Mechel’s successful stock placement in New York showed that the world’s wealthiest and toughest investment community sees Russian companies as global players in the world steel industry.

Andrei Vinkov

Last week, Russian steel corporation Mechel placed 10% of its capital as an additional issue on the world’s most prestigious stock exchange, the NYSE, and attracted more than $291 million from the deal.

The additional placement on the NYSE was only possible in the form of the strictest and most complex stock offering, the issue of third-level American depository receipts or ADR. Only three Russian companies succeeded in issuing ADR before Mechel: Vympelkom, Wimm-Bill-Dann, and MTS (Rostelekom, Tatneft, and Golden Telecom shares are also traded on the NYSE but these companies do not have the right to make additional placements). Just to get on the list of those companies with the right to issue ADR-3s, or in other words to make the list of the most open and attractive companies, is already a major victory. Mechel managed to do even more. The company not only made it to Wall Street, but it also made some decent money. No other Russian industrial company has succeeded in this, not Gazprom, not Severstal, and not Yukos or Lukoil.

A steel Columbus discovering financial America

Until recently, Tatneft was the sole representative of traditional big capital Russian businesses on the US stock market. It seems, however, that the lost faith in the post-industrial economy, which collapsed along with the NASDAQ, rising commodities prices, and political instability have all forced American investors to turn to traditional industrial companies. As it turns out, there are few efficient companies of this type left in the developed world. In their hunger for new opportunities, US investors are even willing to deal with Russian companies’ unpredictability and lack of transparency.

Knowing the strict rules governing ADR-3s, some analysts insisted that Mechel would never be able to get past the Securities and Exchange Commission. Its corporate structure was horribly closed and far from transparent. Until the very last minute, the company did not reveal all the assets incorporated into the group or all of its shareholders. Mechel only released consolidated annual reports according to Western standards for the last three years a mere month before the IPO. For this reason, the company was considered a dark horse not only on the stock market, but even in the Russian steel industry itself, an industry not known for its transparency. In early October, the Mechel Group’s capitalization was at most $1 billion. Yet the group’s owners made a miracle happen.

The influential investment bank UBS was chosen as global coordinator of the Mechel placement, and J.P. Morgan, Morgan Stanley, and Troika Dialogue were brought on board as co-managers. Together, they managed to get American investors interested in Russian steel, despite the definite peculiarities of the company’s business. Investors were not fazed by the fact that even after the New York IPO, Igor Zyuzin and Vladimir Iorikh, with 86% of the company’s shares, were still the full-fledged owners of Mechel. In the end, demand exceeded supply by three times and the total earnings from placing 10% of the shares in Mechel were more than $291. The company’s capitalization increased to almost $3 billion.

“Mechel has opened the road to the US stock market for other companies in the industry,” believes Sergei Suverov, head of the Analytic Department at Zenit Bank. “Mechel’s placement was not hampered by rising interest rates in China affecting metal prices and sending most metal companies’ stock prices downward, or by insinuations that the company was not transparent. American investors showed they have faith in Russian industrial corporations, and in particular in Russian steelmakers.”

Lots of good, little bad

According to forecasts from Prospekt Investment Company, world market conditions for steel should continue to be favorable for the next two years. This means steelmakers’ shares—and especially Russian steelmakers’ shares—should continue to be in high demand. According to Denis Nushtaev, an analyst at Metropol Investment Company, compared to other mining and metals companies on the NYSE (Brazilian, Chinese, and American), Mechel looked pretty good (see Table 1). As would other Russian companies, if they were to enter the market. For historical and geographic reasons, steelmakers in Russia have serious competitive advantages on the world market. Their costs are some of the lowest in the world as companies pay very little for inputs (coking coal and iron ore), energy, or labor. Russian companies only face higher transportation costs, as most mills are located right in the heart of Eurasia. Even high transport costs do not detract from Russian metal companies’ charms. As a result, the Russian steel business’ profitability remains far above that of its world competitors. Not surprisingly, portfolio investors are ready and willing to snap up any slightly undervalued assets in Russian steel.

Coal suppliers are increasingly influential in world metal production. As Brunswick UBS reported in recent overview of the ferrous metal industry, “due to a world deficit in coking coal resulting from increased steel production and the lack of new coal mining capacity, prices for coking coal are growing faster than those for other inputs in the industry. Rising coal prices are a cause for concern among steelmakers.” There is no lack of coking coal in Russia, however. Of course, only three companies are able to keep themselves comfortably in coal: Severstal, Yevrazholding, and Mechel.

The expansion begins

With the New York IPO, Mechel has substantially expanded it opportunities to attract capital. Thanks to its ADRs, the company can also take advantage of cheap debt financing. Outside financing is incredibly important for Mechel as now few analysts doubt that the group’s owners are gearing up to fight for control of Magnitogorsk, Russia’s largest steel mill. If it succeeds in taking over this company, Mechel will become the leader not only on the Russian market, but on the world market. According to Denis Nushtaev, in addition to the money from the IPO, Mechel has already gathered $700-800 million in anticipation of the auction of the state’s stake in Magnitogorsk. Of course, Nushtaev notes, this could not be enough. To win at auction, Mechel will need allies. Mechel’s most likely partner, Nushtaev believes, is Novolipetsk Metal Works.

Even if Mechel does not succeed in taking over Magnitogorsk, the group will still have plenty of options for investing its newly found funds. Only one of the group’s investment programs stipulates that the company will invest $900 million in production over the next four years. The IPO funds, Sergei Suverov believes, might be used to buy additional mining assets in Kazakhstan or Ukraine, most likely iron ore mines. Irina Lozhkina, metals analyst at Prospekt, has a similar opinion. She believes that the iron ore market in Russia is currently in a fairly dire state and some metal works could become dependent on mining monopolies.

Table 1
Investors have seen the value of Russian metal producers’ scale, but have yet to notice their efficiency.
 

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