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By John Helmer, Moscow

When there was a Russian steel consumption boom three years ago, the domestic steel business wasn’t open to foreign steelmakers, even if they were prepared to pay premium prices to buy into Russian steel assets. And the Russian steel sector remained just as closed when the crash came, driving most of the mills to the verge of bankruptcy — that’s because discount asset values are reserved for Russian buyers. If money doesn’t talk in the Russian marketplace, who or what does?

Prime Minister Vladimir P:utin was complaining to the Germans the other day that it was unfair of Lakshmi Mittal to take over the European steelmaker Arcelor in 2006 because he offered more money for the assets than Alexei Mordashov. According to Putin, “Severstal, which has done a great deal to acquire another major company, I think it is called Arcelor, it’s located in Luxembourg – the deal was also blocked.”

Whoever briefed Putin on the competitive bidding for Arcelor which took place over nearly six months between January and June of 2006 may have referred to anti-Russian remarks that popped up at the time, but omitted the more pervasive and virulent anti-Indian ones. Putin was apparently not told also that Mordashov offered to discount the value of Severstal shares in a swap of 90% of the Russian company’s assets for a 32% stake in Arcelor, giving the foreigners $2.7 billion more in value than a fair valuation of Severstal’s assets should have conceded.

In short, Mordashov was selling out to the foreign steelmaker on terms contrived by the Europeans to block a takeover bid from Mittal, lodged four months earlier. The upshot was that Mittal raised his share price bid by 49%, and put €8.6 billion in cash up front. Mordashov’s was paid €140 million for his trouble. In the middle game, the Arcelor board, the French, Luxembourg, Belgian and other governments involved, and Goldman Sachs acting for Mittal, all calculated that the Russian assets were worth less in money terms and in political security than the Indian ones – and that Mordashov’s cash offer was far too paltry to match Mittal’s.

Putin might be contemplating privately how many billions of dollars Mordashov then went on to borrow, then lose, when he bought US steelmills instead. But he hasn’t said a word.

Instead, the prime minister claims that the bailout of Mordashov and other Russian steelmakers from their debts – the key element of the Kremlin’s anti-crisis programme – has been a big success because, in Putin’s words, “we resisted the temptation of simple solutions. It was important to ensure that there was still space in the economy for entrepreneurship, to avoid a government takeover of the economy. We did not feel this temptation, and oddly enough, businesses inquired about it. Businesses were ready to sell themselves entirely to the state, to hand all the responsibility over to the state, but again we resisted the temptation and supported the economy.”

Before the crisis struck global steel demand in the autumn of 2008, causing Russian steel exports to collapse, along with domestic steel prices, the Russian position seemed to be almost as well buffered as China, and local steelmaking production levels secure. There was virtual unanimity at the time among Moscow’s investment banks and industry analysts, not to mention the steelmakers and traders, that state intervention funding would sustain domestic demand for infrastructure building, railways, shipyards, new housing, not to mention the Sochi Winter Olympics projects in the southwest. These money flows would offset the fall in export revenues, went the political economy projections at the time.

But this isn’t what happened. The Power Vertical did give the order to spend, and the cash went duly out the treasury door. But the intervention funding failed to arrive at the point where there was genuine demand – severe domestic economic contraction was the result.

Where did the money go so successfully, according to the prime minister? First of all, it went to preventing bankruptcy and forfeits on loans which Mordashov and his oligarch peers had contracted to pursue assets abroad – Alexander Abramov and Roman Abramovich for Evraz; Igor Zyuzin for Mechel; Dmitry Pumpyansky for pipemaker, TMK. Secondly, what state stimulus spending achieved domestically for these men’s Russian steelmaking operations went to the bottom of their consolidated balance-sheets to subsidize their losses abroad and cover their foreign bank debts. This has enabled the share prices of Severstal and the others to revive – Severstal, for example, is up 94% over the past 52 weeks.

Don’t call this a Keynes Plan success for Russian steel – call it Russia’s Marshall Aid Plan for American steel and Russian oligarchs

Just two Russian steelmakers have gone bankrupt in the past three years – Nikolai Maximov and Vadim Varshavsky. Maximov’s miscalculations got the better of him even before the crash, and he sold out to Vladimir Lisin, owner of the Novolipetsk group. The collapse of the Estar group of Vadim Varshavsky followed the crisis, and has left behind bigger liabilities; the episodes of his story can be found here. The Estar assets have been divided up between Zyuzin’s Mechel group, and one of the big central region steeltraders, Metallservis. If this increasing concentration of ownership of Russian steelmaking assets is a measure of crisis plan success, then success is indeed what has happened.

And the success keeps on coming. This week, Igor Konovalov, the chief executive and controlling shareholder of Inprom, next to Metallservis one of Russia’s largest steel distributors, is finalizing the sale of his company to Evraz. Konovalov told CRU Steel News that he is in process of a merger with Evraz’s distribution company, and will make an official announcement next week. Inprom had earlier discussed buyout or joint-venture proposals with Kloeckner of Germany, Stemcor of the UK, and ArcelorMittal. But none of those deals had materialized at Konovalov’s asking price, before Inprom’s financial position went down with the rest of the domestic steel economy at the end of 2008.

Evraz has disclosed the new deal by filing an application with the Federal Antimonopoly Service (FAS) in Moscow to permit the acquisition of the market competitor. Inprom currently operates 27 major steel processing, service and distribution centres across southwestern and central Russia. Inprom’s net debt currently amounts to Rb5.5 billion ($175 million), including a bond issue, on which the group defaulted at the end of last year.

The acquisition of Inprom, reports Boris Krasnojenov, steel analyst at Renaissance Capital, “may improve Evraz’s access to the customer base in the regions with the highest activity in the construction sector, including southern Russia. Evraz has already faced visible competition from long steel producers from Turkey, Belarus and Ukraine this year. The acquisition of a large metal trader may also help Evraz to increase the share of higher-value-added steel products in its sales mix.”

By big Russian steel standards, Inprom is a minnow. But its disappearance into Evraz is a reminder, not of how competitive and entrepreneurial the Russian steel sector has become, but rather of the opposite.

Steel service centres (SSCs) are well-known in the developed metal industries of Europe and North America, because they provide steel consumers and users (housing, bridge and railroad builders; heavy engineering works; automobile plants) with the processing, batching, and delivery requirements, which the mills themselves cannot do at a profit. Up to 70% of the steel that is consumed in Europe passes through the SSC sector. Naturally, it has become an attractive target for consolidation by such companies as Kloeckner, BE of Sweden, and Ryerson, Reliance and Russel Metals of the US.

Even in a static to shrinking steel consumption market, like North America, these companies can grow by merger and acquisition, adding to their cash flow, and protecting their margins by immediately passing on their rising costs to their customers. When there is a downturn in steel demand, industry analysts believe the earnings (Ebitda) performance (and the share price) of these companies is more resilient than the steelmills.

The Russian steel sector has evolved differently, without requiring the establishment of SSCs — until recently. Because of the emphasis in the 1930s on integrating steelmaking with iron-ore and coking coal supplies, and then because of the 1941 attack by Hitler’s armies, Russia’s steel mills are monster combinations, located far to the east of the main steel-consuming centres, like Moscow, St. Petersburg, Rostov, and Yekaterinburg. Not only are they far from end-users, but they despatch such large lots of steel, intermediation is required to make this steel available and usable to those who want to buy it. There was no place in the Soviet planning system for the SSC sector. Now there is an increasing demand for the sector to process the steel, adding value to the product, before it is delivered to the end-user.

During the post-Soviet 1990s, hundreds of intermediaries sprang up to buy this steel, batch it, and trade it in the domestic Russian market. But not until there was a sustained revival of domestic steel demand has a group of traders evolved into steel processors, and the Russian SSC sector taken off. Once this started happening between 2000 and 2007, the big foreign steelmakers and steel investors saw the largest of the Russian SSCs as a potential entry-point for them to supply Russian steel consumption. The cost of that entry-point was also attractive because it didn’t challenge the established Russian steel producers, and cost a fraction of their asset worth.

Inprom was one of this new breed of Russian steel-trader turned processor and distributor, and it started by surfing the wave of the Black Sea coastal boom. As the business expanded, Konovalov borrowed domestically, firstly from banks, and then from bondholders. He contemplated an initial public offering on the Moscow market. He tried selling minority stakes to foreign steel companies, and at the outset they were keen. Kloeckner’s chief executive, Thomas Ludwig, said publicly in early 2008 that Kloeckner wanted to expand its presence in Central and Eastern Europe via greenfield projects, start-up companies, and acquisitions of existing ones. He explained his rationale: “end-users [of steel] in the region are also starting to demand additional services to basic product supply, including material management, stock management and processing services, such as sawing and cutting.” Kloeckner owns units around Russia — in Poland, the Czech Republic, Romania, Bulgaria, Latvia, Lithuania and Estonia — but was having difficulty crossing the border into Russia.

But Kloeckner’s bid to buy into Inprom was first frustrated by its conservative price which Konovalov wouldn’t accept; and then by the collapse of Inprom’s business into debt default. As Konovalov sank below the waterline, he appealed to the foreigners and to other Russian steelmakers for help. Mechel negotiated for a time. Now Evraz is close to completing its takeover.

Some of the foreigners, like Kloeckner and Stemcor, were short of cash and averse to risk themselves after the 2008 crash. If they believe in a revival of boom in the Russian steel sector, they have been reluctant and slow to show it, or to come back to Inprom. Now it’s too late. Whether any foreign steelmaker will be allowed to buy into the Russian steel industry remains to be seen. Modernization, if that is what is happening to Russian steel, belongs to the oligarchs. The big fish and the minnows are both on the hook – no prize for guessing who is pulling on and playing out the line.

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