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.

DEBT

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.

COLLATERAL

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.

VEB LOAN

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.

RISKS

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.

ON DERIPASKA VISA DENIALS

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.

CHERNEY LAWSUIT

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."

POST IPO SHARE STRUCTURE

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

HK IPOs Sizzling Hot

HK's IPO market has surpassed other financial centers by the proverbial mile this year. The liquidity arriving into HK from China and from the US carry trade have helped fuel the boom. The thing that sets this event apart is the proximity to the recent global crisis, and the pent up demand to raise cash by many large companies. Again, as I have warned before, I am quite uncomfortable with the upcoming UC Rusal IPO, a highly questionable and large IPO. Things could be derailed very swiftly if things do not go as planned.

The Standard: Hong Kong is now the world's premier destination for initial public offerings, having raised US$13.82 billion (HK$107.79 billion) in the first 10 months of the year.

Shanghai along with the increasingly hot Brazilian stock exchanges as well as New York were left in the wake of Hong Kong by the end of October, according to the World Federation of Exchanges after its latest month-by-month review.

Hong Kong was ranked top as the largest listing market by fund-raising size, the federation revealed. In taking the No 1 spot, it knocked the Shanghai exchange from the perch it had occupied for three straight months since July. Shanghai's IPO take for the year now stands at US$12.37 billion.

Yet funds being raised are still comparatively modest when compared to the 2006 and 2007 golden years - a period that was brought to a crashing end by the financial tsunami. In each of those years, the Hong Kong exchange counted more than HK$300 billion, driven by heavyweight listing candidates such as Industrial and Commercial Bank of China (1398). That raised HK$124.9 billion in 2006.

Hong Kong is now seeing investment capital pouring into the listing market "as there is no other way to go due to the low interest rate," said Bright Smart Securities general manager Nelson Chan Kai-fung.

The number of offerings this year to yesterday was 62 percent up on last year. Forty-seven companies have turned to Hong Kong this year for flotations, and two-thirds of them were listed in the July

-November period, according to Hong Kong Exchanges and Clearing (0388). "I believe the number of listing candidates will continue to climb in early 2010," said Prudential Brokerage's Mark To.

Companies are eager to cash in on market liquidity "before the central banks tighten monetary policy in the wake of economic recovery," To added. The surge in listings is also expected to continue next year because the SAR is considered a main beneficiary of efforts by the mainland to maintain its momentum. Indeed, brokers see China as the economy with the most growth potential. "The world is looking to tap the China market, and Hong Kong is the place which enables other economies to have access to it," To said. "Nearly 99 percent of the listing candidates generate income from the mainland."

Chan has a similar reading on the potential for the Hong Kong market. He believes it will draw more listing candidates from other countries, helped by an intense effort by HKEx to attract overseas firms.

Continuing the trend, UC Rusal, the world's biggest aluminum maker, is likely to be the first Russian firm to list in Hong Kong. It has a listing hearing on Thursday. It hopes to dual list 10 percent of its shares in Hong Kong and Paris this year - a move with an estimated value of US$2 billion.

p/s photos: Zhou Weitong

Big & Juicy (Or Is It Dicey) IPOs - Sands China & UC Rusal

Sands China, the Macau casino operations owned by Las Vegas Sands (LVS), yesterday kicked off the roadshow for its Hong Kong initial public offering with the aim of raising between HK$19.41 billion and HK$25.96 billion ($2.5 billion to $3.4 billion). The launch came on the same day that China Minsheng Banking also launched its $3.6bn IPO, which looks set to become the largest Hong Kong listing so far this year.

The institutional tranche for Sands Asia, accounting for 90 percent of the shares, has apparently been "multiple times" oversubscribed. The Macau unit of billionaire Sheldon Adelson's casino company will offer locally 10 percent of its 1.87 billion shares at between HK$10.38 and HK$13.88. It costs around HK$5,608 for a lot of 400 shares. Sands China will spend 42 percent of the net proceeds on repaying shareholder loans and inter-company payables, and one-fourth on the completion of Parcels 5 and 6 in Cotai.

Michael Leven, chief operating officer of Las Vegas Sands, said as a growth company, Sands China requires a certain amount of earnings to be retained to develop the Cotai project. Sands China will seriously consider more rapid growth or dividend issuance only after the monetization strategy kicks in. Chairman Sheldon Adelson said Sands China will sell the non-core assets such as shopping malls and serviced apartments. The capitalization rate on malls will increase as they take time to benefit from full hotel operations. He said net debt will drop from 2.86 times to around 2.3 times on the offering day while the full operation of Parcels 5 and 6 in 2012 will further bring its leverage to below one time.bankers argue that Sands China could be the ticket.

The casino operator, which is owned by Las Vegas gaming magnate Sheldon Adelson and holds one of six casino licences in Macau, already controls about 30% of the mass market and is raising money that will go partly towards the re-starting of a development project on the Cotai Strip that was halted last year as the parent company was running out of cash. According to syndicate analysts, the company is also in a prime position to capitalise on any growth in retail spending by Chinese visitors to Macau as it operates about 74% of all grade-A retail space available in the former Portuguese colony.

As I considered the Wynn Macau offering to be an avoid, and a purer gaming play, hence my view on Sands China is even bleaker - although I think their Marina Bay unit is more attractive if you can hive that out. Big offerings like this are market-timed vehicles, it can cause you to lose a lot of money (e.g. going 10%-20% below IPO) if you get caught in a wrong market mood when its actually listed. But at the same time can get you 10% (looks to be the topside considering the size of the offering) upside if the market mood stays good.

A more combustible and heady IPO, closely watched by all foreign media, is the listing of UC RUSAL, a vehicle owned by one of Russia's favoured sons, Oleg Deripaska. Well, they can't list in Russia for now owing to the market sentiment there. Surprisingly, they bypassed London as well, which was considered as a natural for a company like this.

Before a planned $2 billion Hong Kong IPO in December, the world's largest aluminum producer UC RUSAL is close to a deal to restructure $7.4 billion in debt to foreign banks, according to The Wall Street Journal. Controlled by Russian oligarch Oleg Deripaska, the aluminum producer is expected to announce the deal as early as next week, which will allow it seven years to repay $16 billion of debt. HK regulators are expected to give the green light to RUSAL's listing on November 19.

United Company RUSAL is the world leader in the aluminum industry sector, implementing the full production cycle from the extraction of bauxites to the manufacture of primary aluminum and alloys. The company has operations on five continents and in 19 countries around the world. The market share of the company encompasses approximately 12% of the entire global output of primary aluminum and 15% of the world’s alumina production, the necessary raw materials for manufacturing.

United Company RUSAL was founded in March 2007 by the merger and consolidation of RUSAL, SUAL, and the alumina assets of the Swiss company Glencore. Currently the company is comprised of 15 aluminum smelters, 12 alumina refineries, 7 bauxite mines, 3 foil rolling mills, and power-generating assets. UC RUSAL employs more than 100,000 persons at within its structure.

The Russian billionaire is in the final stages of agreeing a restructuring deal with foreign creditors on $7.3bn in debts, a vital precondition for the initial public offering valued at between $1bn and $2.5bn to go ahead. But even if the tycoon reaches agreement in time for a key November 19 hearing at the Hong Kong Stock Exchange, he must still race to win creditor committee approval from the more than 70 banks by the end of November and then market the sale to investors in the two weeks left before most leave for Christmas in mid-December.

It would be the first time a big Russian company has listed on the HK bourse, but they should perhaps first ask why Mr Deripaska is not going straight to London - long the natural harbour for large commodities groups seeking funds on the market. What is the attraction of HK, if not the lure of easy money and bucket loads of liquidity and enormous interest from China over resource plays? All adds up to a recipe for a big truckload of bad things waiting to happen - too eager, too much backslapping, too many wink-wink nods, ...

Could it have anything to do with his problems in the UK, where he is facing legal action, including a suit in the high court from a former partner in Rusal claiming massive compensation? Clearly, the uncertainty surrounding a case that could potentially cost Rusal up to $4bn is mathematical sum that is hard to put inside research reports. The last-minute withdrawal of Goldman Sachs as a lead adviser on the IPO underlines the risks surrounding what would be one of the biggest offerings of the year. Goldman Sachs withdrew as a lead adviser just one week before the company filed its initial application to the Hong Kong Stock Exchange on October 2, because it said it needed more time to familiarise itself with the deal, people close to the situation said. That should be the key already, where in the world would Goldman Sachs relinquish the right to lead a massive IPO if not for "graver concerns".

Mr Deripaska, once Russia’s richest man, has been dogged by issues surrounding his past partnerships in the Russian aluminium industry in the 1990s, a time when it was racked by crime. He is being sued by one former partner, Michael Cherney, in London’s High Court for a stake in his UC Rusal; Mr Deripaska contends he owes nothing to Mr Cherney, who he claims was not a partner but ran a protection racket to extort money out of his company. Mr Cherney denies any ties to organised crime.

IPOs being IPOs, in HK the IPO market is in full swing, issues are very huge, they suck up a lot of liquidity - anything untoward happening to just one could derail the overall markets for s sustained period, and will affect capital flows negatively for the rest of Asia. Enough said ....

p/s photo: Fiona Xie Wan Yu