Ahead of official announcements by Severstal and Lucchini, sources close to the Russian steelmaker expect that Severstal will sign an agreement this week to pay $570 million for a 62-percent stake in the Italian steelmaker, Lucchini. The family-owned business has been losing more than a quarter of a billion dollars per year, and is carrying debts of about $2.4 billion. By contrast, Severstal’s debt at the end of 2004 was just under $500 million.
Exactly why Alexei Mordashov, the oligarch who controls Severstal, should want Lucchini to damage his Russian balance-sheet has yet to be explained by Severstal. As announcements of the deal were appearing Tuesday in Italy, Lada Astikas, spokesman for the Severstal international group, told The Russia Journal she could confirm nothing: “At the current stage, the Severstal Group doesn’t have information about this matter,” she said.
One reason for the caution in Moscow is that Mordashov’s Italian deal, if confirmed, would be the largest Russian investment abroad since fellow oligarch Vladimir Potanin had his Norilsk Nickel mining company pay $1.16 billion for a 20-percent shareholding stake in South African goldminer, Gold Fields. That transaction, on March 29,2004, violated Russian capital control laws. The Kremlin,increasingly suspicious of attempts by the oligarchs to drain their Russian companies of cash in order to buy offshore assets, told Potanin to reverse it. He has yet to do so,
Severstal’s acquisition of Lucchini is roughly double the value of its purchase of another bankrupt foreign steelmaker, Rouge Industries in Detroit, last year. In value transferred offshore, Mordashov’s newest acquisition ranks just ahead of the $461 million, which Oleg Deripaska, the controlling shareholder of Russian Aluminium, is proposing to pay for a 20-percent stake of Queensland Alumina Limited, a major supplier of the alumina required to produce aluminium. That deal has yet to be approved by either the Russian or Australian governments. Current Russian capital control laws require Central Bank review of the deals, and the deposit of half the transaction value in a Central Bank account for a period of about 60 days.
According to Lucchini’s press leaks, Severstal is to purchase a new capital issue by Lucchini with two instalments of cash. Half is payable now, and the second payment will fall due in a year’s time.
Severstal will have an option to raise its stake to 70-percent, if the Lucchini family agrees to further reducing their shareholding. For the present, and following the capital issue which Severstal will acquire, according to the terms of this week’s agreement, the Lucchini family will retain a diluted 25-percent of the plant while 13-percent will remain with Banca Intesa SpA and Unicredito altaliano SpA, the principal creditors of the debt-laden steel maker. In 2004, Lucchini reports revenues of Eurol.9 billion ($2.5 billion). In 2003, revenues were Eurol.8 billion, but losses totaled Euro256 million.
Lucchini Steel produces 2.3 million tons of crude steel annually from old blast-furnaces at plants in Italy, and another 1.1 million tons from more modern electric-arc furnaces at a French subsidiary, Ascometal. In total, its output was 2.9 million tons in 2004.
Severstal’s main Russian plant, Cherepovets, is producing about 10 million tons of steel per annum, and with Rouge added, the total is 13 million tons. This steel is rolled into what the industry calls flat products. Lucchini produces an entirely different assortment of what are known as long products, especially rails. Part of the reason for Lucchini’s losses has been that the price of the raw materials required for turning out steel — iron-ore, scrap, and coking coal — have been going up faster than its sale revenues. However, Severstal almost certainly cannot provide any of these inputs to enable Lucchini to economize.
According to Moscow steel analyst Rob Edwards, “Severstal will post revenues of $7.2 billion in 2005; this would rise to $8.7 billion were the deal [with Lucchini] to be consummated.” He is skeptical that the deal will be profitable for Severstal. “Unlocking real long-term synergies between Lucchini and Severstal will be a more complex issue,” he said, using polite investment banking language instead of the language of risk. “Capacities at every level of the Severstal business are already stretched to deliver into rampant global demand.
Strategically, the deal would be very positive for Severstal, but again, we have to assume that Group margins will further erode, as we have seen as a result of the [Rouge] acqusition in 2004.” In short, Mordashov is about to spend half a billion dollars for a lossmaker. Why?
One theory offered by steel industry analysts is that through Lucchini, Severstal can establish a presence within the European Union, and thereby evade the tight restrictions which the Union imposes each year on imports of Russian steel. In theory, Severstal’s Cherepovets mill can turn out low-cost semi-fabricated steel, which can then be re-rolled into more valuable products for sale in the European markets which limit would otherwise limit the entry of Severstal’s metal. However, with a Severstal plant in Latvia subject to no flexibility in the European import quota for this year, Severstal has already discovered that owning European steel plants does not, and maybe cannot, breach the quota wall erected by Brussels.
Another industry explanation is that, in buying lossmaskers, Mordashov is in essence using cash that might otherwise be taxed by an increasingly diligent Russian Tax Ministry, and converting it into offshore assets that may, one day, generate untaxable benefits for Mordashov’s offshore fortune; this is currently estimated to be worth more than $5 billion. A Tax Ministry report to the Prime Ministry last September noted that Severstal was paying far less tax than the norm among Russian oil exporters, employing a variety of transfer pricing and tax optimization schemes. This isn’t exactly money-laundering, as Brussels understands the term, at least not yet. In any event, Italians in command of declining industries are desperate for any cash lifebelt that is tossed at them, whatever the source.
Some of Mordashov’s fellow steelmakers believe there are more cost effective methods for optimizing on Russian taxation than buying offshore losses. They regard Mordashov’s forays — he has also been negotiating to buy Stelco, a bankrupt Canadian steelmaker; Krivorozhstal, the state-owned Ukrainian mill; and Vitkovice, a state-owned Czech plant — as exhibiting more personal vanity than commercial sense.
Late last year, Mordashov told a steel industry conference that he anticipates “a situation in the steel industry where within a few years four to six companies each had a capacity of about 100m tonnes of steelmaking per year. We would like to be among those companies.”
Even with Lucchini’s output added, Severstal’s aggregate output this year would be no more than 16 million tons. To meet his ambitious target, Mordashov has 84 million tons still to buy.Such over-reaching ambition may have its political value, if the atmosphere for the oligarchs were to deteriorate more sharply at home, and if President Vladimir Putin were to try to retrieve his falling support among Russian voters by a fresh campaign to attack the oligarch fortunes at their root. In the past decade, oligarchs on the defeated list — Vladimir Gusinsky, the media mogul, and Mikhail Khodorkovsky of Yukos — used their cash to buy what they thought would be powerful American support to shield them from the Kremlin. When he acquired the American palladium miner, Stillwater of Montana in 2003, Potanin did much the same thing. Mordashov’s entry into the US steel market, and now his move into Italy, may, in his thinking, be a similar insurance strategy against a new Kremlin campaign.