What made Mordashov stop and think

by Simon Pirani

When Severstal lists its shares on the London stock market this month [November], its main owner Aleksei Mordashov may well reflect not only on future takeover bids… but also on what might have been.

A listing on a big western exchange might have given Severstal the added firepower it needed when it tried, and failed, to merge with Arcelor earlier this year, bankers in Moscow say.

And once the talks with Arcelor broke up in June, one of Mordashov’s first decisions was to push forward the company’s initial public offering (IPO) in London, which could raise up to $1.5 billion and value Severstal at more than $12 billion.

One banker with knowledge of the deal said: “There were political considerations that made the Arcelor deal difficult, but these may have been overcome by a stronger commercial incentive for Arcelor shareholders. And a London listing would certainly have helped.”

A share price quoted in one of the world’s main financial centres offers the wider investment community a price it can understand, and enables companies to offer their own shares as payment in takeover deals. In Severstal’s tussle with Mittal over Arcelor, investment bankers’ valuations and a Moscow listing turned out not to be enough.

Severstal has now retained Citigroup, UBS and Deutsche Bank to arrange its IPO. Much of the documentation used for the Arcelor bid can quickly be adapted for the offering, enabling it to be prepared relatively quickly – in five months, rather than the usual 12-18.

Severstal now finds itself catching up with a trend: IPOs have become de rigeur for Russian metals companies, both ferrous and non-ferrous, whose gigantic cash piles have turned them from hunted to hunters in the mergers and acquisitions (M&A) game.

Jan-Teun van Efferink, ABN Amro’s corporate director with responsibility for metals in Russia, says: “Six or seven years ago, many Russian companies looked to the rest of the world for help, support or money. But now it’s about how they can expand. I would not be surprised to see some more big takeovers by Russian producers in the next two or three years.”

And Rob Edwards, metals analyst at Renaissance Capital, the Russian investment bank, points out: “Magnitogorsk is a Russian Posco in terms of efficiency and product quality. And Novolipetsk is the highest margin steel maker in the world.”

Severstal’s London IPO will follow the pattern set by Mechel in 2004 (in New York), and Novolipetsk (London) and Evraz-holding (Luxembourg) last year, by listing only a minority of its shares, around 10%. Magnitogorsk steel works, which has mandated ABN Amro, Morgan Stanley and Renaissance Capital to arrange a London IPO in the first half of next year, will sell a similar proportion.

For these are more about paving the way for M&A than about raising cash. Sergey Donskoy, metals analyst at Troika Dialog investment group in Moscow, says: “These companies need the IPOs in order to be valued, to become more transparent, and to turn their shares into a currency that they can use for M&A activity.”

Of all the Russian steelmakers, Severstal most of all “wants to be part of the global consolidation game”, Donskoy says; its purchases of Lucchini and Rouge Steel presume an upside in improving efficiency. Its strategy contrasts with the straightforward approach of Evraz-holding and Novolipetsk, who seek to move downstream to supplement their slab capacity, as evidenced by their purchases, respectively, of the Italian reroller Polini and Bertoli and Dan Steel.

Once Magnitogorsk lists, all Russia’s big five steelmakers will be on the international map. But the IPOs don’t stop there: the pipe maker TMK listed in London and Moscow last month [October], perhaps paving the way for its part-owners Sergei Popov and Andrei Melnichenko to cash out. Chelyabinsk Pipe plans to follow suit.

Other metals companies that plan IPOs this year or next, either locally or internationally, include Inprom, Magnesit, and Polyus, Polymetall and KGD gold companies. And investment bankers are licking their lips at the thought of mandates from the big Ukrainian steel producers: first to go may be Rinat Akhmetov’s SKM group, whose representatives say it would like to be ready to IPO in two to three years.

But the IPO to top them all may arise from the merger of Rusal, Sual and Glencore’s aluminium and alumina assets. The three sides were last month reportedly close to agreement that they would respectively own 65%, 21% and 14% of the new company, which would be the world’s largest aluminium producer with a market capitalisation of about $30 billion. Morgan Stanley and JP Morgan are advising Rusal and Sual respectively.

Moscow-based bankers say Sual is insisting on a commitment from Rusal that the new company be listed on the London stock exchange within three years. This, and the merger partners’ respective valuations, were the outstanding issues being haggled over early last month. Donskoy of Troika said: “The IPO is very important to the owners of Renova [which controls Sual]. It would enable them to monetise their investment at a later stage.”

It is widely assumed that the Rusal-Sual talks have the blessing of president Vladimir Putin, who has talked about building “national champions” in a range of industrial sectors to push Russian interests. Some even suggest that other “national champions” could be in the making – in the steel sector, or on the basis of such companies as the gold miner Polyus or the titanium maker VSMPO-Avisma. No Moscow financier doubts that Kremlin assent is vital for the aluminium mega-deal – but some say the political factor should not be exaggerated.

Edwards at Renaissance says: “After [Roman Abramovich’s holding company] Millhouse bought in to Evraz last year, people talk about Evraz as being favoured by the Kremlin as a consolidator in the steel sector. I am sceptical.

“I don’t see a particularly political agenda. I see a commercial rationale for taking relatively cheap Russian steel assets and putting them in an existing London hub, in the form of Evraz, thus achieving greater critical mass and greater relative asset values.”

Development strategies are driven mainly by markets; the state encourages strong Russian companies but doesn’t necessarily invest in them. VSMPO-Avisma, of which Rosoboroneksport, the state-owned military export agency, bought 41% in September, is arguably a special case: as the world’s largest titanium sponge producer it is a vital aerospace industry supplier.

While the big players contemplate cross-border acquisitions, second-tier Russian metals companies have also transformed their finances to make capital investment. The standard pattern is a mix of ruble-denominated bonds – of which there are currently 43 billion rubles outstanding from 22 metals sector issuers – and bank loans. Locally-issued equity plays a much smaller part.

Pavel Gurin, head of corporate banking at Raiffeisen Bank in Moscow, says that the strong ruble, and the robust macroeconomic fundamentals that underpin it, has made all forms of locally-raised debt attractive.

The yields on metals companies’ rubles bonds issued this year – 7.36% for a two-year Rusal bond and 8.4% for a three-and-a-half year Mechel paper – are reasonable for the borrowers, he points out. “And Russian banks can often provide funding on better conditions than foreign banks, which is particularly relevant to second-tier players,” he says.

Estar, the special steels and pipe group, provides an example of where the second-tier groups’ finances are at. Last year the group financed construction of a rolling mill at Rostov with a secured loan from Moscow Narodny Bank, secured on export receivables from its Zlatoust special steels plant; this year its Novosibirsk pipe mill issued 1.2 billion rubles’ worth of domestic bonds; next year up it is planned to issue up to $100 million of credit-linked notes (CLNs) on the eurobond markets.

While the largest Russian players have moved from being net borrowers to net spenders, the second tier has rationalised its finances sufficiently to upgrade its capital stock. Even when world prices come down again, the Russian companies will be in an immeasurably stronger position than they were when the current boom began.
 

This article appeared in Metal Bulletin Monthly, November 2006.
Posted October 2006; © 2006 Simon Pirani
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