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By John Helmer, Moscow

Not since the Biblical one – 5 (loaves) x 2 (fish) ÷ 5,000 (mouths) — has the division of assets proved to generate a value multiplier like the one Igor Zyuzin, owner of the Mechel steel and mining group, is trying to pull off. Or proved less convincing to the crowd in the market place, who over the past few weeks has chopped 20% off Mechel’s share price:

Mechel 6-month share price trajectory

Last week, Zyuzin arranged for a troop of Moscow bank and brokerage analysts to visit mining operations at Southern Kuzbass, his Kemerovo-region subsidiary and currently Russia’s largest producer of coking-coal, the vital ingredient of blast-furnace steelmaking. Impressive though Southern Kuzbass’s four open pits and three underground mines may be in digging out 16 million tonnes per year at one of the world’s cheapest costs per tonne, the analysts were underwhelmed by the prospect that Southern Kuzbass, already counted in the Mechel share price, may be spun out, and sold as part of a separate mining company in an initial public offering (IPO) in three months’ time. According to a Uralsib Bank report on the visit to Southern Kuzbass, “the forthcoming placement of Mechel Mining shares on the London Stock Exchange in October-November 2011 is likely to create a significant overhang in the stock, and Mechel shares may underperform their peers prior to the placement.”

The market logic is common sense. Mechel Mining has this month announced the intention to place 3.6 billion new shares at par value of Rb7.37 (US$0.26), making a target valuation of the proposed spinoff company at $940 million. Since this year’s peak share price in April, Mechel (steel and coal) has lost almost $2.5 billion in market value; so the division and subtraction of assets has already exceeded what Zyuzin thinks is a fair count of the Mechel Mining value being taken out of the Mechel group. So, either Zyuzin is planning to become even poorer in the coming months; or else Mechel Mining is to make a brand-spanking new coalmine acquisition to stop Mechel’s share price from collapsing, and give price support to the shares of the new company.

Last week too, it was claimed by the chief executive of Vnesheconombank (VEB), Vladimir Dmitriev, that state-owned VEB has not decided to buy an 80% stake in coking coal mining company Raspadskaya for $5.3 billion, putting a valuation of on the entire enterprise of $6.6 billion. Instead, VEB is considering financing someone else to make this purchase. “I would not deny that potential investors have turned to us for financial support with a view to acquiring this asset,” Dmitriev said, according to Reuters. Raspadskaya runs second to Southern Kuzbass as a coking coal producer in Russia. Its ownership is for sale by the Evraz steelmaking group, led by Roman Abramovich, and veteran managers, Alexander Vagin and Gennady Kosovoy.

Exactly what Dmitriev was denying and what he was acknowledging but keeping to himself he won’t tell. That VEB is prepared to finance someone to pay $5.3 billion for 80% of an asset which, according to Moscow banking sources, VEB has already valued at little more than $3 billion – that is half the transaction valuation – is a miracle for which Dmitriev isn’t claiming credit. VEB’s valuation number for Raspadskaya remains secret. Yekaterina Karasina, Dmitriev’s spokesman, refused last week even to say whether VEB has already valued Raspadskaya.

So who may be ready to assume the risk of borrowing from VEB to buy something worth half as much? Gennady Timchenko has been assembling coal-mining assets for months; but there are sources who claim he looks physically to be tiring these days, possibly unwell, and losing the acquisitive ambition he used to have. Vladimir Lisin needs more coking coal to support the planned expansion of his Novolipetsk steelmaking group, but he is reported to be unwilling to add to Novolipetsk’s indebtedness for as much as VEB is claiming Raspadskaya is worth.

That leaves a couple of dark horses, without track records of handling (and returning) $5 billion worth of state money – and Zyuzin. But he has proved extremely reluctant, even when facing severe debt pressure in 2008-2009, to accept VEB financing on account of the collateral requirements. Still, when Zyuzin has dug in his heels and made a display of stubbornness, he has eventually buckled to warnings from the Kremlin or from rivals. In December 2004, for example, premises of Mechel’s trading company were raided by armed police accompanying tax inspectors. The timing came just ahead of the state privatization auction of a 24% shareholding in Magnitogorsk Metallurgical Combine (MMK). Until the raid, Zyuzin was saying he intended to bid for the state shareholding and combine it with a 17% bloc of shares he already held, to make a takeover bid against MMK’s controlling shareholder, Victor Rashnikov. After the police raid, Zyuzin abandoned his bid and sold his MMK shares to Rashnikov, who went on to consolidate the state shareholding as well.

Better remembered in the markets was Zyuzin’s refusal to appear at a meeting of steelmakers called by Prime Minister Vladimir Putin in July of 2008 when Putin was trying to roll back rising prices of steel and coking-coal. In the two days following Putin’s threat to initiate criminal proceedings against Zyuzin for transfer pricing of coal exports (at one-quarter of the domestic level), Mechel’s share price fell from $35.51 to $16.49.

Zyuzin has been on his best behaviour ever since, and has been rewarded with state-backed bond financing for his Sakha coalmine projects, as well as federal and regional authorizations to take over the bankrupt steelmills of Vadim Varshavsky. A year ago, on July 26, 2010, Putin visited Chelyabinsk and issued Zyuzin with a public absolution. “I can only regret,” Putin said of his remarks in July 2008, “that this caused the company’s capitalisation to fall by 20%, if I am not mistaken. Anyway, Mr Zyuzin, I want to thank you for everything you did and your continued respect for domestic consumers and Russian law.”

Putin may have wanted to bury his hatchet, but US shareholders in Mechel have continued a class-action lawsuit against the company for the violations Putin had identified and the equity value losses the US investors suffered as a consequence. The case was still pending, without judgement from the federal US District Court in New York (Southern District), when Mechel filed its annual report for last year on May 9, 2011. American jurisdiction holds because Mechel has been listed on the New York Stock Exchange since 2003, and is subject to the US Securities and Exchange Commission (SEC) and its regulations.

A year is a long time in Russian politics, and last week the lights appear to have started flashing red again inside Russia. An armed police raid occurred on July 6 at Mechel’s Chelyabinsk steel mill (ChMK), ostensibly in pursuit of evidence in a federal government tax claim. Mechel has acknowledged that the gunmen were accompanying tax inspectors conducting an audit for 2008-2009. Spokesman for Mechel, Yekaterina Videman, told CRU Steel News “the tax authority is carrying out a scheduled field inspection of ChMK. As part of the activities in accordance with the Tax Code, a variety of measures of fiscal control is being carried out – discovery of documents, interviewing the staff, viewing the area, scheduling of an expert evaluation, etc. On July 6, 2011 the tax authority carried out inspection of several plant shops. As the representatives of the tax authority said, the special police unit was present to ensure the physical security of the inspectors (as provided by law). There was no real need for the presence of the special police unit because the employees of ChMK did not, nor were going to, resist the inspection of the plant territory. All the representatives of state agencies were admitted to the plant.”

These events could be nothing more than disgruntlement on the part of the tax men in their three-year battle in the domestic courts against ChMK. That litigation has focused on rebates of value added tax claimed by ChMK but not repaid by the tax authority. Last year, the sums involved in the court claims went as high as Rb33 million ($1.1 million). But the court rulings have generally gone in ChMK’s favour against the Federal Tax Service.

US investors in Mechel have expressed concern before that in his 8-year listing record, Zyuzin has made much less disclosure than would be required by US regulators if Mechel were domiciled in the US, as well as listed there. Since Zyuzin ran up more than $5 billion in debt at the crash of 2008, Zyzuzin has undertaken a number of transactions without making clear what the cost and risk to shareholders may be. In 2009 Zyuzin’s reports to the SEC acknowledged that in the aftermath of the crash, the company violated many of its loan covenants, particularly the required debt to earnings ratio. Since then it is unclear how further asset acquisitions by Mechel and Zyuzin have been paid for and agreed with the lenders.

But is it likely that the New York or London Stock Exchanges, the US or UK regulators, will allow Zyuzin to raise his leverage even higher than it was at the crash of 2008, and reward him with a rising share price for both Mechel and Mechel Mining? The answer to that is – do you believe in miracles?

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