Part of Palms & Company's Commercial Intelligence Assistance as PurchasingAgent for Buyers of Russian Aluminum billets and ingots

RUSSIA'S OTHER NON-FERROUS METALS INDUSTRY OWNERSHIP TODAY (JULY 10, 2002)

Talking about getting a slice of the metals pie has become fashionable in

Russia over the past decade, and now it is more or less clear who owns

what. Only now are the players assessing their weight and their potential

in the sector. Many of the sought-after assets in the "metals wars" are

losing their attractiveness. Rather than being multi-million-dollar cash

cows, metals companies are desperate for multi-million-dollar investments.

Theoretically, the process of carving up the sector should have ended when

each of the nine large companies Severstal, ZSMK, NLMK, KMK,

Magnitogorsk, NYMK, Mechel, OEMK and NOSTA found themselves an owner. The

only company still looking for an owner is NOSTA, because Avtobank and its

ally, oil trader Nafta-Moscow, are fighting to remove Stiltex, their

former ally in the fight against the management.

The rest of the companies have already pledged loyalty to this or that

feudal lord owner of a controlling stake or creditor debts. But only a

lousy feudal lord doesn't dream of becoming an emperor. The current balance

of power in the sector is based on not just the Big Nine companies, but

also on the suppliers of raw materials and major consumers.

Various sector players chose different strategies. Severstal's head Alexei

Mordashov figured the best way to build the empire was to form contractual

alliances. Severstal agreed to defend its partners in the alliance from

potential problems by using its political influence (e.g. protecting a

state-owned company from privatization), while the partners weren't to

flirt with Severstal's competitors.

Viktor Rashnikov, the head of Magnitogorsk steelworks, bet on protection

from the authorities and building a vertically integrated company modeled

after the giants in the oil sector. Alexander Abramov and Iskander

Makhmudov, meanwhile, followed a strategy of horizontal integration and

acquisitions of coal companies.

So far, all these strategies have proved worthy. By the middle of this

year, up to 80 percent of assets in the metals sector have been united

through various means into roughly seven major alliances and empires that

set the climate on the market.

Strange though it may seem, the country's major metals alliance a

partnership between the Urals mining and enrichment plant and Evrazholding

hardly seems to exist. But this partnership, built on personal ties

between its participants, control up to 40 percent of all assets in the

sector and run three of the Big Nine NTMK, Zapsib and KMK. The alliance

makes no secret of its plans to get its hands on a couple more major

companies.

Alexander Abramov and Iskander Makhmudov sealed their alliance during the

battle for the Kachkanarsky mining and enrichment plant. The ideas author,

Sverdlovsk entrepreneur Pavel Fedulov, was one of the most colorful

figures of the "bandit capitalism" period. He served time in Sverdlovsk

Oblast prison for his brutish methods of resolving a business partner, the

buyer of 19 percent of shares in the Ural-Start mining and enrichment

plant. Fedulov, who was a major shareholder of Kachkanarsky, intervened in

negotiations between Djalol Khaidarov, Kachkanarskys general director, and

Alexander Abramov, who controlled NTMK.

Fedulov realized that if Khaidarov sold his shares to Abramov, his own 19

percent stake lose its value. He decided to team up with Khaidarovs

partner Makhmudov, co-owner of UGMK, who soon removed Khaidarov from the

company, and then it was Abramov's turn to worry. Instead of mining and

enrichment company, for which NTMK was a major consumer, he got an

influential and powerful competitor at the steelworks. After Khaidarov

helped Evrazholding resolve its conflict with Sverdlovsk Oblast Governor

Eduard Rossel, the trilateral union began to grow fast.

The alliance went on to swallow the remains of empire built by Mikhail

Zhivilo, a Siberian metals magnate accused of plotting to assassinate

Kemerovo Governor Aman Tuleyev. Once it had Zhivilos KMK and a number of

coal companies under control, the alliance became the largest organization

on the Russian metals market. Through its common co-owner Makhmudov, the

alliance sealed a partnership with Russky Aluminy, the Kovdorsky mining

and enrichment plant, Kuznetsky ferro-alloys, Vostisibugol, Chitalugol,

MDM-Bank and its parent company MDM Group, which owns the Pipe and Metals

company.

The alliance is quite aggressive in its desire to be the most influential

player in Russian industry overall. For example, it is showing unambiguous

interest in Magnitogorsk steelworks, which has managed to stay independent

thanks to its political connections, including the deputy prime minister

Viktor Khristenko, governor Pyotr Sumin and presidential representative

Pyotr Latyshev, who is in conflict with Governor Rossel and cant stand

Makhmudov.

But the image of Makhmudov as the shadow owner of all Russian industry is

undoubtedly exaggerated. Serious players on the market regard Makhmudov, a

Tashkent native who speaks Arabic, with respect, but without superfluous

seriousness. Makhmudovs name comes up whenever assets in any industry are

being carved up. In August, the Kommersant daily came up against an

unusual situation. During a battle for a small plant in the Sverdlovsk

Oblast, both sides in the conflict said they were fighting Makhmudovs

people. And the manager of the Lebedinsky mining and enrichment plant, who

is in conflict with the local authorities, said that "Makhmudov himself

came twice" to the little town where the plant is located. The plants

management surrounded the buildings with Tatra trucks to keep the enemy

out, but Makhmudov never turned up.

The Makhmudov factor reached a boiling point when a Moscow-based tabloid

seriously debated whether Makhmudov wasn't just a virtual character, or

something of a dragon from fairy tales for middle management. The wildest

version was that Makhmudov is Governor Rossel himself.

The other three metal Goliaths haven't shown any interest in Evrazholdings

horizontal integration strategy. They are able to build their own empires.

The only thing the owners of NLMK (Vladimir Lisin), Severstal (Alexei

Mordashov) and Magnitogorsk steelworks (Viktor Rashnikov) lack is powerful

political support.

UGMK-Evrazholding benefits from Makhmudovs close contacts with Roman

Abramovich and Rossel, but Lisin and Mordashov have demonstrated the power

to appoint the governors personally. For example, Vyacheslav Pozgalyov,

the governor of Vologda Oblast where Severstal is located, used to be

Severstal's deputy director for social and cultural affairs. But Severstal

cant give Pozgalyov more weight as a governor.

Rumors have it that both Lisin and Mordashov have been invited to join the

government on several occasions, but have refused. Lisin says he refused

because he loathes working in public service, while Mordashov does not

bother to explain. Rumors have it he could have traded a controlling stake

in Severstal for the post of deputy prime minister, but the millionaire

metals boss was obviously not ready for a such a radical career change.

Despite lacking a major political sway, the empires of NLMK, Magnitogorsk

and Severstal are quite effective and growing. This year, Severstal

unexpectedly acquired assets in the automobile industry, specifically the

Zavolzhsky engine plant, which supplies the GAZ and UAZ automobile plants.

Most likely, Mordashov was trying to get back at Russky Aluminy and Oleg

Deripaska, who already bought GAZ and the Pavlovsky bus plant, and is

eyeing the Minsk automobile plant. Russky Aluminy has had no luck in

buying the technologically important engine plant from Mordashov.

Whats more, Mordashov was able to convince MDM Groups head Sergei Popov

that Kovdorsky plant, Severstal's ore supplier wouldn't change its sales

policies as soon as MDM buy it. Severstal solved its coal problems easily

by lobbying for the Komi coal holdings to be excluded from the list of

companies up for privatization. Mordashov became friends with all the

influential coal people on the European side of the Urals Mountains.

Tuleyev quickly had the coal people on the Siberian side of the Urals

making friends with Makhmudov.

Another of Severstal's important acquisitions was the United Steelworks

pipe factories, the Vyksunsky and Chelyabinsk pipe plants. These plants

represent a third of the pipe market.

Rashnikovs empire is not as large, and includes only part of the

Chelyabinsk Oblast's metals processing plants. Magnitogorsk's main ore

supplier, Sokolovo-Sorbaisky mining and enrichment company, is located in

Kazakhstan. Magnitogorsk has perfectly friendly relations with its

suppliers.

Lisin, who heads NLMK, has also not shown much interest in expanding his

business. He seems satisfied with the KMA ore company at the Kursk

magnetic anomaly, and a small stake in the Lebedinsky mining and

enrichment company. He sees NLMK as the core of his business. Lisin was

the first of the Russian metals chiefs to announce an equipment overhaul

program for his plant; as a result, NLMK is quite a modern plant compared

to, say, Magnitogorsk or Nizhny Tagil.

NLMK plans to invest over $1 billion in production development over the

next four to five years. Lisin, who used to manage Trans World Groups

Russian affairs and is largely responsible for its demise, says his desire

to spend money on production is justified. Within five to seven years, his

competitors empires wont be able to keep up because of their technological

handicap, he explains.

Until spring of this year, Lisin struggled to build his empire. Then,

after a two-year battle, TWG finally sold its NLMK stake to Interros,

Lisin's former opponent. It took Lisin a year to persuade Vladimir Potanin

to invest money in NLMK. But Potanin refused to do it through an

additional share issue, forcing Lisin to get a $200-million bank loan.

The idea of investing in production, as foreign as it may seem to the

oligarchs, is reasonable. Over the past decade, only a tiny portion of the

profits have been reinvested into the metals production; the greatest

achievement a top plant manager could have had to his name was a press

release saying that production had resumed and that the plant had regular

outputs. What resources fed the plants operations or whether it was an

attractive acquisition target was not important. That is why NLMK press

releases refer to Lisin as the "professor" he was the first to realize

the importance of investment in production.

The allotment process ended fairly peacefully at the other two Big Nine

companies OEMK and Mechel. Gazprominvestholding, an investment arm of

Russia's oil giant Gazprom, considers OEMK its subsidiary. At Mechel,

Glencore, the reincarnation of Mark Rich and Co., voluntarily gave up

control to Igor Zyuzin, the owner of a coal company Yuzhny Kuzbass.

At first glance, Alisher Usmanov, the head of Gazprominvestholding, is a

serious candidate for Metals Emperor title. OEMK, built in 1990, is a

modern plant that uses modern techniques for steel processing. Electric

steel processing is considered the most promising direction for the future

of ferrous metals. Moreover, OEMK has a controlling stake in Lebedinsky

plant, the country's largest iron-ore producer. OEMK hardly requires any

coal.

But Usmanov doesn't seem to be planning any territorial takeovers, most

likely because Gazprom, the plants ultimate owner, wont invest money in

the metals sector. Gazprom couldn't even assist in lobbying for stan-5000

large-diameter pipe-making equipment to be installed at the Oskolsk plant.

Alexei Ivanushkin, Mechels general director and a former head of Glencore's

Moscow sub-division, is clear that building holdings doesn't interest him.

Glencore bought Mechel as a launching pad to bring Mark Rich's empire back

to Russia in 1996. At one point, Mark Rich and his partner Willy

Schtrothotte, the head of Glencore, played just as significant a part in

the Russian metals sector as TWG. But the Mechel project failed because

German company Krupp refused to enter an alliance with Glencore in

Russia. At that point, Mechel started searching for the buyers.

The plant, very efficient by Russian standards, found a buyer only by

November 2000. Yuzhny Kuzbass and its partner Boris Zubitsky, the owner of

Kemerovo coke-chemistry plant, began negotiations to buy Mechel. Today,

Yuzhny Kubass has a controlling stake in the plant, while Zubitsky, rumor

has it, has temporarily backed out of purchasing the rest of the shares.

As a result, the takeover, which would have made Zyuzin and Zubitsky the

owners of yet another empire, was paused in mid-stride. Ivanushkin has no

reason to hurry in this situation.

But the list of potential "emperors" doesn't end there. Aside from the

companies turning ore into cast iron and steel, there are companies

turning scrap metal into steel, and they also carry a certain weight. The

Taganrog steelworks, for example, controlled by Moscow group Alfavit, is

far removed from metals-sector assets carve-ups, as it uses scrap metal.

The MAIR Group, which controls 40 percent of the scrap metal market, also

bases its business on ferrous scrap metal.

Furthermore, major players such as Alfa Group and MDM Group have become

involved in rebuilding technical links in the metals sector. MDM already

began building a metals holding, while Alfa made an unsuccessful attempt

to acquire Tagmet, and is likely to go after other metals companies. But

neither Alfa nor MDM have the administrative resource to convert money

into assets that turn into even larger chunks of money.

Rossiisky Kredit, which is coming out of a slumber, will also probably

want to expand its empire. The Metalloinvest holding, closely affiliated

with Rossiisky Kredit, controls the Mikhailovsky and Stoilensky plants.

Alisher Usmanov tried to buy both at one point, but the deal didn't go

through. Metalloinvest also owns Tulachermet and a number of steel rolling

plants, such as Orlovsky. Boris Ivanishvili, a co-owner of Rossiisky

Kredit, is one of the contenders for the metal kings crown.

There are plenty of other challengers who want to get rich. Anything is

possible in the Russian metals industry so long as a director of a Big

Nine company can find himself replaced during negotiations with an

influential governor; so long as someone like Mikhail Zhivilo can go from

being the head of an empire to being an accused murderer within six

months; so long as the fate of a $1-billion contract is decided not based

on its financial effectiveness, on the personalities of influential its

lobbyists in the government. The history of how metals companies acquire

shareholders is still far from complete.

Courtesy of Palms & Company, Inc.

First, Wholly American Owned, Washington State Corporation

Licensed by Ministry of Foreign Economic Relations of the Soviet Union

in 1989

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