By John Helmer in Moscow
High River Gold (HRG:CN) is being prepared for a sale, along with other goldmine assets of the Severstal Resources group belonging to Alexei Mordashov, to a Chinese buyer.
At least, that is what Moscow sources report as the rationale behind a proposed swap of equity for loan, announced by HRG and the Troika Dialog-Standard Bank group last week. This proposal has drawn immediate opposition from independent minority investors in HRG, who have complained to the Toronto Stock Exchange that the transaction is a sweetheart deal at an advantageously low price for the new shareholder.
“The transaction in the first stage aims to raise C$57 million, and repays a loan of $27 million, at an undervaluation of the company,” the sources with access to Troika have revealed. “The second stage, and Mordashov’s aim, is to resell HRG and Severstal’s other gold assets at a significant value multiple to a Chinese beneficiary.”
The key to the Chinese sale is Industrial and Commercial Bank of China (ICBC) – state-controlled, and one of China’s largest banks — which bought a 20% stake in Standard Bank of South Africa at the start of 2008; and then took de facto financing control of Standard’s international mining business. How advantageous that deal was to ICBC was kept under wraps in South Africa at the time, as were problems emerging in the balance-sheet and management of Standard Bank’s Russian operations. A year later, between March and October of 2009, London sources close to Standard say, it was Chinese cash that helped empty the pooled liabilities and fund the merger of their Russian businesses between Standard Bank and the Moscow investment house, Troika Dialog. That deal assigns Standard Bank a 33% stake in Troika for $200 million in cash, and another $100 million in capital injection to Troika.
Evidence of growing Chinese interest in Russian goldmining assets is attested by North American investment bank advisors, as well as a leading Russian goldminer, who acknowledges that his company recently rejected a Chinese approach to finance exploration and development of an unmined deposit. The reason, according to the Russian miner, is that it was reluctant to concede operational control over the project, which was the quid pro quo for the Chinese financing.
HRG has four operating gold mines in Russia and Burkina Faso, and two mine projects in development. According to the second-quarter production report, issued in August, attributable gold production for the quarter ending June 30 was 72,346 ounces, at a cash operating cost averaging $497 per ounce.
Attributable gold reserves were estimated in February by Dan Hrushewsky, then HRG’s investment relations director, at 2.2 million oz, with silver reserves at 5.2 million oz. A subsequent release from the company on March 17 reported a MICON expert audit of gold reserves at the Zun-Holba and Irokinda mines (Buryat region of southeastern Siberia). Altogether, counting the Bissa gold project in Burkino Faso and the Prognoz silver project (Sakha region of fareastern Siberia), and converting silver reserves into gold equivalent, HRG’s gold equivalent reserves and resources, on the Canadian NI 43-101 basis, add up to 6.4 million oz.
A takeover of the HRG minority shareholders was attempted by Mordashov’s managers, but this failed in August. At the same time, the financial pressure on Mordashov to reduce the indebtedness of his international steel group has intensified. For several months, there has been speculation in Moscow that, in order to restructure his group’s debts, and lower his debt to Ebitda ratio, in line with his borrowings, he may consider selling out himself from HRG. All the major Russian goldminers had looked at HRG before Severstal moved in last year. The more liquid of them are showing signs that they are reconsidering the target once more. “I believe Severstal is ready to sell,” says one well-known Russian goldminer, “but the buyer would have to acquire all the gold assets of Severstal Resources, including some which were very over-valued when Mordashov’s managers bought them. Some of those managers are no longer with the company.”
The speculation appeared to be confirmed at a Moscow investment conference on October 22, when the chief financial officer of the Severstal group, Alexei Kulichenko, said the company may divest its gold business in the first half of next year. This was reported by Alfa Bank to investors, with the comment that “the divestment will occur earlier than we anticipated. Previously, the management planned the divestment for 2011. We understand that the company still has to do a lot of preparation work for the divestment by consolidating financials and auditing and publishing reserves, etc.” A day after Kulichenko’s remark, Severstal issued a formal denial of its intention to sell its gold business.
On October 27, the company authorized this announcement from HRG: “High River Gold Mines Ltd. (“High River” or the “Company”) announced today that the Toronto Stock Exchange (the “TSX”) has accepted notice and conditionally approved the listing of up to 150,000,000 common shares of the Company (the “Shares”) in connection with a proposed private placement (the “Private Placement”) to Polenica Investments Limited (“Polenica”), an affiliate of Troika Dialog Group (“Troika”). Subject to negotiation of final agreements and due diligence, as well as the receipt and clearance of a Personal Information Form in respect of Polenica by the TSX, Polenica will acquire 150,000,000 Shares, representing approximately 23.1% of the 649,213,040 currently outstanding Shares, at a price of $0.38 per Share. The proceeds of the Private Placement will be used by High River to repay the approximately US$27 million outstanding under the two credit agreements that were assigned by Standard Bank Plc to OAO Severstal (“Severstal”) as of April 20, 2009, with the balance being used to fund the exploration program at Buryatzoloto and for general corporate purposes.”
The announcement reported that the transaction had been “unanimously approved by the Board of Directors of High River, with nominees of Severstal abstaining.” Since the release, HRG’s share price has gone up to 39.5 Canadian cents. Its current market capitalization is C$256.4 million.
Igor Klimanov, the newly appointed CEO of HRG, said that after the issue of new shares, the new shareholdings will be 50.1% for Severstal; 31.1% for the minorities, and 19% for Troika. He declined to comment on the reserves and resources estimate for HRG and the other goldmines in the Severstal Resources portfolio. In the mining section of the Severstal financial report for last year, HRG is listed as having reserves of 105 tonnes (3.4 million oz); the former Celtic Resources mines now part of the Severstal group, 31 tonnes (997,000 oz); a group of Russian assets sold to Severstal by the Arlan group of Moscow, 251 tonnes (8.1 million oz); and Semgeo, 30.4 tonnes (977,360 oz). This cumulative total in this report is 417.4 tonnes (13.4 million oz); Severstal Resources claims on its website that its reserves add up to 600 tonnes (19.3 million oz).
In Severstal’s latest consolidated report, gold output for the group is shown as a consolidated figure of 143,614 oz, a gain of 29% over the second-quarter total, and up 219% over the same period of last year. No breakdown by mine has been published. HRG is not due to release its latest quarterly results until later this month.
Russian goldminers believe that in his haste to build up a gold portfolio for his mining division, Mordashov overpaid for the Arlan deposits. They are also skeptical of the reserve count and value currently attributed to them. According to a report by Alfa Bank, “we value Severstal’s gold mining assets at $1.6 bln on an EV/EBITDA basis, applying a multiple of 8.0x to reflect a conglomerate discount to the segment’s estimated EBITDA of $200 mln.”
A Moscow-based stakeholder in HRG said that the latest operational data suggest that “HRG has good cash flow on the quarter, so if you include the cash from this placement to the already cash-flow positive quarter, I think its safe to say that the ‘bankruptcy’ question is off the table for good. And that is a good thing for sure. As for the placement — I’m not going to draw conclusions until there is confirmation that the deal passes.” This source says that his back-of-the-envelope estimate is that if and when Mordashov sells his goldmining assets, “that is a $2.5- $3 billion market cap company if they packaged it up and sold it to a strategic buyer. I think they would likely sell to a strategic investor rather than to market as they need the cash, not the equity valuation. That would make a huge step in making OAO Severstal’s debt payments more manageable.”
A leading spokesmen for the minority shareholders in Canada, Chris Charlwood, has issued a detailed statement that is critical of the Troika deal.
“By my calculations,” Charlwood has told the market, “upon closing of the $57M financing with Troika (via Polenica Investments, announced 10/27/09), HRG is essentially debt free on a net basis (‘net’ being debt minus cash & 3rd party shares). At the end of Q2, HRG stated their debt position was $135M. Deducting cash at that time, debt was $112M. If on Nov. 13 HRG reports $26M in positive cash flow from operations for Q3 (an approx. average of the 1st two quarters) then debt is down to $86M. With this $57M financing, it brings the debt down to $29M. The shares HRG owns in third party companies including Detour Gold are worth approx. $50M based on current market prices. Hence, HRG has more than enough cash and shares now to cover all debts as they come due plus fund the exploration program at Buryatzoloto and for general corporate purposes. When the debt is cleared, the company looks like it will be producing over $100M/yr in free cash flow from operations.”
Accordingly, Charlwood and most of the institutional shareholders believe that Severstal has given Troika and Standard a highly advantageous buy-in price, and an extremely disadvantageous valuation for the company. “With Friday’s closing price at $.39, HRG’s current market cap sits at (an extremely low) approx. 3 times cash flow from operations. HRG’s peer group of West African and Russian mid-tier public gold companies (Polymetal, Randgold Resources, Petropavlovsk – formally Peter Hambro Mining, Golden Star Resources, Red Back Mining, Semafo Inc., Highland Gold) is trading at an average of approx. 19.3 times Q2 Operating Cash flow on an annualized basis. If HRG were trading at this average multiple, the share price would be C$2.95. HRG was trading at $3.40 early last year. The minimal 5% discount to market price and zero warrants negotiated in this financing may suggest a floor in share value at $.38.”
According to Charlwood, “the disappointing aspect of this financing is that minority shareholders communicated to HRG management that they would be interested in participating in a Rights Offering to prevent dilution. It seems like these requests have been ignored by HRG management in favor of a financing with Troika. Herein lies the main concern. Troika has arranged and consulted on many financings and other transactions for Severstal in the past. Although Troika may have sold off part of this financing to its investors, they may choose to use influence to have these shares tendered to or voted with Severstal in a future minority buyout transaction.”
Charlwood, who was part of the highly successful mobilization of HRG shareholders on the internet to oppose Mordashov’s buyout offer, says he and his allies have now filed a complaint to the Toronto Stock Exchange. This asks the exchange to rule that a rights issue should be brought to all shareholders and this transaction cancelled. At the very least, …these shares, due to “related party status” should be deemed “non-voting” in any further buyout transaction attempt by Severstal.”
So far the Canadians do not appear to be aware of the Chinese end-game transaction which Troika sources have disclosed in Moscow. Klimanov was asked what is the current status of the discussions between Severstal Resources, Troika, Standard Bank, and Chinese gold asset purchasers? He replied: “I have no idea what you are talking about.”
Responding to the criticism of the Canadian investors, Klimanov said: “We believe that the transaction is fair to everyone; it is done at a market price and the dilution is the same for all shareholders. We have interacted with existing minority shareholders before choosing Troika. Troika is a non-related party, and everyone who says otherwise is a liar.”
[+] The latest report on Russia-wide gold production from the Union of Russian Goldminers indicates that in the nine months to September 30, Russian gold output was 151.3 tonnes (4.9 million oz), up 15% on the same period of 2008.