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By John Helmer, Moscow

Why would Roman Abramovich and his pals decide to buy a small steelmaker in South Africa at a price that would add to their debt by the very same amount they offloaded last year on to share buyers, so as to keep their debt-to-earnings ratio down, and their bankers sweet?

That’s the question on which Evraz’s press and investment relations spokesmen have been thunderingly mute for the past two days. Most of the enthusiasm for the transaction (and its premium price) is being leaked by Anglo American Corporation, while industry analysts say Anglo’s asking price is unrealistic. No wonder the Evraz tongue looks tied.

According to Sunday media leaks in London and Johannesburg, Evraz, the Russian steelmaker owned by Abramovich (image front left), Evgeny Shvidler (image front right) and Alexander Abramov (image rear left), is considering the takeover of South African steelmaker Scaw Metals. Anglo American’s steel division is the seller.

If the deal goes through, it would be the second in South Africa for Evraz, which acquired Highveld Steel and Vanadium from Anglo in 2006, paying $678 million. At that time, it was suspected Highveld was worth more to Evraz for its vanadium, a steel-hardening alloy, than for its steel, in a Russian plot for capturing a corner of the global vanadium market. The scheme aborted, but this time it’s a new plot – borrowing money to buy an asset which is barely break-even in an offshore market where the Russians are already in trouble. How high can the jink go?

Scaw Metals produces rolled and forged steel, and alloy iron castings, with a market in southern Africa. The takeover reportedly values Scaw Metals at between $500m and $750m; a year ago Anglo’s asking price reportedly was between $800m and $900m. But according to Alfa Bank steel analyst Barry Ehrlich, the discount is too little; even $500m would be an “unjustifiably high price for an African asset with political risks and a potential burden of social expenses.” Ehrlich thinks $400m should be tops, so long as there isn’t any debt on Scaw’s books.

A year ago, Evraz’s chief executive Alexander Frolov announced Evraz’s focus was on Scaw Metals without explaining the reason. “We’re interested in acquiring iron ore deposits and steel distributors in SA,” Frolov was reported as telling Bloomberg on March 31, 2011, adding that his group had been explicitly targeting Scaw Metals. He made his remark just weeks after Anglo reported it was selling two associated steel assets, Moly-Cop (Chile) and Alta Steel (Canada), to Australia’s OneSteel for $932 million. Getting rid of all its steel assets is Anglo’s current corporate strategy.

Evraz spokesman Tatiana Drachuk is refusing to respond to questions from Business Day, intimating that Evraz will not respond to the sale claims for the time being. Drachuk has practised saying nothing for years.

The latest Evraz financial report for 2011 indicates the group’s existing South African operations at Highveld generated $544m in sales revenues (steel, vanadium, and iron-ore), amounting to 3.3% of the group’s total revenues.

The Evraz group’s net debt as of December 31 was $6.44 billion, down from$7.18billion the year before.. To reach the lower figure and satisfy bank loan covenants fixing the ratio of debt to earnings (Ebitda), Evraz took $553 million off its balance-sheet debt line by converting bond debt into shares.

Evraz also reported in December that for the year 2011 its Highveld plant produced less steel than in 2010. Crude steel volume came to 681,000 tonnes, down 13% on the year before. Finished steel products totalled 564,000t, down 4.4%. The most important of Highveld’s portfolio, flat rolled steel products, fell 16.5% to 287,000t; construction steel volume fell 0.2% to 179,000t.

Highveld’s financial report, issued in mid-March, reported the good news that the company incurred a loss of Rand15m (US$2m) for the year; that was good because the loss the year before was R383m ($50m). The bottom-line profit was a minuscule R45 million ($6m), but in 2010 that had been a loss of R549m ($71m). The reason for the improvement, said Highveld, was “higher sales volumes and prices.” Evraz’s operations report for the fourth quarter and the full year, issued on January 17, indicates that Highveld was able to lift its flat steel price by 18% during 2011, and by 20% for its construction steel. How it achieved those higher prices is a sore point right now with the South African regulator, as we shall in a minute.

Even with price-rigging, the report from Evraz headquarters reveals that its sales of flat steel in South Africa grew in 2011 by just $7m (2.7%) over the 2010 sales figure of $257m. Revenue from sales of construction steel in the same market grew by $20m (14.5%) to $158m.

As for the prognosis for this year’s performance in South Africa, Highveld reports more jitters than hijinks. “It has become evident that the weak global economic situation is beginning to impact on the South African economy as well, resulting in a persistent soft local steel market demand.”

In a report to Alfa Bank Moscow clients today, Ehrlich expressed skepticism that in this unpromising market, the purchase of Scaw Metals would add value to the Evraz group. “We see no clear potential synergies with existing operations in the country since Highveld is vertically integrated and produces different products – thick plates and structural sections.”

After disposing of Moly-Cop and AltaSteel, Scaw has reported that its 2011 production of steel was 677,000t. Operating profit for the year was $40m, down 76% from 2010.

The timing of the Scaw sale leaks coincides with a ruling issued yesterday by South Africa’s Competition Commission, charging Highveld and ArcelorMittal with price collusion in the South African steel market since 2008. The Commission said the two steel companies had “adjusted their prices for (flat) steel products around the same time and with similar percentage increases”. Highveld had followed ArcelorMittal’s lead on “the pricing mechanism and changes in pricing, including discounts and transport tariffs”, the Commission has found, and had “divided the markets by specific types of goods, maintaining market shares and allocating supply quotas for exports”. ArcelorMittal has 80% of the SA market in flat steel products and Highveld 20%.

ArcelorMittal is saying it won’t comment until its lawyers decide what’s to be done, and what to say. Highveld and Evraz are saying nothing.

So why is Evraz borrowing good money to toss at more South African risk? Ehrlich calculates that the deal “would increase Evraz’s net debt from $6.4bn to $7.0bn and its net debt/EBITDA ratio from 2.2x to 2.4x. The ratio is expected to increase further on an anticipated y/y decline of the company’s 2012E EBITDA.” That, you understand, is something for Evraz to stay silent about.

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