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By John Helmer in Moscow

Severstal has announced a transaction which returns the Italian steelmaker Lucchini to Alexei Mordashov, the controlling shareholder of the Severstal group, who originally bought the asset and then re- sold it to his company in 2005-2006.

The Severstal announcement says that a 50.8% stake in Lucchini has gone to Mordashov for one euro. Mordashov’s private companies first acquired the Lucchini stake in 2005, using funds borrowed from Severstal. Mordashov then sold the stake to Severstal for a price equivalent of €1.1 billion, including assumption of Lucchini’s debts. The profit earned by Mordashov on that transaction was €182 million, and the transaction drew sharp criticism of Mordashov for profiting at minority shareholder expense.

On this occasion, by appearing to sell the asset, Mordashov is the first of the Russian steel oligarchs to reverse their decade-long pattern of offshore haven buying of steelmills in Europe, North America, and Africa. By flipping the asset to himself on a string, Mordashov has also demonstrated that he has no intention of letting go; and every intention of gulling minority shareholders into bidding his share price up. “We believe”, reports Troika Dialog this morning, “that investors should appreciate such a move, which appears to be responsible behavior in line with the best corporate governance standards.” In trading immediately after the news became known, the stock markets cut Severstal by 2.2%.

Lucchini operates twenty plants in Italy, France, Poland, Sweden and the UK, and specializes in making long steel products, like rails. In 2005, before the Mordashov takeover, it produced 3 million tonnes, with revenues of $2.99 billion, and net profit of $69.5 million. Last year, production was 1.7 million tonnes, for sales worth $1.8 billion. Earnings were reported as in the red by $202.8 million. These performance figures explain why noone wants to buy Lucchini. ArcelorMittal, Tata Steel and Baosteel had been rumored to be interested, but nothing eventuated.

The loss-making Lucchini, whose financial operations were reported in Severstal’s accounts for the first quarter as discontinued and held for sale, is now entirely removed from the Severstal balance-sheet. The effect is to improve the group’s financial condition and lift its earnings, as well as the debt-to-earnings ratio under covenant with Mordashov’s banks.

At the same time, Severstal retains the 49.2% balance of the shares in Lucchini. According to the company announcement, “OAO Severstal retains the right to re-acquire the stake from Mr Mordashov for one euro. In addition, any gain Mr. Mordashov may realize on a subsequent sale of this 50.8% stake to a third party will be transferred to OAO Severstal.”

Renaissance Capital steel analyst Boris Krasnojenov reports the exercise as justifiable balance-sheet juggling, because Severstal has been unable to find an arm’s length buyer for Lucchini. “Overall, we support the idea of divesting loss-making, non-integrated assets on overseas markets, as Severstal may strengthen its financial position and earnings by following this strategy. We have been sceptical about Severstal’s ability to spin-off Lucchini at an EV estimate of $1.5-2bn.” According to the Rencap report, about $736 million of the total Severstal group debt of almost $7 billion (according to the group’s first-quarter financial report) comes from Lucchini, and can now be written off Severstal’s books.

In April, Severstal’s first-quarter accounts also recognized an $854.8 million loss from Lucchini.

“The deal looks acceptable to us from a corporate-governance standpoint”, the RenCap analyst says, “as the Lucchini assets can be bought back by Severstal in the future, if they become profitable.” But he casts doubt on the veracity of the earlier transaction in March of this year in which “Severstal allegedly paid EUR100mn to the Lucchini family, which had exercised a put option, selling 20% of Lucchini to Severstal. Thus, Severstal actually paid cash for the loss-making asset it has now sold for EUR1.” According to Severstal’s accounts, this transaction value was €$82.5 million ($113.3 million).

Dmitry Smolin, Uralsib’s new steel analyst, said “we welcome the idea to divest loss-making non-Russian assets, which should help Severstal to strengthen its financial position and to focus more on its Russian steel and mining operations.”

In a negative report on Severstal in January, Fitch Ratings explained what has been obvious for several years – the steel oligarchs have been stripping cash from their Russian operations to cover operating losses and debt service incurred by their offshore acquisitions. According to the Fitch report, Severstal’s non-Russian operations “may remain dilutive in 2010, with a negative EBITDAR margin of 6%-9%. Fitch expects Severstal’s FY10 gross leverage to improve to 3.3x-3.5x compared with expected gross leverage of 8.0x-9.0x in FY09, and for net leverage to improve to 3.0x-3.2x compared with expected net leverage of 5.0x-6.0x in FY09…. Fitch nonetheless notes that incurrence covenants for eurobonds remain at the existing level (debt/EBITDAR less than 3.5x) which limits Severstal’s ability to access new debt, except for specifically permitted instances including debt refinancing, until it complies with these covenants. The Negative Outlook reflects Severstal’s high dependence on the speed of recovery in demand and prices for steel products in various markets, high expected leverage in FY09 above ‘B+’-rated peers, uncertainties on finalizing restructuring plans for North American and European operations, and the risks in executing these restructuring plans.”

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