Evraz and Severstal mull forming new Russian steel giant

By bne IntelliNews December 13, 2011

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The head of Evraz has raised the possibility of a merger with peer Severstal on December 12, saying that uniting the two Russian steel companies would be a "good idea." That has set analysts off to discuss the pros and cons of the pair getting together to form what would be the world's eighth largest steelmaker.

Speaking in an interview with the Financial Times, Alexander Abramov left it unclear whether this was an invitation for talks or if talks are already underway. According to analysts, the only indication that something might be in the wind is that both companies have been involved in significant corporate actions over the last six months or so. Severstal is spinning off its gold business, while Evraz has been trying to offload coal miner Raspadskaya and recently listed its shares in London.

According to Alfa Bank, the merger of Russia's two largest steel producers would create a vertically integrated steel giant with an annual crude steel capacity of over 30m tonnes. The merged company would be the world's eighth largest steel producer in terms of volume, just behind Japan's JFE (31.1m tonnes) and Nippon Steel (35m tonnes). The aggregate market cap of the new combined company could reach $17bn.

The idea is hardly new, however. The mega-merger of these two Russian companies has been discussed in a number of different combinations many times in the past. Combining the two would create a company with a dominant product mix in Russia. Although of similar size in terms of production, Severstal, as a flat steel producer, is by definition a higher value-added producer and makes more cash per tonne of steel.

At this stage, it is impossible to judge whether Abramov's statement will lead to an actual deal and what the timing and structure would be. However, it could be significant that these comments come from the Evraz side. Severstal CEO Alexei Mordashov was ready to merge his firm with Arcelor in 2006 (it merged with Mittal to form today's ArcelorMittal), and in 2007 said that he would like to get involved in the consolidation of the Russian steel industry. Evraz has always rejected such ideas.

Analysts at Troika Dialog, "suspect the idea of a merger could appeal to Evraz Plc's core shareholders (Roman Abramovich, Alexander Abramov and Alexander Frolov), who could be prepared to monetize their stakes at a good price and ultimately cash out."

According to Alfa Bank, potential benefits from a merger include cost synergies, SG&A cost reduction, a higher weight in the FTSE 100 if the merged company remains in the index (Evraz was recently included), and more power in negotiation with suppliers. "Importantly, it would also resolve the issue of high leverage, because combined, the two companies would have much stronger cashflow power," write VTB analysts.

However, the Troika analysts suggest Evraz has the most to gain. "Such a deal would make little sense for Severstal," they write. "The company's business model is currently coherent and sound... adding Evraz Plc's Russian and global assets will not create any value. Additionally, the combined company will find itself highly leveraged because of Evraz Plc's liabilities."

Traders at Citigroup also suggest a deal may not be the greatest fit, pointing out that Evraz trades at a 24% premium to Severstal, despite the latter being "a much higher quality asset."

They add that "Evraz's bargaining position is likely weakened by the absence of foreign buyers - due to perceived political risk and required Kremlin blessing. Most likely much ado about nothing."

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