Victor Rashnikov, 59 years old, was raised in the Soviet Union and in the ‘90s succeeded in privatizing and taking personal control of Magnitogorsk Metallurgical Combine (MMK), the country's largest steel mill, and the icon of Soviet industrialization. Thus in middle age, Rashnikov learned how to pay 1 ruble for a 500-ruble value, and keep 499 in personal profit. This was the proprietorial custom in Russia in the 1990s. It is a hard sell to metal investors in the international market today. But two of the sharpest investment bankers in the City have complicated their task by mis-wording their pitch. In so doing, they oblige investors this month to consider how much they really want to pay Rashnikov, and for what value in return.
For the first time in Russian steel investment history, the owner of a major steel maker has been identified as one of the risks investors have been cautioned about in an investment memorandum offering shares for sale.
Rashnikov, who controls about 97.32% of the shares issued by MMK, is identified as a risk at the head of his company's share sale prospectus, which was circulated in the market this week. According to the document, one of the "risk factors" of the company -- listed on a par with a cutoff of raw materials, falling steel prices, Russian economic instability, loss of operating licences, tax claims, and legal problems -- is "the ability of MMK's controlling shareholder Mr Victor Rashnikov, who is also the Chairman of MMK's board of directors and President of OOO MMK Managing Company, to exert significant influence over the MMK Group."
Proprietor risk was not identified when Alexei Mordashov floated Severstal last autumn in London, nor when Vladimir Lisin listed Novolipetsk Steel in December of 2005. In June 2004, when Evraz issued its IPO, also in London, the company prospectus warned that dominant shareholding control by Alexander Abramov and Alexander Frolov, who together held 87.3% of Evraz shares, prior to listing, carried the risk of "conflict with the interests of holders of the GDRs." To mitigate this, Evraz said "it continues to seek to conclude all related party transactions on an arm's-length basis."
Rashnikov's shareholding control has been revealed for the first time in the prospectus, which MMK refused to provide Mineweb. However, copies were leaked to the Russian media for promotional purposes this week, as MMK's roadshow presentations in London got under way. Rashnikov is on the roadshow, his spokesman said, but he is not answering Mineweb's questions.
The prospectus was drawn up by the IPO managers -- ABN Amro Rothschild, Morgan Stanley, Renaissance Capital, and Gazprombank. Legal advisor for the issue is Linklaters. Rashnikov has changed bankers for this share issue several times; MMK's auditor was also changed from KPMG to Deloitte Touche last year.
At over 97%, Rashnikov's control of the company is near-total --greater than the other oligarchs who have already listed the major Russian steelmakers. Rashnikov's shareholding comprises blocks of shares held by Mintha Holding Ltd., a Rashnikov company registered in Cyprus, holding 42.44%; Fulnek Enterprises Ltd., holding 43.11%; a block of 7.37% which Rashnikov traded to a Deutsche Bank company last June, with the obligation to buy it back by June of 2009; and a block of company treasury shares, amounting to 4.4%, which Rashnikov indirectly manages through his control of MMK and MMK's managing company. Just 2.68% of the shares issued are not controlled by Rashnikov; these are identified as a free float held by 8,100 shareholders.
MMK spokesmen told Mineweb they cannot explain or clarify Rashnikov's repo deal with Deutsche Bank last June. If this was done at a discount to the prevailing market value of MMK's shares, it would have netted Rashnikov between $500 million and $600 million. This is roughly equal to the cash sum Rashnikov may be hoping to earn for himself from the IPO.
The only seller of shares identified for the MMK IPO in the prospectus is Rashnikov himself, through Mintha. Share-buyers are being invited to buy a minority stake of between 10% and 14%, paying Rashnikov a 9% premium over current market valuation, according to the pricing advertisement MMK issued this week. The share transaction should close at the end of April.
The IPO, according to the prospectus, is to take the form of a new share issue of 1.45 billion shares (13.6% of the current issue), which will be offered for sale, along with 2.86 billion shares from Rashnikov's Mintha holding (63%). The effect of the dilution on his remaining stake is not disclosed; it is unclear how much of the new share issue Rashnikov will buy back, and how much will be available for the free float. The prospectus says only that Rashnikov "intends to use all of the proceeds...to subscribe for newly issued Ordinary shares in the open subscription". If a target fund raising of $1 billion is achieved, as MMK's press statements suggest, then it appears Rashnikov will leave his company with less than $500 million of the new money. This may be spent, according to the prospectus, on "capital investments to be made as part of MMK's modernization investment programme and other general corporate purposes."
MMK reports a plan to invest $5.2 billion on capital projects for the next five years. Almost half of this is projected for investment in new steel rolling plant. Last year the company reported revenues of $6.4 billion, and after-tax profit of $1.4 billion. Cash on deposit at the start of this year was just over $1 billion. Capex for this year is planned at $782 million; for next year, $954 million.
Strange to relate, in this investment plan MMK says almost nothing about its mining investment in iron-ore, coal, and limestone. The mill is currently supplied by a company limestone mine, and just $58 million is projected for investment there over the next five years. More than three-quarters of MMK's iron-ore supplies are contracted for the next decade from a Kazakhstan mine. This is naturally cheaper than investing in iron-ore mines. But it is less secure from an operating and profitability perspective. And so, according to the prospectus, "to supplement its purchases of iron ore from third parties, MMK has recently made strategic acquisitions of iron ore sources, such as its acquisition of a licence to develop the Prioskolsky iron ore deposit in December 2006 and its purchase of a 51 per cent. stake in OOO Bakalskoye Rudoupravleniye, a Urals-based iron ore producer, in January 2007. MMK also owns iron ore reserves at open-cast mines near Mount Magnitnaya and in Malyi Kuybas which in 2006 provided approximately 10 per cent. of MMK's total iron ore consumption."
A search of the 289-page prospectus failed to reveal any disclosure of how much was paid for these mineable assets, who paid for them, and who - Rashnikov or MMK - owns them.
Taking into account the cost of opening new mines and upgrading steel production lines, the London share sale is a drop in the bucket. The lion's share of the proceeds will be taken by Rashnikov. Whether he intends to use the cash to clear the debts he accumulated to build up his shareholding is not disclosed. Nor is the size of this debt revealed. MMK's long-term debt is reported to be $537 million.
The small print of the prospectus indicates that Rashnikov controls coal and scrap metal supplies to the steel mill through companies he, his kin, or his trustees run. MMK is the only Russian steel major which has not yet integrated its own coal and iron-ore mines. As has been the practice at other Russian steel companies, these mining enterprises are owned by the mill owner, and depending on the mill owner, they either sell at a price that adds profit to the mill, or the mill pays at a price that leaves profit in the hands of the mineowner. Ahead of their London listings, the controlling shareholders of Evraz, Novolipetsk, and Severstal all sold their mining assets back to their companies, and consolidated their profit and loss accounts within the group. Rashnikov has not done this, and has not explained why. Thus, minority shareholders in other Russian steelmakers are not as exposed to transfer pricing and profit risk as Rashnikov is obliging his share buyers to accept.
In Rashnikov's case, the prospectus reveals that he controls the Kazankovskaya Coal Company, which is borrowing from MMK's treasury -- $53 million to date -- in order to develop and start mining its coal. The prospective coal mine appears to be half-owned by Rashnikov, half by MMK. It is believed to hold reserves of 430 million tonnes of coal, but at least another seven years will pass before a single tonne is lifted.
Rashnikov's sideline scrap business is bigger, and more immediately lucrative. Aptly named Closed Joint Stock Company Profit, it sold a total of $1.4 billion worth of scrap to the mill in 2004-2006, according to the prospectus. MMK has sold scrap for reprocessing by the company in the same period for $243 million. Transfer pricing risk is acknowledged in the general risks section of the prospectus, but no details of MMK's scrap transactions are available. Last month, MMK committed itself to the next five years of procurement from Profit of up to 32 million tonnes of metal.
The prospectus also identifies Rashnikov as owning the insurance company SKM, which has taken $98 million worth of premiums from MMK, plus a $2 million loan. SKM-Invest, another Rashnikov company, sells leasing services to MMK, and took in $26 million in payments since 2004, with another $62 million still to be paid. MMK has guaranteed $62.4 million in obligations SKM-Invest owes to banks. This list of Rashnikov-controlled units goes on, and there are also related-party borrowings, guaranteed by MMK. Details of these are scarce; the prospectus sums them to a present value of $134 million.
Related-party risk is acknowledged in the MMK prospectus. "The practice of interested party transactions may result in transactions conducted on terms less favourable to the MMK Group than would otherwise have been negotiated with third parties and could have a material adverse effect on the MMK Group's business."
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