Severstal has issued a claim in US Federal Court (Manhattan Southern District) against RG Steel, a unit of the private American steelmaking group, Renco. Severstal owner Alexei Mordashov (left image) wants it to be known in the Russian media that he thinks he’s been stiffed. But he doesn’t want anyone to read too carefully into the court papers in case they detect evidence of Severstal accounting…. well, let’s not say fraud until and unless the US court rules on the matter.
Leaks to Interfax and Kommersant this week indicate that Severstal is claiming that more than $120 million in payments are due for the sale of Severstal’s loss-making US mills, Warren (Ohio), Wheeling (West Virginia), and Sparrows Point (Maryland). The transaction terms were announced in March, when Severstal announced it would receive from Renco $125 million in cash, $100 million in a deferred payment note, and an undertaking to clear $317 million in “third-party debt”.
The sale also required Renco, a privately held steel investment holding based in New York, to assume employee-related and environmental liabilities totaling $650 million; these had accumulated since the Severstal takeover three years ago. For instance, early this week, RG steel, a Renco unit and new owner of Sparrows Point, agreed to pay the Maryland state regulator $135,000 for air pollution violations after a furnace release accident in 2009.
Here is the deal announcement from Severstal.
This week Severstal was asked to confirm that it has filed in the US court, and clarify the money claims. Lyudmila Guseva, head of press for Seversatal at Cherepovets, the main mill site in Russia, said she was relaying the emailed questions to Natalya Ivanova, the company spokesman in Moscow, because the questions concern Severstal abroad, not in Russia. But Ivanova did not reply. Telephoned directly, and told Ivanova was playing hide-and-seek, Guseva said that Yelena Kovaleva, head of external communications for Severstal, should be contacted. She refused to provide mobile telephone numbers for either Ivanova or Kovaleva. Kovaleva’s office telephone rings without answer.
What is Mordashov trying to hide behind his ladies’ skirts?
In the first place, there is the loss of several billions of dollars in operating losses at the US steelmills, loan charges at penalty interest rates, and cuts in market capitalisation value for the company, all of which flowed from Mordashov’s ill-fated ambition to become the one of the biggest steelmakers in the US and in the world; to that end he borrowed to pay prices noone else believed the assets were worth, and by the end of 2008 took Severstal to the brink of bankruptcy.
Earlier, that ambition had led Mordashov into a bidding match against Lakshmi Mittal in 2006 for control of Arcelor, the European steelmaking leader. Two years later, Mittal got the better of him again when he sold the Sparrows Point steelmill. Such embarrassing misjudgements by Mordashov can’t be concealed from the market; but Mordashov’s spokesmen are instructed to avoid touching the tender spot at home.
In March of this year, the reported $542 million in Severstal compensation was a fraction of the $2.4 billion purchase price for the assets which Mordashov had agreed to pay in 2008. Sparrows Point was bought in March of that year from ArcelorMittal, while Warren and Wheeling were bought in May from Esmark. Mordashov’s acquisition of Warren and Wheeling paid $465 per tonne of steel output capacity; this was almost 30% higher than the $350/t price he had paid for Sparrows Point a few weeks earlier.
When the buying spree was under way, Michael Kavanagh, then a steel analyst at Uralsib Bank in Moscow, commented that Severstal had not explained why it paid a higher valuation multiple for Sparrows Point than Severstal itself was worth at the time; or the valuation at which other Russian steelmill purchases in the US had been made by Evraz, Novolipetsk, and TMK the pipemaker. “In our view,” reported Kavanagh, “the acquisition will be initially dilutive for Severstal, as the deal took place at a 2008E EV/EBITDA multiple of 10.9, which is high in comparison with recent Evraz steel deals at 6-8 and Severstal’s multiple of 5.3.”
Comparing the price per capacity tonne for each in this series of transactions, Severstal’s transaction with Renco this past march amounted to the disposal of 7.8 million tonnes of US plant steelmaking capacity at just under $70 per tonne, one-quarter of the average $308/t paid in 2008. The contrast between Mordashov’s buy and sell prices is even sharper if the separate transactions are compared — Warren and Wheeling were sold to Renco for an 85% discount on the 2008 purchase price, while Sparrows Point went for an 80% discount.
According to wire service Interfax and Kommersant, Renco is claiming its assessment of the value and liabilities of the three mill assets allows it to pay Severstal just $1.9 million of the initial cash obligation of $125 million. The court papers indicate that accountants for Renco have challenged Severstal’s balance-sheet reports for the plants’ debts and working capital, and progressively reduced the cash obligation as their due diligence proceeded. Severstal has applied to the court to review the accounting evidence, adjudicate the conflicting claims, order Renco to pay the full amount agreed, and compensate the litigation costs. But Renco didn’t agree to pay Severstal’s announced price, and the evidence from Severstal’s financial reports shows that Mordashov has acknowledged that, albeit in misleading terms to shareholders.
This is not the first time that Severstal’s accounting of its US steel operations has been challenged. A group of steelworkers from the United Steelworkers Union at the Severstal plant in Dearborn, Michigan – formerly known as Rouge – have claimed to have uncovered irregularities, the effect of which was to transfer financial benefits accruing in the US to Severstal’s Russian accounts, and to cut productivity payments owed to US steelworkers. Severstal North America has denied the charges, and the steelworker claims have been dismissed by the labour tribunals
Severstal’s accounting is the second problem Mordashov has reason not to want to expose publicly. But the court action he initiated on October 3 leaves him vulnerable to Renco’s accounting and to the counter-claims.
On August 24, KPMG, Severstal’s auditors, signed off on their review of the company’s accounts for the first half of the year. The report appears on the Severstal website , dated at the end of August. In the customary disclaimer letter at the head of the financial report, KPMG says that Severstal management was responsible for preparing the financial data, while “our responsibility is to express a conclusion…based on our reviews.” Then KPMG makes a double-disclaimer about its conclusions. “A review substantially less in scope than an audit…and consequently does not enable us to obtain assurance that we would become aware of all significant matters that might be identified in an audit.”
But can KPMG disclaim responsibility for not detecting that millions of dollars reported to be income for Severstal weren’t income at all?
At Note 2, page 10, the KPMH auditors, peering through their eyeshades, applied their quill-pens to report that the “sale” to Renco was worded to avoid specifying how much Severstal would receive from the transactions. The Jack Russell terrier knew there was no meat on that bone.
According to KPMG’s fumbled wording, “preliminary [sic], the total consideration is assessed by management in the amount of US$156.4 million…. The final fair value assessment is expected to be completed by the end of 2011.”
At deal time last March, and even in August, that looks like money in the bag for Mordashov and Severstal’s other shareholders. But in retrospect, now that the court papers are available and Renco’s due diligence is clear, the KPMG report is at best misleading. Severstal “management” told KPMG there was income, when there was the contingency KPMG should have recognised that there wasn’t.
In the transaction history so far, it is noteworthy that Renco, which usually plays its dealmaking close to owner Ira Rennart’s chest, has avoided announcing what it proposed to pay Severstal. Here is the deal announcement issued in March by Renco. Note that this omits any reference to a payment by Renco to Severstal, except for the reference to the “transaction value of $1.2 billion”. That, it’s plain, is what Renco considered to be the value of the assets to itself.
On March 31, when Renco announced that it had closed the deal with Mordashov, here’s what it said about a bank borrowing it had arranged. “As part of the transaction, Wells Fargo Capital Finance, part of Wells Fargo Company (NYSE:WFC), and GE Capital, Corporate Finance, structured a new four-year $750-million syndicated credit facility. The facility, which was oversubscribed, has 12 international banks and financial institutions in the syndicate with Wells Fargo, GE Capital Markets, Inc., Bank of America Merrill Lynch and UBS Investment Bank acting as Joint Lead Arrangers and Joint Book Runners.”
This omits to say who would be the beneficiary of the money. But supposing that Renco was planning to meet the debt obligations Severstal was transferring of $317 million, and in time would also pay out on $650 million in other liabilities, the total owing comes to $967 million. That suggests that Renco was calculating that it would pay nothing to Severstal. Nix. Ничего.
Renco has been asked to clarify the terms of the transaction and the calculations now in the New York court. For the time being, there is nothing official on the company website.
A report by UBS Moscow steel analysts Alexei Morozov and Kirill Chuyko suggests that Mordashov should be thanking his lucky stars that he got rid of the American assets at any price at all. Their intimation is that it is folly to expose the accounting claims in a US courtroom now when nothing is a fair price for the steelmills. “The difference in payment of $123m equals 1% of Severstal’s market capitalisation, so it would not have a significant effect on its consolidated fundamentals. We also believe that the sale of the unprofitable North American assets would make sense even at a price of one dollar, as these assets are value-destructive due to their losses and capex required and, more importantly, the unclear outlook for the US economy.”
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