Guy Norton in Zagreb -

Billionaire fund manager Nathaniel Rothschild may be a devoted fan of Montenegro, recently selecting the country as the venue for multi-million dollar party to celebrate his 40th birthday. But while his guests, who included Russian oligarch Oleg Deripaska, quaffed Bollinger and scoffed Beluga caviar to their hearts' content, lesser mortals were left worrying about whether they would ever see a return on any of the hard-earned cash they have poured into Montenegro in recent years.

UK private equity firm Ethemba Capital, for one, is less than happy with its treatment by the Montenegrin authorities over its investment in Montenegrin steelmaker Željezara Nikšić, which is currently mired in a controversial bankruptcy process. Ethemba - whose moniker ironically means "believe, confide in, have faith in, trust" in Zulu - is now in open conflict with the powers that be in the Montenegrin capital of Podgorica and has taken the unprecedented step of suing Veselin Perišić, the bankruptcy administrator for Željezara Nikšić, in the UK High Court in London.

At issue is the refusal by PeriÅ¡ić to recognize the €60m invested in Željezara NikÅ¡ić by Ethemba and its co-investor MN Specialty Steels via Netherlands-registered joint venture MNSS BV Amsterdam. MN Specialty Steels originally purchased 66.67% of Željezara NikÅ¡ić in November 2006 for €5.2m, with an agreement to invest an additional €118m over the next five years. The balance of the equity is held by a total of 3,000 minority shareholders, including the Montenegrin government. The firm is listed on the Free Market segment of the Montenegro Stock Exchange where its shares were trading around €0.98 in late July, heavily down on the €13 or so level when Ethemba came on board in 2008 and way off the lifetime high of €38.02 in April 2007 when the Emerging Europe investment boom was at its height.

The saga surrounding Željezara Nikšić is a classical example of the pitfalls of the transition from a centrally planned to a market economy. Željezara Nikšić is a giant steel mill located on a 100-hectare site in Nikšić, the second largest city in Montenegro. The plant was constructed for the Yugoslav government in the 1950s and was designed and equipped to make high-quality engineering steels for the Yugoslav military and other Yugoslav engineering companies. At one point it employed over 7,000 workers.

In the period 2002-2006, two Russian companies - Rusmontstalj and Midland - tried to run the mill, but ultimately relinquished control, leaving huge utility and supplier debts behind them. In February 2008, Ethemba acquired a controlling stake in Željezara Nikšić from MN Specialty Steels, a firm managed by expatriate Montenegrins, and also negotiated amendments to the original privatisation agreement.

Although a producer of high-quality steel, like many of its peers in Emerging Europe, Željezara Nikšić's financial performance has been blighted by the socialist legacy of chronic over manning, with the result that it has consistently generated losses even at times of high prices for special steel production. As Daniel Brol, a senior portfolio manager at Ethemba Capital in London relates, the theory behind their investment was a simple one - introduce the necessary new technology, management know-how and customer contacts to make Željezara Nikšić competitive on a global basis. "We always believed that if properly restructured, Željezara Nikšić could be a viable, profitable business," says Brol.

Turnaround

When Ethemba signed an agreement with the Montenegrin government in 2008, it was confident that it could turnaround the company's financial fortunes despite the downturn in the outlook for steel markets around the world that followed the global crisis. Brol says that having secured management control of the plant ahead of competition from Greek and German investors, it was more than happy to invest in a new arc furnace at Željezara Nikšić, improve anti-pollution measures and upgrade facilities at the Montenegrin port of Bar on the basis that it could push through a restructuring plan that would involve an agreement with trade unions that would have seen the workforce reduced from 1,500 to 700 in an attempt to restore the mill to profitability. So far, so good. Events however soon took a turn for the worse.

Prva Banka, the local lender that has served as Željezara NikÅ¡ić's house bank for decades, soon proved a less-than-reliable partner, claims Brol. Despite the fact that the bank boasted €34m worth of deposits from MNSS, it proved unwilling to release funds for Zeljezara's outstanding liabilities relating to the investment programme, forcing the investors to take legal action against Prva Banka to force it to hand over the necessary funds to pay off outstanding debts. Despite receiving the blessing of the Montenegrin government in 2009 for its restructuring plan, and securing €26m from Credit Suisse to support it, Ethemba and its partners soon found themselves at odds with the mill's trade unions who railed against any head count reduction. "We always wanted to act as a socially responsible employer," says Brol, adding: "But we also expected something back from the employees in return."

Those hopes soon turned to dust, with the result that in December 2010 the trade unions occupied the mill in protest at unpaid wages and social benefits, and, according to Brol, physically assaulted the company's management. Events took an even nastier turn this year when, in a bid to see the company taken back into state control, the trade union successfully lobbied to have the firm declared bankrupt in April on the basis of €4m in unpaid wages and benefits. At the same time, the Montengrin government provided an interest free loan to the trade union for payment of salaries without notifying Zeljezara's management. As a result, the Commercial Court in Podgorica has taken management responsibility away from Ethemba and its partners and passed it on to local firm Neksan.

In May, Neksan's owner, Miodrag Davidovic, was given three months to remedy the situation at Željezara NikÅ¡ić, but has clearly found the going equally tough. He recently told Serbian daily Novosti that Željezara NikÅ¡ić will be out of business by early August if things don't improve. Under the terms of an agreement between Neksan and German metals group Scholz, Željezara NikÅ¡ić was supposed to supply 6,000 tonnes of special steel, but an initial delivery of 4,000 tonnes was rejected because it was a sub-standard quality. Meanwhile, now former owner Ethemba faces huge uncertainty of its €60m investment in Željezara NikÅ¡ić given the refusal of Perisic, the bankruptcy administrator, to accept their claims as creditors.

In the UK High Court action, Ethemba et al are seeking recognition as creditors on the basis that Perisic's rejection of their claims is based on information that is "either untrue, irrelevant or both". They are also suing PeriÅ¡ić in the Montenegrin courts, claiming he has committed an abuse of office in his role as bankruptcy administrator. For his part, Perisic recently told Montenegrin daily Pobjeda that Ethemba and their partners are attempting to discredit him both personally and professionally, and he accuses them of causing havoc at the plant, racking up €100m of losses and €193m of unpaid claims.

While the outcome of the legal action is still undecided, what is not at issue is the fact that Željezara Nikšić is now on its knees, some 1,500 workers face a highly uncertain future, a group of international investors is highly disillusioned, and Montenegro's reputation as an attractive destination is now at stake. All in all, a lose-lose situation for everyone involved.