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By John Helmer in Moscow

A client alert was issued Thursday by Deutsche Bank analyst Olga Okunova, warning that even if the Mechel Group succeeds in refinancing a $1.5 billion loan, which has been overdue since March, the group faces serious cash shortage and debt service problems this year and next.

Mechel has made new information available to shareholders and banks, though not in a public news release, ahead of the scheduled annual general meeting (AGM) of shareholders on June 30. This identifies problems with creditors, who have loaned Mechel $2 billion for the purchase of fareastern coal mining assets, including Yakutugol, which the group controlled by Igor Zyuzin won at a state auction in October 5, 2007.

Mechel won the large but relatively undeveloped assets with a bid ofRb58.196 billion (then $2.3 billion), defeating Arcelor Mittal and Alrosa. Zyuzin then raised $2 billion in new loans to finance the acquisition. The money was provided in the form of a 5-year loan for $1.7 billion, secured for repayment by coal exports; and a smaller 3-year loan of $300 million, apparently secured by shares. The original lenders were ABN AMRO, BNP Paribas, Calyon, Natixis, Sumitomo Mitsui Banking Corporation Europe Limited, Société Générale Corporate & Investment Banking, and Commerzbank Aktiengesellschaft. Sumitomo had already been identified as a financial backer for Mechel to expand its coal output, and exports to Japan, from the Yakut coalfields. The assets included the issued share capital of Yakutugol (75% of the statutory issued share capital minus one share), Elgaugol (68.86% of the statutory issued share capital), and the real estate complex of a railway and a road from the Zeysk Railway Station (Far Eastern Railway) in Zeysk to the Elga coal deposits.

It appears from the latest Deutsche Bank report that the five-year term of the loan, requiring repayment in 2012, was foreclosed by the banks, because of loan covenant breaches by Mechel that have not been disclosed before.

According to the Deutsche Bank report, “apart from restructuring the USD 1.5bn Oriel Resources bridge, where Mechel managed to reach some progress and expects to sign the final agreement by July 15, Mechel is also in talks with creditors in regards to the USD 2bn Yakutugol loan. This loan was raised at the end of 2007 to finance the acquisition of Yakutugol and its terms were very favourable. Given that this loan was a preexport financing (PXF) facility (i.e. it was collateralized with future coal exports), the interest rate was just LIBOR+1.5%. The debt covenants on this loan were broken in 2008 and now the company is trying to renegotiate the terms with the syndicate banks, which include ABN Amro, BNP Paribas, Calyon, Natixis, Societe Generale, SMBC and Commerzbank.”

Mechel has announced that it wants to put a limit on the shareholdings it is prepared to put up for security for the refinancings now in negotiation with the banks. But it has not said publicly how much of the unit and group shareholdings Zyuzin has already pledged.

In the AGM materials that have been publicly released, Mechel says it is prepared to pay an interest rate on new lending of 6% to 7%, and to limit the fresh collateralization at 35% of the Zyuzin’s main mill, the Chelyabinsk Steel Plant; 50% minus one share in Oriel Resources, the ferroalloy producer acquited in March 2008 for $1.5 billion; and a minority stake in Southern Kuzbass.”

The Deutsche Bank report warns that Zyuzin has already been obliged to pledge blocking stakes in the Siberian coal producer Southern Kuzbass and in Yakutugol, thus limiting the security available to cover the loans now in refinancing talks. “Please remember,” writes Okuneva, “that Mechel had already pledged the blocking stakes in Southern Kuzbass and Yakutugol for the USD 1bn the Gazprombank loan raised in January 2009.” Unstated is the earlier indication from Mechel that Zyuzin had opted for the Gazprombank loan, because its collateral conditions were less demanding than those required by the state bailout bank, VEB, chaired by Prime Minister Vladimir Putin, which reportedly offered Mechel a comparable loan, after Mechel had applied for the bailout late last year.

According to Deutsche Bank, there is reason for concern that Mechel’s expected revenue for this year will not exceed $4.8 billion, and that its net profit will be a negative $192 million. According to Okuneva, “the most worrying thing is that even after restructuring the USD 1.5bn Oriel bridge (USD 500m to be paid in 3Q09, followed by a one-year moratorium for principal payment) and the USD 2bn Yakutugol PXF loan, Mechel still has to pay USD 913m in short-term debt in 3Q09 and USD 710m in 4Q09. Add to that USD 723m in capex, over USD 300m in dividends and the likelihood of a negative free cash flow for FY09 and one can get a full picture of Mechel’s liquidity challenges.”

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