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By John Helmer in Moscow

Confucius say – why buy a treasure from a man, if you can wait for him to lose it.

The turmoil now affecting Oleg Deripaska’s United Company Rusal has become a critical test of the difference between the Russian and Chinese approach to resource concessions and national company value. Even those guardians of international financial propriety, the Financial Times and Wall Street Journal, have noticed that Rusal’s market valuation is dropping through the $20 billion point and reaching the mark once privately predicted by Renaissance Capital, now a Mikhail Prokhorov property and Rusal underwriter – just $10 billion.

The problem at this point is whether, as Mikhail Fridman and the Alfa group suspect, Deripaska and Rusal are now in negative value territory – assets worth $10 billion, liabilities of at least $16 billion. If the lead French bankers running Rusal’s $8 billion foreign creditor syndicate mutely agree, then they are contemplating the same option that Alfa has tried – bankruptcy and liquidation. Not many more bankers, not to mention honest commonsensical folk, should reach the same conclusion before it becomes apparent that a crisis of collapse is imminent.

And what does Deputy Prime Minister Igor Sechin, in charge of conserving sovereign resources from loss to foreign owners, do when such a threat impends? He and Prime Minister Vladimir Putin do what they did a year ago when Rusal’s insolvency was about to forfeit a 25% shareholding in Norilsk Nickel to the banking syndicate of Royal Bank of Scotland, Barclays, BNP Paribas, Calyon, Credit Suisse, Goldman Sachs, ING, Merrill Lynch, Morgan Stanley, Natixis and UniCredit Group? State funds, through VEB, were ordered into the breach, and the $4.5 billion loaned to Rusal for immediate repayment to the banks. This wasn’t so much a bailout of Rusal or Deripaska, as it was a rescue from foreign takeover of Norilsk Nickel (the banks’ 25% plus the free float would have reduced the Russian position in Norilsk Nickel to less than a majority). Thus, the nationalization of Rusal had commenced.

In mid-2007, it was that prospect which concerned the underwriting banks advising Rusal on a London Stock Exchange listing. Morgan Stanley, Goldman Sachs, and JP Morgan-Cazenove required that Deripaska produce a signed commitment from the Russian government that it would not, or ever, take Rusal back. But all that Deripaska managed to bring to the underwriters’ table, was a letter signed by a middle-level man with an unpronounceable name, who lacked the power to obligate the Russian state.

For the London underwriters, that meant that Rusal might be reclaimed by the Putin-Sechin administration on grounds the underwriters and auditors judged then to be both credible and possible. At the same time, they knew that, in parallel, moving slowly but surely through the UK courts, was the possibility that Deripaska might have to meet his signed obligation to Michael Cherney (Mikhail Chernoy) to hand over more shares or cash than Deripaska could afford to pay, thereby triggering a shareholder revolt and financial crisis for the company. On these two grounds, the Cazenove respectables quailed. They are quailing even harder, now that Cherney is gaining in the High Court, with trial likely in the spring; and the collateral takeover of Rusal’s assets by the Russian state accelerating.

And so the Hong Kong Exchange and the Euronext Exchange (aka the Paris bourse) have tried feeling their way into this risk gap, driven in part by the ambition to one-up the London exchange; and by desperation calculations on Deripaska’s part and on the part of Credit Suisse, BNP Paribas, and Societe Generale, that they must get quick cash out of the ailing aluminium giant, if they are to clean their balance-sheets of a year of technical defaults, de facto insolvency, and postponements of debt restructuring. Without a share listing – aka initial public offering (IPO) – the banks cannot get their cash; and Deripaska’s shareholding partners Mikhail Prokhorov, Victor Vekselberg, Len Blavatnik, Glencore, and Cherney – cannot achieve the share valuation they are entitled by contract to claim from Deripaska.

Renaissance Capital, Prokhorov’s bank, had been counseling for delay and a listing attempt next year, when aluminium prices and Rusal revenues may have improved. But they were compelled by the logic of the other banks, who have insisted they will not agree to debt restructuring now, unless there is a listing now, and cash up front.

At this point, some weeks ago, Deripaska and his advisors tried magic. That is, they offered to sell a substantial stake in Rusal to a de facto foreign state purchaser with large amounts of cash, and a special interest in the future of aluminium. The Chinese were obvious candidates, because they need the metal; they lack cheap electricity to produce it, and they don’t have enough bauxite or alumina for future requirements.

Less obvious was the Libyan connexion. Muammar Qaddafi, the ruler of Libya, has long toyed with the idea of taking investment stakes in real estate in Putin’s home town and other schemes which, according to Qaddafi’s line of thought, would give him influence with the Russians in case he needed it to protect himself from the Americans and other enemies. Qaddafi’s son, Saif al-Islam Qaddafi, has cultivated Russian oligarch connexions for both his business and pleasure. On Rusal’s side, there has been interest in the Libyans since initial feelers were made to their Ambassador to Italy several years ago, when Qaddafi was under Anglo-American sanctions. At the time, Deripaska calculated that the Libyans had the gas to power aluminium smelting, but they lacked the know-how and trading network of a serious aluminium company.

Saif recently asked his investment contacts what they thought of his buying a stake in Rusal. The contacts replied, but judged that their recommendation were so negative, Saif had given up on the idea. More recently, there have been signs of a change of Libyan sentiment, as the French banks worked to persuade Qaddafi junior and senior that they could have almost the entire Euronext placement for themselves, at a discount price.

It should be clear – Rusal’s IPO strategy in Hong Kong and Paris is nothing but an O strategy, not for the first time, and without the public. But this can’t succeed if the Chinese have different ideas; and when the Hong Kong Exchange is having difficulty with potential conflict of interest on its Listing Committee, not to mention warnings from Dechert, Cherney’s lawyers in London. Then there was the reaction from Putin and Sechin when it began to dawn on them that Deripaska’s alternatives to the collapse of Rusal as a going concern was a Libyan or a Chinese rescue.

The Russian leaders were encouraged in their apprehensions by the small, hitherto unnoticed west African state of the Republic of Guinea. Formerly a French colony, and then a 25-year military dictatorship which gratefully conserved the old Soviet concession for bauxite supplies to smelters Rusal now owns — Guinea started afresh in January with a programme of audits and legal reviews of its mineral concession deals. These reviews uncovered Rusal conduct which was illegal under Guinean law, according to a court in Conakry; it ruled in September to revoke the privatization of the Friguia alumina refinery. Fresh court action is planned to shortly deal with $1 billion in tax and other financial claims. Deripaska sent in his special negotiator, a former Russian military intelligence officer with a Latin American background. The negotiations aren’t going well for Rusal.

Rusal’s home smelters cannot be run at current capacity on Russian supplies of bauxite and alumina. And for Rusal to expand its output, it must expand its raw material sources. Guinea is more vital than ever. But for the first time, Rusal is facing the loss of its principal source of non-Russian bauxite, and roughly 20% of the global Rusal group’s asset value. And if the Guineans have the legal grounds and political will to take their resource concessions back, what may happen to the rest of Rusal’s global empire – in Jamaica, Guyana and Australia, for example?

The Chinese approach has been to answer this question with another – why not negotiate directly and secure Chinese bauxite and alumina requirements, without having to depend on Rusal or the Russians? This in turn has led to recent negotiations between Chinese state funds and the Guinean government, with the possibility that what Rusal may lose there, on legal grounds, the Chinese may bid for, and acquire for themselves.

In the past, the Chinese government was slow to grant Rusal representational status in the country. There have been historic problems of fixing the terms of business between Chinese formulas, and those Rusal prefers. As for Chinese interest in cleaning up their small-scale aluminium smelters, the solution for the long term may require cheap Russian power, but not necessarily indirect shareholding interest in Russian smelters. So, recently, the Chinese have been slow to appreciate the value of buying an equity stake in Deripaska’s company, when it has two other options. Guinean bauxite is one; and a long-term purchase agreement for Rusal aluminium, at a solid discount to market price, is another. Both options are secured by the bird in the hand. Why risk the Deripaska bird in the shareholding bush? To answer that, the Chinese have not shelled out large sums in due diligence research. They have simply read the rulings of the UK High Court on the subject of Rusal business practices, and the value of Deripaska’s signature on contracts, trusts, and other commitments.

The Wall Street Journal has managed to capture this oriental cogitation, according to a dispatch of November 19: “The company has been trying to line up Chinese and other Asian state companies and investment funds as core investors in the issue, but hasn’t gotten solid commitments, according to people involved in the preparations. One Asian sovereign wealth fund looked at investing in the Rusal IPO but decided against it after concluding that the company’s production costs and debt levels were both too high, according to a person familiar with the situation.”

Bloomberg – which bears the same relationship to news reporting as Michael Bloomberg to New York mayoral politics – has given Deripaska a recent platform to explain to prospective Chinese share-buyers that Rusal is “committed” to Asia, and wants to list shares in Hong Kong “to attract more partners from this region who are interested in developing new projects with us.” Naturally, new projects mean new money – and Rusal is short of the old stuff. So this is a pitch for more Chinese capital than the shares are currently worth. Accordingly, Deripaska has invited the Chinese to trust him to manage their money. Bloomberg obliged: “A lot of people are jealous [of me] but I don’t care,” Deripaska told the news agency in interview on November 17. “I am not working for money.” Deripaska’s record as a trustee is the very issue that faces trial in the Royal Courts of Justice.

For Rusal to sell shares to China or Libya poses another problem for the Russian government, and that problem suddenly got more serious in the past few days. In part, that is because there were signs of reluctance on the Chinese side to buy any shares at all. This has triggered the realization in Sechin’s and Putin’s offices that if there is no I, no O, no IPO, then Rusal may lose what foreign assets it requires to keep running, and the foreign bankers may claim a chunk of assets now under the collateral protection of VEB and other state banks.

The Hong Kong Exchange Listing Committee was to have met on November 19 to review for approval Rusal’s share sale prospectus. But the exchange got cold feet. At least seven of the listing committee members, including a deputy chairman, work for banks, lawfirms or accountancies with a vested interest in Rusal’s equity value and its debt repayment capacity. There may have been other problems as well, as the executive leadership of the exchange changes over the next few weeks.

On the underwriters’ side, the cold feet may have been catching, as they noticed the rising Rusal risk discount, and the plummeting value of the market capitalization, which even the Financial Times couldn’t help but record in its report of November 19: “The company is seeking to raise up to $2.5bn, people familiar with the situation say. But another said the company could face a valuation that would price the 10 per cent stake closer to $1bn.” If Rusal is priced in the Hong Kong market at a total of just $10 billion, according to the Financial Times, then its worth, net of debt, is negative. The foreign bank syndicate must therefore judge whether to abandon the standstill debt formula it has accepted for almost a year, and look to bankruptcy, an asset grab, and the liquidation of Rusal.

Rusal’s spokesman, Vera Kurochkina, doesn’t respond to questions from reporters or publications which Rusal HQ considers to be less than positive or supportive. Moscow newspapers, Vedomosti and Moscow Times, which are owned by a syndicate of the Financial Times, Wall street Journal, and Sanoma of Finland, have called this policy, accompanied by threats from a lawfirm of one of the Rusal directors, “a terror campaign”. If the sky is falling in on Rusal, this Chicken Little (“kurochkina” in Russian means “little chicken”) will be the last to acknowledge it.

Rusal’s published policy on governance calls for something better. According to the company website, “by working with international institutions such as the European Bank for Reconstruction and Development and the International Finance Corporation, UC RUSAL developed and implemented its corporate governance standards, based on the principles of transparent and responsible business operations.” Implementing these standards and principles was a condition of an EBRD loan to Rusal of $150 million in January 2006. The EBRD claimed at the time that the loan “is based on full disclosure of ownership by RUSAL’s and Basic Element’s owner Oleg Deripaska, and additionally provides for detailed commitments to greater transparency, good corporate governance and high business standards, covering RUSAL and Basic Element. Compliance with these commitments is covenanted in legal documentation with the EBRD and IFC.” EBRD spokesmen have been asked several times since this announcement whether they have noticed any covenant breach. Their response suggests they haven’t.

But the threat of the sky falling in for Russia’s aluminium monopoly is obvious to state administrators. Look at the faces of the VEB board, chaired by Putin on November 19, as they discussed how to protect the value of their loans to the company, and the asset collateral they hold.

They were also considering an obvious question – for an outlay of no more than $2 billion to $3 billion, would they take the chance of conserving Rusal’s value for later, and ward off a catastrophic bankruptcy action by at least 70 of the world’s banks; loss of assets on which the production chain of Rusal’s operations in Russia depend, and the employment of thousands of Russian workers; and loss of value for the $4.5 billion in Rusal collateral VEB is already holding? And the alternative – if the VEB board and the Prime Minister don’t commit the money now, then do they want to risk Rusal’s future on Qaddafi, on the Guinean leadership, on BNP Paribas and Credit Suisse?

Dmitry Kozak’s head seems more deeply bowed at the table than most (third on Putin’s right). This was the man whom Sechin forced out of the Kremlin in Moscow, and into exile in the Caucasus in 2004, when Kozak attempted to block concession schemes Sechin had in mind. That at least is what you can read in evidence being given in the UK High Court trial of state shipping company Sovcomflot, now under way in London.

But it is too late for high Russian officials to recriminate with each other over, or with Deripaska, over the deadline Rusal faces next Thursday, November 26. That is the day appointed for the Hong Kong Exchange Listing Committee to meet to consider Rusal’s O.

That is also the deadline extension, according to Rusal chairman Vekselberg, when the foreign banks should sign their agreement to Rusal’s debt restructuring terms. This is more chicken-and-egg than Kurochkina can admit to. Without a share sale, the debt arrangement collapses. Without a debt arrangement, Rusal faces liquidation all over the world.

The response from Sechin and Putin looks inevitable. They must bail out Rusal – but as they did with the VEB loan of November 2008, they must do this for their own, and the national interests, not Deripaska’s. Bloomberg reports Deripaska as saying that, since he isn’t working for his own money, he is working for the state interest. The implication is that he thinks they coincide, and maybe this week, they do. “I have my interests and I try to realize what I can do, and for now I am focused on Rusal because it is very important for Russia.” Just who settles what is important – Russia’s or Deripaska’s interests – has yet to be decided, and it isn’t likely to be Deripaska’s call. The entire Russian oligarch system, invented by President Boris Yeltsin, and refined by Sechin and Putin, will be tested by the outcome.

In the meantime, the Russian taxpayer must contribute, through VEB, Sberbank, and other state holdings whatever it takes to stave off the losses. The stock exchange operations in Hong Kong and Paris are a sideshow, and also a smokescreen, for what is really happening. The obviousness is therefore balanced by the ridiculous in the Financial Times, which reports one assessment: “There is no way they are going to get this done without some sort of state entity participating. It’s a quasi-bail-out.”

And on the other hand: “the deal would be ‘a strong signal that the company has the backing of the government and should give people confidence about whether it is sponsored by the Kremlin. People should relax about the normal Russian risks about whether it will have its assets taken off it by the state.’ The person said the deal could also encourage other big institutions being courted by the company on mainland China to participate in the offering with anchor orders.”

But the anchor is the Kremlin – I mean, the Russian White House, where Sechin and Putin have their offices. They have no choice but to nationalize now. Thus, it turns out that the risk that helped kill the London Stock Exchange listing when aluminium and Rusal were at their peak in 2007 has now materialized. And for the time being, the Russian government cannot make up its mind on what is to be done about Mado – typo, Deripaska, until Rusal gets clean out of this crisis.

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