed current assets by $952 million. The financial results indicate that posted revenue was $1,479 million, a little above analyst forecasts, but down 38% on the same period of 2008. Cost of sales came in at $1.3 billion, reduced by 28% from a year ago. The cost of TMK’s borrowings — incurred mainly for purchase of North American mills last year — jumped to $212 million, up 149%. The after-tax loss reported compares with a net profit for H1 2008 of $158 million. Labour costs are reported to have been cut from $232 million in H1 2008 to $183 million this year, a reduction of 21%.

The auditors’ notes also reveal that the Russian operations of the group accounted for 75% of the sales and 71% of the costs, generating for the six-month period an operating profit of $54 million. By contrast, the North American mills generated just 19% of sales; 24% of costs; and recorded an operating loss of $94 million. That, plus the financiing charges incurred for the loans to buy the US assets, explain most of the group loss.

In a highly unusual warning for oligarch-owned Russian companies, Ernst & Young says in the notes: “based on the current economic environment and the management’s outlook, when the Group’s consolidated financial statements for the year ending December 31, 2009 are published, the Group may not be in compliance with financial covenants under certain of its debt instruments, which, if not resolved, could also constitute a cross default under its other debt instruments. Such an event would permit the Group’s lenders to demand immediate payment of the outstanding borrowings under the relevant debt instruments.”

A report by Alfa Bank reports that the “net debt of $3,560 mln was worse than we anticipated. This implies a net debt-to-EBITDA 2009E ratio of 5.8x, based on Alfa estimates.”

The warnings are omitted from the company’s press release. This acknowledges that in the first half of the year, “the Russian OCTG [oil country tubular goods — pipes for the oil and gas sector] market was the least affected by the crisis. Demand for OCTG pipes in Russia in the first half of 2009 dropped by approximately 18%, while the US OCTG market shrank by 33% during the same period. Despite Russian oil and gas majors cutting E&P budgets, drilling activity in the first six months of the year was only down by 5%. The OCTG market performed relatively well due to the high tubing pipe consumption rate in Russia; TMK sales of tubing pipes in Russia increased by 16%. TMK expects a visible recovery in OCTG and line pipe demand in Russia in the second half of 2009; however this might not be sufficient to bring 2009 annual volumes back to 2008 levels.”

A pick-up in large-diameter pipe demand, which comes primarily from the oil and gas sector, is noted by the company from May, “driven by the construction of major Gazprom, Transneft and Turkmengas pipeline projects. We continue to see robust demand in the second half of 2009 with bookings for longitudinal welded large-diameter pipe extending through the first half of 2010.” But the company concedes that it is not anticipating much of a recovery in OCTG volume in the US market before the second quarter of next year, “owing to the high level of US pipe inventories and depressed gas price levels.”

As for the warning from Ernst & Young that some birds can’t fly, and not all chickens come home to roost when and where the poulterer wants them, the auditors attach this note: “the management is considering a number of alternatives to proactively address this situation, including a financial covenant reset and/or waiver from its lenders. The Group may incur additional costs related to these alternatives.”

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