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By John Helmer, Moscow

Let’s hear it for Polymetal’s control shareholders – they have devised a scheme that appears to have fooled much of the Moscow market, but few in the London market. By moving Polymetal to the main board of the London Stock Exchange (LSE), they have camouflaged a free floating share bloc which isn’t, in order to create a better share-price platform to sell out. And that is what is known in the toy balloon business as a prick.

Polymetal is the creation of Alexander Nesis and a group of his long-time St. Petersburg partners. They have skilfully moved in and out of the gold and silver mining company, generating substantial profit for themselves, and also for the investors behind Suleiman Kerimov. At present, Polymetal is the second largest gold producer in Russia, trailing Polyus Gold. Counting the gold equivalent of its silver output, Polymetal is currently at an annual production level of 817,000 ounces, growing at an annual rate of 21%. In terms of reserves, Polymetal reports gold of 11 million oz, and 369 million oz of silver. With a current market capitalization of ₤3.6 billion ($5.8 billion), it is 60% of the value of Polyus Gold at $9.6 billion.

Here is Renaissance Capital’s most recent charting of Polymetal’s control shareholders, prior to the Russian-domiciled company’s reversal into, and share swap with, the Jersey Island-registered Polymetal International (POLY:LN), which took place at the end of October:

An analysis by Alfa Bank metals analyst Barry Ehrlich revises and clarifies these stake figures – prior to the transfer into Polymetal International, the Kellner stake was about 20%, the Nesis stake 17.2%, Mamut 9.7%, and Mosionzhik (see image), 4.3%. Their total came to 51.1%. The free float was 40.3%, leaving company-owned treasury shares amounting to 34.5 million in number, or 8.6% of the total issue.

The requirements for listing the new Polymetal International on the LSE as a non-domiciled company include a free float of 50%, so Polymetal failed to qualify at the outset. The scheme used to cross the 50% threshold was a series of September transactions in which the Moscow brokerage and investment bank Otkritie agreed to a $250 million loan and repurchase transaction covering 34.5 million shares belonging to Polymetal and classified as treasury shares. Here’s the announcement of that deal on September 28. Officially, Polymetal was claiming it needed the money to refinance $216 million in short-term debt, and was happy to pay a premium interest rate to get hold of the cash.

There was another purpose, though. By reclassifying its treasury shares as Otkritie’s collateral, Polymetal was able to slip the shares into the free float by a bookkeeping device, even though the shares remain under control of the company and control shareholders, and Otkritie is not free to sell them – unless Polymetal defaults when the repurchase (repo) agreement falls due in August next year. An Alfa Bank report, dated November 2, told clients: “since POLY is obligated to repurchase the shares, these shares do not represent a third party economic interest in the company and thus should not be considered as part of the outstanding share count, we believe.”

Still, that bloc of shares fell 13.8 million units short of meeting the LSE free-float eligibility condition – and it is now clear that the Polymetal control shareholders thought up a second scheme for their balloon to take off. This has been reported by Alfa Bank metals analyst, Barry Ehrlich. According to the LSE listing rules, a shareholding of less than 5% may not be classified as part of a strategic control stake. This has enabled Mosionzhik and his holding company MBC, to join the free float, even though this stake hasn’t been termed free float in previous Polymetal disclosures and reports. Reports Ehrlich: “it appears that MBC’s stake reclassification to free float is consistent with FSA listing rules allowing stakes under 5% to be classified as free float.”

Polymetal was asked to provide a breakdown of the number and percentage of shares now owned by Kellner, Nesis, Mamut, and Mosionzhik. It won’t.

A report this week by Andrew Jones of Renaissance Capital describes Polymetal’s market manoeuvre as “surprisingly successful, in our view, given the potential arbitrage available from rejecting the swap and volatile markets. $770mn was raised vs the planned $500mn, a result of pricing the offer at GBp920/share – a 32% discount to the levels of late August. This was dilutive for existing shareholders, but provides a buying opportunity in the aftermarket, in our view.” Jones proposes a 26% increase from current share price of GB pence 924 to a target price of GBp 1,166.

According to today’s chart from Bloomberg, Polymetal is going in the opposite direction and is between 877 pence and 920 pence.

Uralsib Bank analyst Valentina Bogomolova is also enthusiastic. “With the IPO complete and a 51.5% free float in the new entity, a majority of independent directors on the board and sufficient size at a market cap of over $6bn, Polymetal should have complied with all necessary requirements for FTSE 100 indexation ahead of the next rebalancing in December. We expect Polymetal’s attempt to be successful, and this to serve as the major near-term catalyst for the stock. Liquidity will improve, trackers and benchmarked funds will buy in and we expect the stock to achieve a re-rating.” Bogomolova invites punters to bid up the stock price by 55% “given our expectations of strong gold prices and production growth in 2012-13.”

VTB is projecting an even bigger share price gain of 62%. Said an October 31 report by Alexander Pukhaev: “in our view, with the major risk of a stock overhang now gone [sic], Polymetal International’s share price is no longer capped. Were the FTSE commission to decide to add the company into the FTSE100 index, that would be a strong medium-term catalyst for the name. We are initiating our coverage of Polymetal International (POLY LN) with a Buy recommendation as our 12-month Target Price of USD 24 (GBp 1,480/share) implies a strong 62% upside potential. We believe that the company is well positioned to deliver on its ambitious growth plans (a 20% output CAGR in 2010-13) resulting in solid financial improvements (an EBITDA CAGR of 50% over the same period).”

The RenCap report by Jones concedes there are problems for the Russian goldmining sector which may deflate the balloon a trifle. Rising production costs, a stronger rouble, falling gold grades at existing mines, rising capital expenditure requirements for new mines, and for Polymetal, more than $921 million in existing debt, are all negatives. As a silver as well as gold producer, Polymetal will suffer if its silver output falls in value in relation to the price of gold. And of course, there is uncertainty about the future direction of the gold price:

According to Jones, if profit margins dwindle, there won’t be enough dividends to inspire confidence in the marketplace. “Cost inflation has limited margin expansion. Gold majors cannot return significant cash to shareholders in a $1,700/oz gold price environment, which highlights the problem.”

There is also the question-mark which the Russian government regulator, the Federal Antimonopoly Service (FAS), has raised in recent days about whether to approve, or disallow, such manoeuvring of domicile and listing for strategic gold assets, not only by Polymetal’s owners, but also by Polyus Gold, which belongs to Kerimov and Mikhail Prokhorov.

Two charts from Rencap illustrate how weakly the Russian goldminer share prices have been performing this year, especially Polymetal and Polyus Gold:

Compared to the Moscow consensus, Ehrlich’s reporting comes closest to substantiating the negative sentiment now circulating in London. In a November 2 report to clients, Ehrlich reported that earnings projections are 40% too high because they are based on “unrealistic volumes and silver price assumptions…. We believe investors will be disappointed.” According to Ehrlich’s calculation, Polymetal currently has an 8% upside chance, but also a 20% downside.

So what sense to make of the move to the LSE, if there is a serious risk the share price will fall?

Ehrlich reports to clients: “Some have speculated it is part of an asset protection strategy linked to the Russian elections. This argument is not convincing because the assets are not protected by a move to a non-Russian domicile / FTSE listing. An attack would likely come at the asset, not the company level, through mining licenses, safety regulations, or taxation. Nor do we believe that political support would be lent to the company by the UK government in the event of an attack merely from being recently domiciled outside of Russia.”

“This leaves us by process of elimination with one likely motivation: The owners of the respective companies would like to exit their ownership positions at some point in the future. A sale or merger by a foreign strategic buyer would be easier for a non-Russian-domiciled entity. Polyus’ stated intention to merge with a global major may contain a portion of the truth – the real reason behind the move appears to be to provide an easier exit for core shareholders through a company sale or merger into a larger entity.”

Stakeholders like Mamut and Mosionzhik are considered in London to be the most likely to sell, as soon as they get the chance. Speaking in another idiom, that’s what is meant by the balloon going up.

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