By Ilya Khrennikov
Oct. 6 (Bloomberg) -- Russian steelmakers’ plans for world domination are in tatters. A spending spree on U.S. mills meant to lift their billionaire owners into the industry’s top rank is instead forcing them to renegotiate debt and write down assets.
OAO Severstal, the biggest producer, may sell some of the U.S. plants it bought for almost $4 billion at fire-sale prices or seek bankruptcy for them, Uralsib Financial Corp. analyst Dmitry Smolin said. Outstanding debt at Severstal and next- largest producer Evraz Group SA almost tripled after they ramped up buying in 2006, while the cost of funding debt in Russia has risen by about 50 percent, according to data Bloomberg compiled.
“Russian steelmakers’ acquisitions in the U.S. were all unsuccessful,” said Dan Yakub, a Citigroup Inc. analyst in Moscow who recommends investors sell Evraz and who has a “hold” rating on Severstal. “The management wanted a global business, to get more flags on the map. They overestimated the potential of the U.S. market and underestimated the depth of the price collapse.”
While the Russians began buying U.S. mills in 2004, with Severstal’s purchase of Rouge Steel Co., it was rising steel prices two years later that fueled an acquisition binge, which totaled $18 billion according to Moody’s Investors Service. Even as economies and prices retreated from May 2008, Evraz, Severstal and OAO Novolipetsk Steel kept buying to try to pick up bargains. Instead the prices fell further, wiping as much as 70 percent off asset values, according to VTB Group.
Chinese Growth
Steel demand at automakers and builders tumbled amid the global economic crisis, with North American steel prices plunging as much as two-thirds from their May 2008 peak. Lower- cost mills in China, the world’s largest producer, expanded as plants in the U.S., Japan and Europe cut output. U.S. production in August was down 40 percent from a year earlier while China’s rose 22 percent, according to data from the Brussels-based World Steel Association.
Severstal owner Alexei Mordashov, 44, followed Rouge Steel with a stake in Italian steelmaker Lucchini SpA, before buying gold miner Celtic Resources Holdings Plc. By January 2007, as banks such as Credit Suisse Group AG were warning about risky credit derivatives, Mordashov said he was seeking acquisitions around the globe. As late as 2008, while debt markets imploded, Severstal made another four purchases of steel and coal assets.
“I have no idea how much these assets are worth now as there are probably few buyers interested, if any,” said Jean- Louis Tauvy, who as a fund manager in Moscow at Atria Advisors Ltd. helps oversee $120 million in Russian stocks. “It’s more probably a liability rather than an asset for Severstal. Evraz assets are better quality but are still worth much less than what they were bought for.”
Personal Ambition
Moscow-based Evraz, part owned by Roman Abramovich, agreed to buy Claymont Steel Holdings Inc. in December 2007 and spend $2.4 billion on the Canadian assets of Ipsco Inc. in June 2008.
The billionaire steel magnates, while driven by personal ambition, also bought operations in North America and Europe as a way to avoid anti-dumping duties and import quotas on the steel they were shipping from their plants in Russia.
In addition, access to Russian electricity a third the cost of power in western Europe along with cheaper raw materials and labor meant the steelmakers had double the profit margins of foreign rivals, and an impetus to invest spare cash that was out of step with the global economic cycle.
“It was natural for Russian steel companies to look for targets abroad,” said Aivaras Abromavicius, who helps run $2.5 billion in Russian equities at East Capital in Moscow. “Looking back, of course, it seems it would have been wiser either to return more cash to the shareholders in the form of dividends or to use it to pay back some of the loans.”
Loan Waivers
Both Evraz and Moscow-based Severstal may need to seek waivers or changes to loan agreements with creditors to avoid breaching so-called debt covenants this year, Standard & Poor’s said in a report on Sept. 24. “The moderate upturn” in the market “may not be enough to support current ratings.”
The two companies have already written off at least $2.6 billion from the value of their purchases of foreign assets and goodwill, according to Bloomberg calculations.
Price Recovery
“Russian steelmakers will probably test their foreign assets for impairment at the end of the year and may then do further write-offs,” Alex Herbert, an analyst at S&P in London, said by phone. He declined to provide specific estimates.
Severstal remains “committed” to operating in North America, “one of the world’s most important long-term markets for steel,” the company said in an e-mailed response to questions on Sept. 29. It declined to comment on any sales of assets, write-offs or the viability of its U.S. operations.
“We consider our acquisitions in North America to be a real success,” Pavel Tatyanin, Evraz’s senior vice president for international operations, said by phone from Johannesburg. “We bought assets related to infrastructure. They will be among the first to recover and will benefit from U.S. stimulus.” Evraz doesn’t plan to sell the operations, Tatyanin said.
North American domestic hot-rolled coil has rebounded 57 percent from the more than five-year low of $370 a short ton on June 9, 2009. The benchmark for regional steel prices lost two- thirds of its value in the previous year from a record $1,125.
As the worst of the economic slump passes, prices rebound and demand returns, pressure on producers to write down assets may ease. UBS AG on Sept. 23 raised its fourth-quarter forecast for North American hot-rolled coil 20 percent to $570 a ton.
“It would be a misconception to say expansion to the U.S. failed,” Gregory Mason, Severstal North America’s former CEO, said in a phone interview from Pittsburgh. “Those who say it think tactically rather than strategically. Strategic decisions should be viewed over the entire steel market cycle. It would’ve been unwise to sit on cash in Russia.”
Dreams Shattered?
Others say Russian dreams of expansion have been shattered. When Severstal pinned its U.S. ambitions on demand for cars, vehicle sales slumped to the lowest in almost three decades. After Mason said steel assets could be had in the country for “bargain” prices, the industry lost half its market value.
“Severstal will definitely have to reveal the strategy for the market regarding its U.S. plants, which may include either direct sale or filing for bankruptcy for some of the assets,” Smolin said. “Evraz has better-quality assets and doesn’t plan to sell them but may consider the sale some of overseas assets if it fails to pay creditors,” though this remains unlikely.
Severstal International, the steelmaker’s overseas arm, said on Sept. 7 that two of its five U.S. plants were idle and it would only retain its “most efficient” units.
Takeover Scrapped
Evraz sold the Cape Lambert iron-ore project in Australia in August and allowed an option to increase a stake in China’s Delong Holdings Ltd. to lapse. Lipetsk, Russia-based Novolipetsk in November scrapped a planned $3.5 billion takeover of New Jersey-based John Maneely Co. OAO TMK, Russia’s largest steel- pipe maker, ran U.S. plants it bought last year for $1.75 billion at a third of capacity in the first half of 2009.
The Moscow-based pipemaker will boost capacity utilization to 70 percent by the year-end, RIA Novosti reported on Sept. 22.
Severstal’s operations in the U.S. “may have to file for bankruptcy,” said Sergei Belyaev, who helps oversee $150 million in investments from Russia and former Soviet states at Kazimir Partners in Moscow. “The assets that don’t generate cash are basically worth nothing.”
To contact the reporter on this story: Ilya Khrennikov in Moscow at ikhrennikov@bloomberg.net
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