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Some people like to watch the sun going down.

Alexei Mordashov, the third-ranked Russian steelmaker, and a 40-year old man with enormous personal vanity, has been persuaded by some desperate, but clever fellows in Luxembourg that, to watch his own sun going down, and exiting Russia, Mordashov should pay a ticket price of $2.7 billion. For the time being, that costly blaze of light has blinded the world’s business media, and also the Russian stock brokerages, to what the Arcelor-Severstal merger really means, at least in Russia.

For the first time, a Russian metals oligarch has sold out of his business, following oil oligarch Roman Abramovich on the well-trodden path out the exit door, marked by the approaching changeover in the Russian presidency. Unlike Abramovich’s sale last year of his Sibneft oil ^ enterprise to Gazprom, the Russia’s largest enterprise, Mordashov’s exit allowed, apparently and for the first time, a foreign-owned corporation to acquire majority control of a strategic Russian metalmaking enterprise, plus its iron-ore and coalmines. The only comparable -‘oligarch exit in favour of a foreign company like this was the sale by Victor Vekselberg, Mikhail Fridman and Len Blavatnik of their Tyumen Oil Company (TNK) to British Petroleum in February 2003. That deal was allowed by Putin, just before the Americans launched their war against Iraq, when the Kremlin had reason to fear a collapse in oil prices might push the heavily indebted TNK, other Russian oil producers, and the Russian banking system into bankrupcy. When, afew weeks later,Mikhail Khodorkovsky asked Putin to allow his sale of up to 40% of the Yukos oil company, Putin said no, twice. Everyone knows what happened to Khodorkovsky for not listening.

Whether the Kremlin, which has designs on one, possibly two other steelmakers — Alexander Abramov of the Evraz group, and Igor Zyuzin of the Mechel group — had been pushing on Mordashov, or whether he rode off into the sunset by choice, is still far from clear. Asked to say if President Vladimir Putin, who spent an hour meeting with Mordashov on May 16, and the next week met with a group of European Union officials, had heard of the Arcelor buyout from either, or had approved the deal in advance, Putin’s spokesman refused to confirm, telling Russia Journal “we do not have such information.” No one in the Russian steel business believes that Mordashov would contemplate an exit, and the sale of Severstal to foreign control, without Kremlin approval. According to one of Mordashov’s biggest Russian rivals, “the reasons of [Mordashov’s] meeting with Putin were obvious. Severstal has a strategic meaning for the Russian economy. Such decisions never made without approval.”

There are reasons better left unsaid why Kremlin officials do not advertise the obvious. But if the Kremlin approved in secret, Putin is reserving the opportunity to say no publicly, when the government anti¬trust agency, the Federal Anti-Monopoly Service (FAS), must review the terms of the proposed deal, and issue a ruling either approving, rejecting, or modifying it. The FAS does what it is ordered to do by its superiors. It was the agency by which the Kremlin slowed down the sale of two aluminium rolling-mills by Oleg Deripaska’s Russian Aluminium (Rusal) to Alcoa of the US. It was also the agency which forced Siemens of Germany to abandon a bid to buy control, and nickel oligarch Vladimir Potanin to sell out of a turbine builder and heavy engineering firm, proposing a minority stake transfer instead.

There has been speculation in the press that Putin doesn’t like Lakshmi Mittal, and refused to meet him last year, after Mittal had won control of the Ukrainian steelmaker Krivorozhstal, and proposed talking about his steelmaking ambitions there, in Kazakhstan, and Russia as well. If Putin wanted to say no to that, refusing to meet was a polite form of discouragement. For the episode to trigger the idea that Putin encouraged Mordashov to plot with Arcelor, and the governments closest to it — France, Luxembourg, Belgium — to frustrate Mittal’s hostile takeover attempt is unlikely.

For one thing, the Arcelor deal with Mordashov, announced last Friday,had already been rejected by another Russian steelmaker, Vladimir Lisin — owner of the Novolipetsk Metallurgical Combine (NLMK) — because it violated the golden rulebook of the Russian steelmakers:

1. Russians never buy minority stakes below the control, or at least veto level.
2. Russians steelmakers never spend more than $1 billion of their own, or their company’s cash on an acquisition.

According to the terms announced by Arcelor to date, subject to a Luxembourg shareholders’ meeting in a month’s time, and what Mittal may devise as a counter- bid strategy, Arcelor and Severstal claim to have agreed to a “merger”. Mordashov will acquire 32% of Arcelor, while the Severstal units, at least in Russia, will keep their Russian name. Arcelor’s existing shareholders will retain 68% of the company. The combination of companies “will be the Number 1 steel company in the world with Eur46 billion in sales.. .and 70 million tonnes of production.” If the terms are not implemented, Mordashov will earn a deal-break fee of Euro 140 million.

“I do believe in this very much”, Mordashov said repeatedly during a press conference with Arcelor executives on Saturday. Was he trying to convince himself?

Examining the financial terms of the deal, Mordashov receives a position in Arcelor, which according to share values and market capitalization the day before Friday’s deal, should have cost Euro7.3billion, or about $9.3 billion. The official announcements indicate that for this Mordashov is transferring his 89.6% shareholding in Severstal; they include relatively easy to value assets of Severstal North America — the Rouge mill in Michigan, a planned auto steel plant in Mississippi, and the Mountain State Carbon venture with Wheeling-Pittsburgh to build coke batteries. At last Thursday’s market valuation, Severstal was worth $6.5 billion, and thus leaving aside the minority shareholders, Mordashov’s stake was worth $5.8 billion.

In addition, Mordashov is handing over the Russian iron-ore and coal 1 assets he has been planning to sell back to his own company at an ‘r elevated value, $4.3 billion; plus the personally held stake of 42% of the Italian steelmaker Lucchini, acquired a year ago, but not yet fully transferred to the Severstal balance-sheet; this is worth $239.4 million. Altogether, Mordashov’s asset transfers to Luxembourg add up to $10.34 billion. It is customary for foreign buyers of Russian assets to apply what is known as the Russian risk discount, which acknowledges 3 the possibility that the methods by which the assets were acquired were illegal, and could be reversed by the federal government in Moscow; or i that the cashflow accounting by which the management enriched themselves and their shareholders might have violated Russian tax and fraud laws, not to mention the international money-laundering statutes. It is thus not surprising that Mordashov’s asset value exceeded by more than $1 billion the Arcelor value he received in exchange.

But the deal announcement also indicates that Mordashov agreed to sweeten the pot by paying cash of Euro 1.25 billion, or $1.6 billion. Media reports suggest that Mordashov will borrow to finance this part of the transaction. The grand total proffered therefore was $11.96 billion. The difference in Arcelor’s favour is $2.66 billion.

In its announcement, Arcelor Board of Directors said it “believes that the merger with Severstal fully recognises the value inherent in Arcelor, and offers Arcelor shareholders superior industrial logic, greater value and the highest standards of corporate governance compared to Mittal Steel’s offer. Therefore, we believe that this deal is in the best interests of Arcelor’s shareholders.” Mordashov’s pricing allowed Arcelor to claim that its share value was Euro44 ($56.23), a premium on over Arcelor closing price on 26 January, the day before Mittal announced its takeover offer. This price is also Euro 6.26 ($8) over Mittal’s latest offer for Arcelor, announced on May 16.

Mordashov has been announcing publicly since 2004 that he wishes to be the world’s largest steelmaker, or at least the equal of Mittal and Arcelor. Mordashov initially told a steel industry conference that he anticipated “a situation in the steel industry where within a few years four to six companies each had a capacity of about 100m tonnes of steelmaking per year. We would like to be among those companies.” But even with Rouge’s and Lucchini’s output added, Severstal’s aggregate output has been unable to breach the 20-million ton mark. Until now, to meet his ambitious target, Mordashov had more than 84 million tons still to buy. The task was too big for the ambition.

But to sell out his assets to Arcelor is also inconsistent with Mordashov’s ambition. The Luxembourg directorate therefore found the means to make their Russian minority stakeholder feel good. Mordashov, Arcelor announced, is to be appointed the non-executive “President” of the Arcelor board of directors, and have the right to appoint 6 of 18 directors. As the current chairman of the board, Joseph Kinsch, will retain his position, and chief Executive Guy Dolle as well, Arcelor appears to have created a double-headed eagle to symbolize the change, without an underlying shift in management control. Russian oligarchs never spend a billion dollars without acquiring control, unless they are playing a portfolio share-game, and Mordashov has signed a 5-year lockout agreement to prevent him doing that. The small print in the Arcelor announcement reveals what little power Mordashov has acquired at so high a price: “Arcelor’s executive management will remain in place, supplemented by Severstal executives…Mr. Mordashov has agreed to vote his shares in accordance with the recommendations of the Board of Directors.”

The only explicit statement of a Russian government official has so far come from Alexei Kudrin, the Finance Minister. ” I basically consider,” he said, “that Russia goes on to the world markets, and we welcome cases when business itself finds to itself of favour with foreign partners. This is a certificate of trust to Russia as a whole.” In some countries, finance ministers are powerful figures. Russia is not one of them, and Kudrin conducts his portfolio with the ever-present fear of being replaced, and the anxious hope of being restored to the deputy prime ministership which he lost last year. The Finance Ministry and the Ministry of Economic Development and Trade have long favoured Severstal’s lobbying campaign to have the government adopt steel trade arrangements with the European Union and the US which benefit Severstal, at the expense of other Russian steelmakers and the rest of the Russian economy.

Kudrin must have been forgetting a dossier that has been accumulating dust on his heavily loaded desk. That is the one which investigated Severstal’s tax avoidance practices. In a confidential report of the federal Tax Ministry of September 2004, delivered to the Prime Ministry but not acted upon at the time, it was noted that Severstal was paying tax at between 12% and 14% of revenues, far less tax than the norm among Russian oil exporters, by employing a variety of transfer pricing and tax optimization schemes. Another study indicates that Severstal had underpaid its 2003 tax bill by $40 million via tax optimisation schemes based in the Russian republic of Kalmykia.

A tax bill of so little is not the stuff of which the downfall of oligarchs is made. Kudrin’s forgetfulness is indicative of the way he perceives the Kremlin flag is blowing, at least towards Mordashov’s enterprise. Had he been asked whether the Kremlin intends — through monies held in trust by Abramovich — to buy out Abramov’s control stake of Evraz — he might not have wished to say anything at all. Kudrin is not a decision-maker of consequence.

Mordashov has had commercial enemies in the past, and in Russia such enemies often seek ministerial and Kremlin support for their schemes. Mordashov’s biggest rival was the copper and coal oligarch, Iskander Makhmudov. He helped finance a court challenge to Mordashov’s shareholding, but then abandoned it. Makhmudov has steel sector ambitions, but he has even fewer friends in government than Mordashov.

And so the one person on whom Mordashov’s future in Russia depended was President Putin. Their meeting together at Putin’s summer residence in Sochi two weeks ago provoked a great mystery. On the surface, it appeared to be the longest conversation ever conducted on large-diameter pipemaking by a Russian president, and perhaps the longest ever held by any head of state.

Mordashov also told Putin that “in Cherepovets 250 children every year abandon their homes. Who will work at our enterprises and who will live in our cities? It for us even a personal problem.” Putin responded that “it is healthy, that you, in business, understand this sort of thing.” Asked whether Severstal management has been cutting jobs at its plants, a spokesman for the Russian company told The Russia Journal that the payroll at the Cherepovets plant was 35,589 at the end of 2005, down 183 jobs from 2004. At the Rouge plant in Detroit, Severstal has cut 600 jobs since it took over, 22% of the pre-sale workforce of 2,700.

The Kremlin transcript reports Mordashov as telling Putin: “We hope for a great volume of orders [of the LD pipe] from our country.” “Including for the North-European gas pipeline,” Putin asked. “Undoubtedly, our first priority is deliveries for the North-European gas pipeline,” Mordashov replied, referring to the project in which Vyksa and the UMC are already well advanced in supplying Gazprom, the principal Russian project partner. “And how do you build relations with possible customers?” Putin asked. “We perfectly well understand that this is fundamentally important for us. First of all – Gazprom. We have had a working group with Gazprom from the very beginning of [plant] construction. Gazprom…is for us the most important and fundamental customer.” He went on to tell the president that the key issue for Severstal now is “to provide high quality of pipe in absolutely new conditions. An underwater gas pipeline.” Putin asked Mordashov if he remembered where pipes were sourced from for the Black Sea Bluestream project supplying gas to Turkey. “I do not remember, Mordashov said. “Perhaps Japanese or German pipe was used.”

“It is necessary that your quality should be better [than the imports]”, Putin said. “For us, it is fundamentally important to make good steel. This is a big technological call, but I think we shall meet it.”

If Putin and Mordashov had been secretly chatting about the prospect of a Luxembourg-based European steelmaker taking entire control of Severstal, its pipemaking division included, this apparent reference by Putin to beating European imports of pipe looks, in retrospect, to be ludicrous camouflage.

Putin then changed tack, asking Mordashov for other details of the Severstal group, including payroll numbers at both the domestic steelmaking and the automobile divisions, and at Severstal’s plants abroad. “How do you estimate the technological level at your enterprises abroad?” Putin asked. “With us, no worse [than others]. Everyone has advantages. But as a whole, certainly, we are better.” Mordashov claimed that in buying out bankrupt plants in Italy and the US, Russia was “reviving” the industry. “And how are social questions solved at your enterprises?, the president asked. “Except for us,” he said, “nobody can provide quality of life to our workers. This is the situation as it has developed historically in Russia.” He told Putin that Severstal operates at a youth camp in Cherepovets for 2,500 children, plus an ice-hockey team.

In short, Mordashov tried to pull the wool over Putin’s eyes regarding the social welfare policy he has been implementing, beyond youth camps and hockey games. But can he have dared to speak to the President about caring for young runaways from Cherepovets, when Mordashov himself was running away from Russia?

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