This is the tale of how one Russian’s ambition to be the biggest of his kind in the world, and create a safe haven for his wealth in another country, ended up costing public shareholders billions of dollars in equity and dividend losses; enriched a syndicate of international banks; and lost the Russian state treasury billions of dollars in tax deductions. Russian oligarchs don’t make mistakes — they simply pass on their costs.
The Severstal group, 83% owned by Alexei Mordashov, announced yesterday that it has sold three of its loss-making steel mills in the United States — Warren (Ohio), Wheeling (West Virginia), and Sparrows Point (Maryland) to the Renco Group, a New York investment holding owned by Ira Rennert. The brief Severstal announcement of March 2 reports that Renco is paying $125 million in cash, $100 million in a deferred payment note, and the undertaking to clear $317 million in “third-party debt”.
This $542 million in compensation contrasts with the $2.4 billion purchase price for the assets which Severstal paid in 2008. Sparrows Point was bought in March of that year from ArcelorMittal, while Warren and Wheeling were bought the following 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 per tonne 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 to its shareholders why it was paying a higher valuation multiple for Sparrows Point than Severstal’s much more profitable Russian operations were worth; let alone why Mordashov was throwing money at American steelmills at 50% more than the spending rate fior American steelmills of the Evraz oligarchs – Roman Abramovich, Eugene Shvidler, and Alexander Abramov. “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.”
Lehman Brothers Russian steel analyst Valentina Bogomolova warned that Mordashov might be tossing good money after bad, because the losses of the US steelmills he was acquiring had driven them into bankruptcy. “Severstal,” she said, “proposes it can successfully transform bankrupt assets into profitable assets. They have yet to show the market that they are capable of doing so.” A Severstal briefing, called on May 26, 2008, to combat this scepticism, claimed the company’s US acquisitions would generate “a stable 15 per cent profit margin” within “three to four years”. The global crash followed four months later, and the lossmaking has continued.
Yesterday’s announced selloff also requires Renco to assume $650 million in employee-related and environmental liabilities; these have accumulated over the three years since the Severstal takeover. Alfa Bank warned the market that Severstal’s sale announcement doesn’t come clean and identify the real value of the sale transaction, because this liabilities number is a fudge. Writes Alfa steel analyst Barry Ehrlich, “We are unable to precisely identify the deal’s value on an EV [Enterprice Value] basis, as we do not know the amount of employee and environmental liabilities (these are not included in the net debt calculation). Thus, the EV of the deal is in the range of $542m and $1,192m.”
Marat Gabitov, steel analyst at Unicredit Securities in Moscow, is blunter – the $650 million cannot be counted in the sale value, in order to make Mordashov’s losses look smaller, because “we believe that some 90% of these liabilities represent the discounted value of pension plans, which is likely a stay-in-business cost that cannot be accounted for in the valuation of the deal.”
Comparing the price per capacity tonne for each in this series of transactions, Severstal is now selling 7.8 million tonnes of combined US steelmill capacity at just under $70 per tonne; if the liability figure is included, this valuation rises to $153 per tonne. The outcome for Mordashov is either one-quarter or one-half of the average $308 per tonne he paid in 2008. The outcome is much worse if the separate buy and sell transactions are compared — Warren and Wheeling are being sold to Renco for an 85% discount on the 2008 purchase price, while Sparrows Point is going for an 80% discount.
When Mordashov acquired the mills, he announced he was aiming to become one the largest steelmakers in the US, and in the world.
In its last available financial report, issued on November 16 for the 9-month period to September 30, Severstal reported that it valued the assets it was holding for sale at $2.03 billion. The assets counted in this valuation were the three plants which have now been sold, plus Mountain State Carbon, a coking operation in West Virginia which was valued at $240 million when it was formed in 2005. Subtracting that from Severstal’s bookkeeping of September 30 suggests that Mordashov has been telling shareholders a fib exaggerating the value of the three mills he’s just sold by $1.8 billion.
Long and short-term debt at the end of 2010 totaled $6.14 billion. The sale to Renco will reduce this debt to $5.6 billion. At the end of 2008, Severstal’s debt — largely incurred from borrowing to buy these North American assets — amounted to $8.3 billion.
The stock market reaction to the deal has been positive, and at the close of London trading on March 2, the Severstal share price was up 3.6% on the day. Vladimir Zhukov, steel analyst for Nomura in Moscow, reported to clients that the bargain basement disposal was good for Severstal’s balance-sheet. “Severstal has been struggling to turn this asset around, [and so] we consider this valuation as acceptable given the quality of assets. We consider as generally positive the fact that Severstal is getting rid of the bulk of its loss-making operations; it still owns a non-controlling interest in Lucchini in Europe, also a loss-making operation.”
Severstal’s remaining steelmaking capacity in the US includes a mini-mill for construction steel in Columbus (Mississippi), and the former Rouge plant in Dearborn (Michigan), a producer of auto sheet. Their combined capacity by the end of this year will be 6.6 million tonnes per annum.
To sweeten his bitter pill, Mordashov has announced that he will resume dividend payments, offering shareholders a dividend for last year’s operations of Rb2.42 per share (8 US cents). Losses for 2010, announced this morning, came to $577 million; the 2009 losses amounted to $1.04 billion. For pill-swallowing purposes, the new dividend offer represents a dividend yield of 0.4%. If you bought a share from Mordashov, this means he is paying you a return of 0.4% on your investment. Now that is something to write home about, isn’t it boys and girls?