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By John Helmer in Moscow

In some cultures it is considered entertaining sport for a crowd to watch roosters tear each other to death with specially-fitted steel talons. In other cultures, the crowd prefers to watch a man in fancy-dress stab a bull that has been specially bred to do nothing unpredictable with its horns. In yet others, the crowd pays to watch naked women wrestling in mud.

For entertainment, the debt throes of Oleg Deripaska’s United Company Rusal and his Moscow holding, Basic Element, combine all three, though Deripaska himself remains about as transparent as the mud wrestlers.

That’s one of the reasons the Russian government made a little-noticed but unprecedented announcement late on Friday. For the first time, Deripaska’s aluminum empire is to be investigated by auditors from the Accounting Chamber, as the Russian state auditor is known. For years, the Moscow-based chamber, headed by former prime minister Sergei Stepashin, has tried to investigate the multi-billion dollar cashflows generated by Rusal, mostly by export trading schemes employing dozens of companies around the world.

Not since two limited audits in 2004 – of an aluminum smelter in the Krasnoyarsk region, and the use of trading firms registered in Chukotka – have auditors got close to the big money.

Missing the footnote, the headlines got the story wrong. According to press leaks orchestrated by Rusal, the Russian government has agreed to lend US$4.5 billion through Vnesheconombank (VEB), a state development bank, to rescue Rusal from defaulting on a loan given last April by a syndicate of international banks to finance Rusal’s purchase of a 25% stake in Norilsk Nickel, Russia’s leading mining company.

The media were encouraged to believe that the Kremlin – both President Dmitry Medvedev and Prime Minister Vladimir Putin – have been persuaded to rescue Deripaska, the wealthiest man in Russia.

However, the VEB bailout, which is almost double the maximum amount of loan the VEB had earlier announced it would consider granting, has not been confirmed by any Russian government body or official, least of all by VEB. The announcement from the Accounting Chamber refers to the VEB loan only to say that its disbursement will be audited by two of the chamber’s most senior investigators. No amount was mentioned in the five-line chamber announcement.

Officials claim privately that the only rescue decided by VEB so far is of the 25% stake in Norilsk Nickel. That will not be forfeit to the bank syndicate, which includes BNP-Paribas, Merrill Lynch, Credit Suisse and the Royal Bank of Scotland. But far from decided is what will become of Deripaska and Rusal, and who will now have control of the Norilsk Nickel shareholding.

What is about to happen is one of the largest changes in the global aluminum business since Rio Tinto of the UK took over Canada’s Alcan, and BHP Billiton of Australia threatened to swallow Rio Tinto. In terms of output of bauxite, alumina and aluminum, RioTinto Alcan leads the world, followed by Alcoa. Rusal comes either second or third in the world, depending on how bauxite, alumina and aluminum metal are counted. BHP Billiton (BHPB), Hydro of Norway and the Aluminum Corporation of China (Chalco) comprise the top six.

Because China is the leading buyer of Rusal’s metal, and because Chinese partners have been courted to participate in Rusal plans for Chinese plants, as well as mining ventures in Africa and Australia, the prospect of renationalization of Rusal by the Kremlin arouses considerable interest in Beijing. From the Chinese point of view, the sudden loss of Russian liquidity is proving a boon for Chinese companies seeking long-term commodity supply and equity stakes in the Russian energy sector, as well as the metals sector.

For if Deripaska is as insolvent as sources close to Putin say the prime minister believes, and if Rusal is to be investigated by state auditors, then Deripaska’s global empire of bauxite mines, alumina refineries and metal smelters extending from Queensland to Guyana, from Jamaica to Ukraine and from China to Armenia, faces a Kremlin-ordered reorganization. A selloff of some of the foreign assets that aren’t required to feed Russian smelters is also being considered by the Russian government.

Waiting in the wings for the cue to bid for the selloff are the most liquid of Rusal’s global rivals, BHPB and Chalco.

It isn’t easy to say exactly what has happened to Rusal’s fortune – except that it’s gone. Putin is reported to be furious that as the price of commodity aluminum shot up to record highs of over US$3,200 per tonne, and Rusal’s revenues more than doubled, Deripaska took out huge personal dividends in cash and left Rusal, along with his Basic Element holding company, heavily leveraged. According to Rusal’s annual summary for 2006 – the last summary before Rusal merged with Russian competitor SUAL and the alumina units of Swiss-based Glencore International in 2007 – the company recorded sales revenues of $8.18 billion. That is virtually the only financial information the company published for the year. However, according to a bond prospectus drafted by co-shareholder Victor Vekselberg, Deripaska took $4.6 billion in dividends for the same year. That is a highly unusual 56% of the revenue figure.

What Rusal’s costs of production were for 2006, or any other year; what it paid in taxes; and what it owed on what terms, are data of such sensitivity that Rusal has warned banks that, if they are found to have released such data to unauthorized personnel, they risk losing Rusal’s business altogether. Rusal spokesman Vera Kurochkina refuses to respond to questions or requests for clarification of Rusal’s financial condition.

The financial section of a Rusal roadshow presentation, prepared for London equity analysts in mid-2007, claimed that in 2005, Rusal generated $6.5 billion in sales revenues, and earnings before income tax, depreciation and amortization (Ebitda) of $2.2 billion; that makes an Ebitda margin (the ratio of pre-tax earnings to revenues) of 34%. Comparable data for 2006 were not presented to the analysts. But supposing that Ebitda as a measure of Rusal’s cashflow grew at roughly the same rate as revenues, and the Ebitda margin was constant, there can barely have been enough cash to cover the dividend Deripaska reportedly took out of the company. Did Rusal borrow to pay Deripaska’s cash calls?

There is no explaining how it happened that Rusal’s net debt doubled between 2007 and 2008. According to the roadshow document presented in London in June 2007, Rusal said it owed $7.7 billion, and had $200 million cash on hand, making a net debt total of $7.5 billion. One year later, the debt aggregate is reportedly $14 billion, including $4.5 billion borrowed for the Norilsk Nickel acquisition. Since the seller of the Norilsk Nickel stake, Mikhail Prokhorov, is also claiming that he has not received $700 million of that figure, due on October 24, 2008, and is owed another $2.7 billion next April, the actual indebtedness of Rusal appears to be significantly larger than $14 billion – perhaps as much as $18 billion. Of that, about $10.5 billion is short-term debt, and must be repaid by next April.

Where has all the cash gone? That is the Kremlin’s question right now. It is the reason Stepashin has been told to send in his auditors to find out, lest VEB’s bailout loan disappear.

One point is certain. Rusal has paid less tax than any of its Russian metal-exporting peers and far less than Russia’s oil exporters. This hasn’t gone unnoticed, although the only open investment bank report on Rusal to be released – a Renaissance Capital report of February 2000 – omitted to mention tax at all.

Then in September 2004, a report on tax payments by Russia’s metal producers was compiled by the then federal Tax Ministry and delivered to the prime ministry in Moscow. The details were confirmed by prime ministry sources at the time. This is the only known report of a government tax inquiry into Rusal. According to the report, the company paid just 2% of its estimated $4.5 billion in sales revenues in taxes for 2003. The comparable percentage reported for Norilsk Nickel was 19%. Three Russian steelmakers – Severstal, Magnitogorsk, and Novolipetsk – were reported as paying between 12% and 14% of revenues in tax.

How Deripaska arranged to optimize his tax bill, and whether it was legal, are issues which have been controversial for years. An Accounting Chamber investigation, reported in May 2004, indicated that tax optimization schemes were being used, but it did not rule on whether they were legal. Rusal spokesmen refused to comment on these investigations at the time, except to assert that “Rusal complies with all legal and tax requirements”.

Rusal also acknowledged that the reason it paid low tax was that it was an offshore operation. The Rusal spokesman at the time, Yevgenia Harrison, said: “The Russian government is well aware that Rusal is the only Russian metals company whose revenues do not primarily come from the mining of Russian ore. To a very large extent, we are processors of imported raw materials. Thus a relatively large portion of Rusal’s value added is created outside of the Russian Federation.”

In a sequel to the Tax Ministry’s report on Rusal’s tax payments, the Accounting Chamber announced in November 2004 that the tolling contracts and offshore schemes used by Rusal might not be legal: “Companies have to be legally separate to produce a tolling contract. Unfortunately, under the Russian legislation, it’s difficult to prove that an offshore company is a part of some Russian holding group. But if it is proved, the tolling contract becomes illegal.”

The difficulty of investigation for Russian government auditors was deterring in 2004. Today, however, thousands of pages of documents submitted in evidence by lawyers of Michail Chernoy at the High Court in London, where Chernoy is claiming that, according to a 2001 contract, he owns at least 11.4% of Rusal, and possibly more of Basic Element.

These papers provide what has never been readily available before – the link between Deripaska’s ownership of Rusal’s production plants in Russia and of the chain of raw material sources and trading companies outside Russia, which have been used to supply the smelters and sell metal.

If the evidence of Deripaska’s ownership of the entire chain is to be believed, then the government would be justified to tax the transfer price – that is, the difference between the declared value of aluminum, when Rusal exported it from Russia, and the market value realized when it was sold. This could amount to at least $500 million per year since 2001, possibly more. That makes a hypothetical tax liability, including interest and penalties, covering not less than $4 billion in untaxed aluminum revenues.

Again, speaking hypothetically, if the last three years of Rusal revenues, including this year, amounting to about $43 billion, were to be taxed at a peer-group comparable rate of 15% of revenue value, then a fresh tax bill of more than $6 billion might be due and payable.

Deripaska isn’t saying if he has the personal cash on hand to meet the obligations of Rusal, and of Basic Element – a personal holding, based in Moscow, which has regularly borrowed cash from Rusal, and which comprises a diverse group of energy, mining and manufacturing assets, also bought on credit. Some of them were forfeit last month for lack of the means to cover margin calls. Right now Basic Element cannot repay what it owes Rusal, nor can Rusal cover the holding’s debt shortfall.

Deripaska’s financial problem is compounded by four enormous cash obligations that have also started to fall due. The first is more than $6 billion in claims by Chernoy (sometimes referred to as Michael Cherney) in the UK High Court. The amount covers Chernoy’s original 20% shareholding with Deripaska in their Siberian Aluminum (Sibal) company, plus a comparable share of the dividends Deripaska has drawn from Rusal, and of the proceeds of asset sales since 2001.

Deripaska has repudiated the claims, and he denies Chernoy’s evidence.

However, on July 3, 2008, Justice Christopher Clarke issued his first ruling in the case, requiring Deripaska to accept the jurisdiction of the London court for trial on the claims. Clarke also ruled: “I am satisfied that Mr Cherney has a reasonable prospect of success in respect of his claim.” Deripaska is appealing that ruling. In the meantime, Clarke’s ruling triggers the accounting requirement that Rusal make provision of the amount payable, if the court rules in favor of Cherney’s claim.

For practical cashflow accounting purposes, this contingency must be added to the company’s short-term debt, suggesting a total of about $16.5 billion.

Then there are the three undertakings Deripaska signed with his more recent shareholding partners – with Victor Vekselberg and Len Blavatnik, whose SUAL gave them 18.9% of Rusal; Prokhorov with 14%; and Glencore, whose swap of alumina refineries for Rusal paper amounts to 10.3%. Each has been promised that, if Deripaska cannot achieve a public listing of Rusal shares by autumn of next year, Deripaska must give them cash value, and buy them out.

It isn’t known what valuation these agreements place on Rusal. If the London target valuation of $30 billion were agreed among these stakeholders, or the even larger target set when Rusal tried to sell Rusal shares in Hong Kong a month ago, then Deripaska would owe Vekselberg and Blavatnik $5.7 billion; Prokhorov, $4.2 billion; and Glencore, $3.1 billion. Altogether, that makes $13 billion.

The tax liability, Chernoy’s claim, Rusal’s short-term debts and the shareholder claims add up to a grand total of almost $36 billion, or substantially more than Rusal is worth in the market today.

And if the Kremlin cannot trust Deripaska to handle last week’s VEB refinancing, why should Vekselberg, Blavatnik and Prokhorov trust him not to do to them what he has allegedly tried to do to Chernoy.

In short, the only guarantee that all Rusal’s creditors can now accept is a Kremlin-guaranteed reorganization.

Deripaska is barred from entering the US, and according to a London source, he no longer holds a valid visa to enter the UK. In more than ways than one, he has nowhere to go. Not even home.

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