By John Helmer in Moscow
If you can peer through the volcanic dust, you can tell it’s spring again for the world’s farmers and global feed and food grain production. So naturally the Russian fertilizer companies, which have been one-man bands until now, are thinking of coming back to the stock markets. The first to try out is Uralchem, owned by Dmitry Mazepin, which issued its prospectus for a London Stock Exchange share sale on April 19.
A 40% bloc of shares is for sale to raise between $496 million and $642 million, according to Uralchem’s target. But as one-man bands go, mark analysts who have read the offer document, it’s out of tune with the market realities.
The Eyjafjallajökull dust cloud has temporarily postponed the London roadshow, but that’s not the only pollutant causing anxiety for Uralchem’s underwriters. Environmental troubles for Uralchem on the ground in Russia, and with the government regulator in court, as well as at a proposed new plant in Dieppe, France, have been visible for many months now.
From mining phosphates and refining gas Uralchem produces and exports a diversified portfolio that includes the basic nitrogen and phosphate fertilisers such as urea, ammonium nitrate (AN), monoammonium phosphate (MAP) and diammonium phosphate (DAP), as well as complex fertilizer mixtures knowns as NPKs. If pretty girls are judged by how many talents they can show all at once, Uralchem is one. According to the prospectus drafted by Morgan Stanley, Renaissance Capital, UBS and Unicredit: “we believe we have the broadest mineral fertilizer product offering among Russian fertiliser producers.”
The three main production units are KCCW, located at Kirovo-Chepetsk in the Kirov region; Azot at Berezniki in the Perm region; and VMF, at Voskresensk in the Moscow region. Last year, Uralchem’s sales to Russia, Europe and Latin America accounted for 27%, 26% and 25%, respectively, of total revenue. The remaining 22% of exports went to East and Central Asian markets.
But there’s a rub. Actually, several of them, which the prospectus spells out in its risks section – Russian competition for mineable phosphates is one; environmental orders from the Russian regulator and opposition from green groups is another; and heavy debts make the third big risk for London investors.
The battle between Uralchem and Phosagro for supremacy in Russia’s phosphate mining sector has been under way now since 2007, when Mazepin started his Uralchem holding. At stake in this contest is the lion’s share of the profit in one of the most globally concentrated mining industries on earth. US Geological Survey (USGS) data indicate that in 2008 Russian phosphate output of 11 million tonnes ranked fourth in the world producers’ table. China was first with 50 million tonnes, the US second with 30.9 million tonnes, and Morocco and Saharoui third with 28 million tonnes. The world market amounted, altogether, to 167 million tonnes. In terms of phosphate reserves, the USGS ranks Russia 7th with 1 billion tonnes. Morocco, China, US, South Africa, Jordan, and Australia hold larger tonnages. So with so few big-hitting nations involved, phosphate mining is what the experts regard as highly conducive to cartel price arrangements.
In the Russian market, here’s what has happened so far. Fertilizer assets were part of the booty that was divided up after the collapse of the two early Russian feedstock empires – the Gazprom empire controlled by Rem Vyakhirev, and the oil empire controlled by Mikhail Khodorkovsky. Dmitry Mazepin, a government privatization official, emerged to take control of Gazprom affiliate Sibur in 2003, when it was being purged of Vyakhirev allies. But he then clashed with the new Gazprom leadership, and he was ousted from Sibur in 2004. He then started a collection of fertilizer assets as free of Gazprom control as he could manage.
At the end of 2007, he called this Uralchem, and in 2008 he borrowed heavily to consolidate his assets into a big enough holding to warrant an initial public offering (IPO).
The most important, and most costly for Mazepin, was VMF (Voskresenk Mineral Fertilizers), the fourth-ranked phosphate producer in Russia, and a dominant supplier of phosphoric acid to the Russian market. The sellers were a number of foreign and Russian owners, and the deal cost Uralchem $358.6 million, a price which valued Voskresensk at a total of $500 million.
Voskresenk doesn’t dig phosphate rock for itself. Instead, it buys from Apatit, which mines it in the Murmansk region, more than a thousand kilometres to the north. Apatit, with the largest phosphate deposits in current production in Russia, has enjoyed virtual monopoly status in the market – and a controversial history. It was first privatized and taken over by Mikhail Khodorkovsky and Platon Lebedev, the Yukos oil company founders. When they were convicted and imprisoned by a Moscow court in 2004, a successor holding, Phosagro, managed to hang on to the fertilizer assets, despite a range of prosecution threats. The federal government then sought to recover a 20 per cent stake in Apatit.
In parallel, two of the downstream buyers of Apatit’s phosphates, Acron and Uralchem, complained that they were being disadvantaged by alleged monopoly trading practices of Apatit, which was accused of supplying its own downstream NPK plant, Balakovskiye Mineral Fertilizers, at low fixed prices on long-term contracts, of rigging high domestic prices for Acron and Uralchem, and of exporting to keep the profits offshore. A press release by Uralchem in September 2008 claimed: “Apatit has been exporting most of its output at prices significantly below domestic rates. In essence, the company [Apatit, Phosagro] has been subsidizing European mineral fertilizer producers to the detriment of Russian producers and the Russian state budget”.
There was tit for tat. Buyers of phosphoric acid from Voskresensk complained to the Federal Antimonopoly Service (FAS) that the plant, and then its controlling shareholder Uralchem, were abusing their dominant market position in refusing to sign supply contracts. Uralchem defended itself, saying the problem started with Apatit’s manipulation of the supply and price of the feedstock. Uralchem applied to the FAS to order Phosagro to back down, while a press release from Voskresenk, issued in September 2008, requested the FAS to “instruct Apatit to cease its violations of the competition law”.
While Uralchem skirmished with Phosagro and Apatit, Uralchem was also planning to add its own phosphate mine to the integrated production chain, eliminating thereby the dependence on a hostile source. This is the Sordinsky project in the vast Vyatsko-Kamsk phosphate deposit in the Kirov region, 1,400 kilometres to the southeast of Voskresensk. The mining licence for Sordinsky was acquired in 2007. Uralchem would like to start constructing the mine, but it leveraged itself so heavily to consolidate its assets on paper, it doesn’t have the $700 million cash to finance digging in the ground. The deposit is reported to hold 850 million tonnes of reserves, will mine six million tonnes of ore per annum, and produce 1.8 million tonnes of phosphoric concentrate.
Until the Sordinsky mine comes onstream, Uralchem’s fight with Phosagro threatens to weaken the earnings and profit lines on the balance-sheet, and that in turn is casting a shadow over the IPO valuation target of $1.2 to $1.6 billion. Those valuations, according to investment bank analysts, require earnings (Ebitda) of between $250 million and $350 million, if Uralchem is to be valued in line with its international peers, Yara (Norway) and Terra (US). But Uralchem’s Ebitda in 2007 was $131.3 million; in 2008, $328.8 million; and in 2009, $72 million.
Is it possible for this holding group to multiply last year’s earnings fivefold?
There is no answer from Uralchem’s publicly released financials, because those on the company website date from 2008. The April 19 prospectus has been given limited circulation; it is not a public document. There is also no report from the company of its financial results for the first quarter of this year.
Part of the answer to the earnings question comes from the cost side; but there Uralchem is caught in commercial conflicts over raw materials pricing, firstly between VMF and Apatit for apatite concentrate; and secondly with Gazprom over gas. Uralchem’s prospectus acknowledges to investors that “no assurance can be given that we will continue to benefit from favourable prices of key raw materials in the future. The supply of natural gas, electricity and apatite to our production facilities is made by monopolies or entities that have a dominant market position”.
There has been a fight in court between the VMF plant and Apatit over the price of apatite concentrate for this year and next. Last December, the conflict led to a halt of all apatit deliveries and phosphate production. Then in January, Uralchem announced the contract price had been settled with Apatit, and confirmed by the High Arbitration Court. Apatit was ordered to supply 920,238 tonnes of apatite concentrate annually through 2011. The agreement stipulates that the price will be based on the 2009 level of Rb3,050 ($105) per tonne indexed against the industry’s price appreciation measured by the State Statistics Service.
But that’s not the end of the court action. Last week, four days after Uralchem issued its prospectus, Apatit filed suit in a Moscow region court charging Uralchem and VMF with failing to honour contract purchase obligations for the required volumes of phosphates in 2008 and 2009. It is claiming Rb1.4 billion ($48 million) in damages in the Moscow region court, and another Rb1.7 billion ($59 million) in a separate suit in the Moscow city Arbitration Court. At the same time, Silvinit, a leading potash producer, has announced that it is now suing Uralchem for colluding on price with another Russian producer of fertilizers, Acron. According to the Silvinit statement issued last Friday, “for effective functioning of the commodity market for potassium chloride [potash], observance of the requirements of the antimonopoly law by all participants of the market is necessary for Russia.”
As for gas pricing, in 2009 the cost of natural gas supplies represented 73%, 52% and 62% of Uralchem’s costs for ammonia, ammonium nitrate and urea, respectively. That year the company says it spent $188.6 million for supplies of natural gas (approximately 80% of which was allocated for conversion into ammonia and mineral fertilisers) representing 33% of the total cost of sales. Gazprom provides two-thirds of this gas; Novatek, an independent Russian producer, provides 25%.
According to Uralchem’s prospectus, “the Russian government plans to increase domestic gas prices by at least 15% per year for the years 2010 through 2012 with the aim of ultimately reaching netback parity with Gazprom’s European export prices.” Moscow sources believe the animosity between Gazprom and Mazepin runs deep. When Mazepin managed to outbid Gazprom by a fraction to take the state’s 38% stake in KCCW in 2005, Gazprom imposed a virtual blockade of gas deliveries to the plant for four months. There may still be a settling of scores.
Another source of uncertainty for Uralchem’s earnings is a claim for repayment of Rb3.1 billion ($106 million) which is currently before the Moscow courts. In this case, a Cyprus company, linked to rival Phosagro and called Shades of Russia Ltd., is suing for its money after it delivered to Uralchem a 24% bloc of shares in VMF which it had owned in 2008, when Mazepin launched his mandatory buyback offer for the minorities. Uralchem says the shares were submitted after the buyback deadline. But it admits in the prospectus that if the courts rule in favour of the minority stakeholder, “any such payment would have a material adverse effect on our financial position.”
More immediately, there are serious charges of environmental pollution in Russia, and protests against a proposed new plant in Dieppe, France, which add to the uncertainty of Uralchem’s plans for lifting production, exports, and sales revenues. Rosprirodnadzor, the environmental inspection agency attached to the federal Ministry of Natural Resources, has been investigating pollution problems at VMF and KCCW for some time. According to Uralchem’s prospectus, there has been a groundwater contamination problem at KCCW, but “we have adopted an action plan in order to mitigate the negative impact of the resulting contamination and to reduce the risk of future contamination of groundwater. We have had no further adverse findings from Rosprirodnadzor since 2007 in relation to this matter.”
At VMF, there have been several inspections over the past two years, but since last October Uralchem’s management has repeatedly blocked federal government inspectors from inspecting the plant for air emissions, waste handling standards, and ground pollution. Rosprirodnadzor and its parent ministry are reported to be preparing a criminal prosecution of VMF. Ministry sources said they are surprised by the prospectus claims. On April 21, a Moscow court upheld the inspection agency’s right to make unscheduled checks of the plant. Rinat Gizatulin, head of ecology at the ministry in Moscow, says the latest ruling “proves once again that the actions of Rosprirodnadzor [are] recognized as lawful and consistent with federal law…during the trial it was established that neither the right nor the legitimate interests of OAO Voskresensk Mineral Fertilizers are violated during unscheduled inspections. Testing is conducted strictly within the current legislation of Russia.”
In France and in England, international environmental protection organizations have joined local groups, and the Russian Socio-ecoological Union to mount a campaign against permitting the construction of Uralchem’s chemicals and fertilizer storage plant and transshipment terminal at Dieppe. If this goes according to plan, the facility will start building in May of this year and be completed in a year’s time. French protesters have published details of the frequent accident rate at Uralchem’s Russian plants, and called on the underwriting banks to withdraw from Uralchem’s London IPO.
Uralchem acknowledges that the campaign is having an impact on the stockmarket. According to the prospectus, “the operations of our plants, as well as our plans and projects, attract attention of various environmental organisations, activists and press. There have been several publications in the media in connection with our production facilities, as well as our project in Dieppe, France, which contained allegations of violations by us of environmental laws and regulations, technological accidents and failures and other speculations. Such speculations and allegations in the media, whether or not accurate, and any similar publications in the future could adversely affect our business reputation and the trading price of the GDRs.”