Tuesday, January 19, 2010

Making Sense Of The Risks & Rewards Of Owning UC Rusal

None of what's written below is original. All have been culled from various business publications:

... at the core of Rusal’s pitch to institutions is this claim on how it wants to invest in its $2.6bn flotation proceeds:

Rusal has deliberately positioned itself to exploit the urbanisation and industrial growth of China and now claims that it can put aluminium on to the docks at Shanghai more cheaply than its Chinese rival, Chalco.

Rusal’s secret weapon over rival producers, says the paper, is an abundance of “stranded” hydroelectric power in Siberia that cannot be moved far afield and is sold cheaply to local industry.the indebted company sources nearly 80 per cent of its energy requirements from hydroelectric power in Siberia, unlike its rivals which are dependent on fossil fuels.

That means Rusal’s flagship smelters, which generate nearly 80% of the company’s total output (an estimated 4.3m tonnes in 2009), do so at an average cost of $1,338 a tonne.This puts the company in the 1st quartile of the cost curve by exploiting availability of abundant, low cost, stranded hydro power in the region. Power costs constitute only 26% of the company’s total production costs compared to 36% for the industry in H1 2009.

We estimate power consumption in Siberia is running somewhere below 50% capacity right now. Given there are few other power intensive industrial activities in the region, we the potential for aluminium production to double before it become constrained by the availability of cheap power.

So Rusal, which owns 18 aluminium smelters, 12 alumina refineries, 8 bauxite mines and some other mines, is basically a Siberian power play.

But that’s not all. Rusal’s smelters are close to the world’s biggest aluminium consumer — China. This, it is claimed, gives Rusal a transport advantage of circa $40 a tonne over the weighted average of China’s trading partners.

At the moment, Rusal sells only 14% of its output to China, according to the report. But that could change given anticipated increases in carbon regulations in China and the intention of the Chinese government to restrict new aluminium supply.

The report eventually arrives at a valuation range of $20bn-$26bn, using discounted cash flow and peer group valuation multiples. (That implies a PE range of 14.1-18.3 times 2010 earnings, apparently).

Below are excerpts from the IPO prospectus, released on Thursday through the Hong Kong Stock Exchange, the first time ever that RUSAL has given key financial and company details. Russian aluminum giant UC Rusal won backing for its US$2 billion Hong Kong initial public offering from Asia-based tycoon Robert Kuok and two prominent hedge funds, two people familiar with the matter said Tuesday.

The backing could lend credibility to an IPO that got off to a rocky start, after Hong Kong regulators forbade retail investors to participate amid concerns over Rusal's $14.9 billion in debt.

According to the people familiar with the matter, the investors include Mr. Kuok, also known by Chinese name Kuok Hock Nien, whose Kuok Group includes Hong Kong-listed Kerry Properties Ltd. and English-language daily South China Morning Post; blue-blood hedge fund manager Nathaniel Rothschild, through his NR Investments; Paulson & Co., the hedge fund run by John Paulson; and Russian state development bank Vneshekonombank, or VEB.

The four will serve as cornerstone investors, these people said. Cornerstone investors buy into a company during the pre- IPO stage and agree to hold their stakes for a certain period of time, in this case six months.

Rusal plans to raise about US$2 billion from selling around a 10% stake as part of efforts to repay debt. The company is set for a primary listing in Hong Kong and a secondary listing of its depositary receipts on Paris' Euronext stock exchange on Jan. 29.

We believe that Rusal should trade somewhere between Chalco and Western peers considering its low cost, tier 1 assets, the Russain risk and the Chinese premium for the Hong Kong listing.

Although it could be worth more.

UC Rusal is scheduled to repay some $5bn of debt to its lenders by the end of 2013 under the proposed debt terms (excluding the VEB loan). Even after considering this, we estimate free cash flow to equity increase at 7% CAGR creating a value of $36.5bn by 2012, a 40 per cent upside to the top end of our valuation range.

There are other risk factors, however, such as the fact that US Rusal is net short bauxite (it purchased 8.8m tonnes of the stuff in 2008) and also the rather mature age of its assets.

Its smelters and refiners, according to the report, have an average age of around 42 years and nearly 75 per cent of the group’s aluminium production comes from “Soderberg technology,” which is said to be power intensive and pollutive compared to “pre-technology” (whatever that is).

So its just as well that cheap power is on hand.

Rusal also has a very low effective tax rate of 13%, compared to the corporate tax rate of 20% in Russia, the report states.


Rusal's restructured debt is $14.9 billion. It includes $7.4 billion to international lenders, $2.1 billion to Russian and Kazakh lenders, $4.5 billion to state-run VEB bank and $895 million to Onexim Group, owned by tycoon Mikhail Prokhorov.

RUSAL, under the terms of the restructuring agreements, may be forced to dispose up to all of its 25 percent stake in the metal giant Norilsk Nickel .

RUSAL is prohibited to pay dividends unless the Group's debt to banks, except for VEB's and Onexim's debt has been repaid by at least $5 billion.


Moscow-based Norilsk Nickel is the world's largest producer of nickel and the world's largest palladium miner. Norilsk's main shareholders are billionaire Vladimir Potanin and RUSAL, each with a 25 percent stake.

RUSAL has pledged 25 percent plus one share in Norilsk as collateral to secure its indebtedness to VEB.

VEB agreed to switch collateral and will now accept a 5 percent stake in RUSAL itself instead of a 25 percent stake in RUSAL's Bratsk and Krasnoyask aluminium smelters.

EN+, Deripaska's investment vehicle, is expected to pledge 15 percent of the issued share capital of RUSAL to the lenders of EN+ in connection with EN+ $1.04 debt restructuring.


By 29 October 2010, unless RUSAL obtains an extension, it must repay a $4.5-billion loan from VEB.

RUSAL plans to seek a further extension of the amounts outstanding under the $4.5-billion loan, dated 30 October 2008 between the company and VEB. RUSAL's directors believe that, if requested, VEB will extend the loan maturity for successive one-year periods through the override period to October 2013.

RUSAL can also request state-controlled Sberbank to assume all rights, claims and obligations under the VEB debt following a request from RUSAL, and to extend the debt to Dec. 7, 2013.


From the prospectus: RUSAL does not meet the profit test to qualify for listing on the Main Board of the Hong Kong Stock Exchange Limited. The company has been admitted on the basis of a large market capitalisation, revenue of more than HK$500,000,000 and positive cash flows from operating activities.

If the repayment of the whole of the group's indebtedness is accelerated... or if the Company should be unable to extend or refinance or repay the VEB loan as and when it falls due, RUSAL may cease to continue as a going-concern.


Deripaska has confirmed to RUSAL that he had an application for a U.S. visa denied in 1998 pursuant to Section 212 of the U.S. Immigration and Nationality Act, which relates to aliens deemed ineligible for U.S. visas based on security, unlawful activity and related reasons, and this position was reiterated in 1999 and 2000. Deripaska has consistently challenged these denials as being unwarranted and unsupported.

He has also confirmed to the Company that he subsequently visited the United States lawfully a number of times. The most recent visits were in August and October 2009.

Deripaska has also confirmed to the company that, to the best of his knowledge, he is not under investigation by any U.S. authority.


In its prospectus, Rusal said if the Michael Cherney case were to prevail on its merits it could require a payment in excess of $4 billion from Oleg Deripaska. The company cautioned, however, that the case is still in the early stages and that it is too early to say what the final amount might be. [ID:nGEE31QV]

If Deripaska were forced to use his UC Rusal shares to fund the payment, his influence over the company would be "significantly reduced", the company said in its prospectus.

According to the company, Deripaska "strongly denies and will vigorously resist Mr. Cherney's claims."


After the placement, Deripaska's EN+ will have 47.59 percent of RUSAL shares; Onexim Group of tycoon Mikhail Prokhorov will hold 17.09 percent; SUAL Partners, controlled by tycoons Viktor Vekselberg and Len Blavatnik, will have 15.86 percent; and Swiss-based commodities trader Glencore will hold 8.65 percent.

RUSAL will place 10.81 percent of its shares, of which VEB will buy 3.15 percent and International lenders 0.17 percent.

The company's Global Depositary Shares will be also listed and traded on the Professional Segment of Euronext exchange in Paris. Each Global Depositary Share will represent 20 shares. The company will be renamed as United Company RUSAL plc.

p/s photo: Marsha Milan Londoh

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