Mechel’s Shares Spike Up, And Then Down Again As The Latest Trading Numbers From The Leading Russian Steelmaker Disappoint
By John Helmer in Moscow
minesite.com
Confirmation last week from Mechel (MTL:US) of its takeover of the privately owned West Virginia coalminer, Bluestone Coal Corporation, has drawn fire from Moscow bank and brokerage analysts, who claim the price paid far exceeds the value of the deal. Investors ignored this view: in three days they added 9% or $221 million to the market capitalization of the Russian coal, iron-ore, ferroalloy, and speciality steel group. But that was before the company issued quarterly production numbers.
The acquisition was confirmed on April 22nd. The deal first got rolling back in 2008. Late in the year, and without telling the market, Mechel made a cash down-payment that was initially reported at US$425 million. An issue of 83 million preferential shares, completed in March, was the second payment stage of the transaction. This gave an implied valuation to Bluestone, owned by James Justice, of about US$870 million. Negotiations to finalize the deal appear to have continued for several months between Justice of Bluestone and Igor Zyuzin, Mechel's controlling shareholder and chief executive. According to the new release of the "definitive agreement", Mechel says "the aggregate merger consideration is $436 million paid in cash (including $36 million interest paid), approximately 83.3 million preferred shares, plus the assumption of approximately $132 million of net debt".
An analysis of the transaction by Uralsib Bank of Moscow provides further detail: "if the value of the market value plus dividends paid in the next five years is less than $1,585 million in five years’ time, Mechel will make a top-up cash payment on the fifth anniversary of the deal. Finally, Mechel will pay an additional $3.04/ton for every ton of proven coal reserves in excess of 458 mln tons. Mechel’s expectation is that reserves could be 730 mln tons, implying that an additional $828 mln will be paid when the reserves are proven."
Zyuzin had planned last year a spinoff of Mechel's Russian coal assets, and their independent listing in Frankfurt or London. The Bluestone deal is his first move to internationalize the Mechel brand-name in the global coal-mining market. In the news release he says: “The addition of Bluestone’s production assets and large, high-quality coking coal reserves and resources establishes Mechel as one of the largest producers of coking coal in the world”. Bluestone sold 2.8 million tonnes of coking coal in 2008 and generated total sales of approximately US$327 million. According to Mechel, "the transaction is expected to be accretive to Mechel OAO 2009 earnings." Mechel also stated an aspiration to mine seven million tonnes of coking coal at sites in West Virginia and Kentucky in five years' time. That is two and a half times more mine output than now.
If the now plus five-year calculation is right, the newly estimated deal value for Bluestone turns out to be US$1.14 billion, counting both the cash component and the preferential shares. This is significantly more expensive than the market had been led to expect. Uralsib Bank analyst Michael Kavanagh pointed out that Mechel will assume US$135 million in net debt, and concluded a lengthy technical analysis with the telling phrase: “On the face of it this deal seems expensive." Unicredit, meanwhile, recommended selling Mechel’s shares, arguing that, “the acquisition was rather expensive, based on both operational and financial multiples. We believe the fact that the asset is in a region with a high cost base that has not experienced local currency devaluation could add to negative sentiment due to currently weak coal prices and demand from end customers, who are reporting 40%-50% utilization rates."
But the first reaction of the market to the announcement on Wednesday 22nd April was to buy, and by the end of the week that positive momentum, in conjunction with four previous strong trading weeks added up to a 41% rise in the share price. This was well ahead of Mechel's Russian steelmaking peers -- Severstal, up 12 per cent, NLMK, up 13 per cent, and MMK, up 36 per cent. That strength seemed to fly in the face of recent troubles. There are now five US law firms advertising for class-action claimants against Mechel: Barroway Topaz, Coughlin Stoia, Brown Piven, Izard Nobel, and Brualdi. There are refinancing issues. There is a significant cash claim in the Geneva courts, apparently from BNP Paribas, which has not been widely publicized. There are also outstanding mine safety claims against the Mechel group from the Russian mine safety regulator, Rostkhnadzor, which were made public early this week. Mechel's spokesman, Ilya Zhitomirsky, has declined comment on each of these issues.
Since the market for a time evidently ignored the risk of financial loss inherent in the lawsuit claims, and in the approaching May 15 deadline for the overdue loan, the perception appears to have been that Mechel share-price risk couldn’t become greater than that which was already priced into the share price last August, following Prime Minister Vladimir Putin's two attacks on Zyuzin. These attacks reminded the market, at least in Moscow, that Mechel's steel division has long been of takeover interest to the state-owned specialty steelmaker, Russpetsstal (RSS, "Russian Special "Steel"), if and when the price is low enough.
Against this background, the most likely explanation for Mechel's initially exuberant share price performance looks to have been a market upgrading of its non-steel assets, especially coal. Raspadskaya (RASP:RU), Mechel's Russian coking coal peer, is up 63 per cent over the past month. Belon (BLNG:RU), another listed Russian coking-coal miner, part-owned by steelmaker Magnitogorsk Metallurgical Combine, has moved up from a March 4th low of 14.5 US cents to 24c on April 23 – a gain of 66 per cent.
Why the coking coal sector should have been considered to be more buoyant than the steel sector, on whose demand it depends, was never clear. In any case, on Monday April 27th all the exuberance seems to have petered out on disclosure from the company of its first-quarter production results. Coking coal production was one million tonnes, Mechel said, down 76 per cent on the same period of 2008, and steam coal production in the quarter was 2.4 million tonnes, down 19 per cent. The company has also reported that at 929,000 tonnes, iron-ore concentrate fell 20 per cent year on year. Its nickel mine cut production by 33 per cent to 2,900 tonnes. Crude steel for the quarter totaled 1.1 million tonnes, down 30 per cent. The only gainers reported were in the newly acquired ferroalloy division of the group. Ferrosilicon rose six per cent to 24,400 tonnes in the quarter. Ferrochrome production was 7,700 tonnes, with no base figure for comparison.
Vladimir Polin, Mechel's vice president, explained that "at our coal mining operations we changed mining plans in favor of increased production of steam coal, as demand for this product was stable. This allowed us to more than double the output of steam coal concentrate. In our steel segment, pig iron production was reduced due to the overhaul of the blast furnace No. 4 for capital repair in Q4 2008. The furnace was commissioned in the beginning of April, 2009 and we expect the output to reach previous levels. We continue implementing our strategy of increasing the output of high-margin downstream products. That is why we reduced the share of low-marginable products in our product portfolio. Overall reduction of steel and rolled products output is in line with market trends".
The market reaction wasn't so sanguine. Uralsib's Kavanagh reported to clients that Mechel's reduced coking coal output "looks especially disappointing when compared with Raspadskaya’s 1Q09 operational results which reported a 36% QoQ increase in coking coal output to 1.9 mln tons. This clearly shows that Mechel continues to lose market share for its key product due to its reluctance to reduce coking coal prices for domestic customers (MMK and NLMK)." He concluded that "this trading update is very negative for Mechel. With gross debt of $5 bln, weak prices and extremely weak volumes, the company is likely to be loss-making in 1Q09 and in 2009. In our view, the situation in Mechel’s coking coal segment will remain very weak going forward, since Mechel is still in conflict with its major domestic customers (including MMK and NLMK) about coking coal prices. We would avoid Mechel in this market..." Unicredit reiterated its earlier advice to clients to sell Mechel shares "as the weak operating results, low prices, high cash cost steel operations, underutilization of mining assets and rising costs in the segment should hurt the company’s financial results in 1Q09F." And sell they did. At the end of the Moscow and US trading days on Monday, Mechel's share price was down 11.4 per cent. The following day it dropped by nearly six per cent more. And still the selling continues. |
