The state-owned stake in the Magnitogorsk Metal Works will be sold by the end of the year. The company’s management and Mechel Group are both vying for it. In the upcoming fight, Mechel will assert its status as key steel market player, while Magnitogorsk managers try to gain it.

Andrei Vinkov and Dmitry Sivakov

The Magnitogorsk Metal Works, or Magnitka, is a legend among Soviet foundries. It forged armor steel for the Soviet Army and contributed to the victory over the Nazis in the Second World War. It remains the biggest steel-casting and rolling mill in the world. Magnitka has also turned out to be the last tempting steel asset in the process of ownership redistribution in Russia. Last Friday, the Federal Agency for Federal Property Management signed a directive on the terms and conditions of privatization of Magnitka stock. In late December, the state-owned stake in Magnitka of 23.76% of voting shares (17.82% of the company’s authorized capital) will be sold in a single lot at open auction. The stake’s preliminary starting price is about $320 million. There are no doubts that this will go up by several times, since severe competition between contenders is expected at the auction. There are two of main rivals: Magnitka’s management headed by Viktor Rashnikov and Mechel Steel Group co-owned by Igor Zyuzin and Vladimir Iorikh. Both contenders have equal chances of gaining control over Magnitka. Both have considerable financial resources behind them, and both perceive Magnitka as a guarantee of survival on the steel market. The Mechel’s aspirations and the current managers’ honor are at stake.

In the blue corner, Mechel

The big names in ferrous metals were established long ago. Mechel Steel Group became the last company to join the ranks of the great. Its ascent began in 1995-1996 when Igor Zyuzin and Vladimir Iorikh acquired a stake in a large coal company, Yuzhny Kuzbass (Sourthern Kuznetsk Basin). Zyuzikh and Iorikh promptly realized that coal in itself was not a product that would allow a company to build and capitalize a large industrial company. Coal mines, with virtually no access to global markets, are doomed to be the stepdaughters of steel mills that do have this access. The outcome of a tense confrontation with Evrazholding owners came in April-May 2001, when Yuzhny Kuzbass’s owners succeeded in acquiring Mechel Metal Works from Glencore, an international trader. Later, the group got several other small industrial assets. Nevertheless, despite its rapid growth, the group remains the smallest player on Russia’s steel market.

In the meantime, the current trends of business consolidation prevailing on the global steel market and the short-term competitive advantage of domestic metallurgy thanks to the prime cost of hot steel urgently call for consolidation of the steel business in Russia through both horizontal mergers and asset acquisitions on the global market (See Expert issues 10, 26 and 27 of this year). From this perspective, Mechel Group needs to strengthen its position like nobody’s business. Therefore, the chance to fight for Magnitka provided by the state is a unique opportunity for the company not only to strengthen its position, but also become a leader on the Russian market immediately and, if luck is with the company, even one of the top-ten global steel companies.

Naturally, a contender for Magnitka ownership will have to gather all its financial might in order to win a victory at the forthcoming auction. Analysts estimate that Mechel has at least $300 million in its accounts. Furthermore, it’s no accident that Mechel is currently holding a road-show for its stock floatation at the New York Stock Exchange. The placement could amount to about $300 million, and it may well be that the company intends to allocate the funds raised in the US to the purchase of the state-owned stake in Magnitka. It cannot be ruled out either that Mechel would involve outside players to form a consortium for purchasing the stake in Magnitka.

And in the red corner, Magnitka’s management

One common misconception is that Magnitka’s management holds a controlling stake in the mill. According to some unofficial data, the management controls about 60% of Magnitka stock. Therefore, all Mechel’s attempts to crawl into management are doomed to fail. As a matter of fact, there is a considerable gap in Magnitka’s share capital. Magnitka’s management holds only about 32% of voting shares, and around 26% of the stock is on the company’s balance sheet. The story behind this is obscure, tangled and, most likely, not irreproachable from the legal point of view (see below). This is the reason why Magnitka’s management is extremely interested in obtaining the state-owned stake to be sold this year. This will not simply strengthen its position but also put a barrier up against outside corporate raiders. Thus, Viktor Rashnikov and his team will become full-fledged players among the elite of Russia’s steel business and will be equals in setting the tune for domestic and foreign markets. So far, Rashnikov’s market power has only been recognized with the caveat “only until the sale of the state-owned stake.” How much is Magnitka’s management ready to pay for its peace of mind? We have heard an estimate of a billion dollars. In February 2004, when Magnitka’s stock appeared in the RTS listing for one day, the state-owned stake was valued at about $600 million. To this amount should be added a large-stake premium that could be as high as 15-20%. According to Sergei Suverov, head of Analytical Department at Zenit Bank, the amount of cash available on Magnitka’s accounts is in the range of $700-800 million. According to him, Magnitka has an opportunity to involve even greater resources in the auction. Should Mechel win at auction, it will not take control of Magnitka; yet, it will get a chance to interfere. And this will inevitably lead to the intra-corporate warfare at Magnitka, where the management will have far fewer tricks for winning a victory. 

How passions flared

The Magnitogorsk mill was privatized in November 1992, with 51.3% of its stock remaining state-owned. In July 1994, the state represented by the Fund of Chelyabinsk Province Property sold 30.46% for vouchers at auction. A bit earlier, Magnitka established a subsidiary, Mekom, the main objective of which was to buy up the complex’s stock from the population and at voucher auctions. Magnitka’s manager Rashid Sharipov was in charge of the company. He managed to consolidate around 30-32% of Magnitka’s stock that was transferred to the complex and the latter, in its turn, contributed them to the authorized capital of Magnitogorskaya Stal (Magnitogorsk Steel), a specially established company. In August 1994, this company purchased another 3.045% of Magnitka’s stock at a monetary auction.

More mysterious and less transparent events followed. In November 1995, Magnitka exchanged 26% of Magnitogorskaya Stal’s stock (from its 60-percent stake) for Inkombank stock. And in February 1996, 19% of Magnitogorskaya Stal stock was exchanged for a promissory note issued by a certain OOO Magsta. Thus, the company ceased to control its subsidiary guaranteeing its tranquil existence. Soon it was discovered that 55.67% of Magnitogorskaya Stal stock was owned by entities directly subordinate to Rashid Sharipov. It was brought to light after Magnitka’s General Director Anatoly Starikov tried to take a loan of $100 million from EBDR using Magnitogorskaya Stal stock as collateral. Thus, Rashid Sharipov, who headed the mill’s board of directors at the time, was caught red-handed withdrawing assets.

What happened afterwards entered the annals of Russian privatization. In 1997, the majority of Magnitka’s key managers (Starikov was replaced by Viktor Rashnikov on account of inefficient management as General Director) joined forces against Sharipov. Sharipov managed to find buyers for the Magnitka stock, still owned by Magnitogorskaya Stal under his control. Rumors ran that those buyers represented Iskandar Makhmudov’s companies. These same companies provided legal protection for the deal. To this end, the best lawyers specializing in deals of this type were involved, such as Alexander Dobrovinsky and Mikhail Nekrich. However, the other side was about to surrender. The Office of the Public Prosecutor of Chelyabinsk Province initiated several arbitrary investigations and criminal charges against Sharipov under the banner of “protection of state and public interests.” The Office of Public Prosecutor restored Magnitka in its rights in such a way that someone has yet to explain. It restored Magnitka’s rights to direct ownership of about 26% of its own stock and not to possession of the controlling stake in Magnitogorskays Stal. According to some indirect information, the trick can be simply explained: the register of Magnitka’s shareholders was revised somewhere in the depths of the law enforcement agencies.
 
The subsequent information war between Magnitka’s management and Makhmudov’s companies came to an end only as recently as 2002-2003, when Putin implicitly sympathized with the problems facing Magnitka’s managers by visiting a presidential judo championship organized by mill. According to information available to Expert, it was then that Makhmudov lost his interest in Magnitka and began to negotiate the sale of both his own stake (about 5%) and the rights to Sharipov’s questionable stake of 32%. It was most likely Mechel Steel Group that purchased this stock and rights.

Come rain or shine, the fight will begin

Recently, Mechel has been given permission from anti-monopoly agencies to acquire more than 20% of the mill’s stock. Many investment company analysts were asked not to touch on the topic of the value of Magnitka’s stock in their reviews. This is all but direct evidence of the heated atmosphere before the fight.
 
According to a qualified source, Magnitka’s General Director has proposed a strategic alliance with Mechel’s management but failed to find a common language with major shareholders of the group.  

More in Russian>> www.expert.ru