Clare Nuttall in Almaty -

Just three months after listing on the London Stock Exchange and buoyed by declining global metal production, which has caused demand and consequently prices for its products to soar, Kazakhstan's largest listed company ENRC shot into the FTSE 100 index. Now the metals and minerals giant says it's moving on from its abortive takeover of Kazakh copper miner Kazakhmys to pursue an international expansion programme.

ENRC - the Eurasian Natural Resources Corporation - is the world's largest ferrochrome producer, the fifth largest producer of aluminium, and the sixth largest exporter of iron ore. Rising commodity prices on world markets mean revenues from the company's three metals divisions are set to grow for the foreseeable future. High energy costs have slowed production in countries from China to South Africa, reducing supply of iron ore and aluminium, and pushing prices up further.

By contrast, ENRC is self sufficient in energy through its power division, which also supplies electricity to third parties, accounting for 16% of Kazakhstan's total electricity generation. It is, therefore, able to take advantage of rising metal prices on world markets. "Ferrochrome has clearly been helped by the production shortages in South Africa, and we believe the ferrochrome market will continue to be strong for the foreseeable future," says ENRC Chief Financial Officer Miguel Perry. "We have also seen tremendous increases in iron ore prices - by around 75% on average - and we expect to see more supply going offline worldwide, which will ensure strong pricing in 2009 and beyond. The aluminium market is being affected by the current energy supply constraints, particularly in South Africa and China, which will support future price increases in this market."

This is not to say that ENRC's future is problem free. One issue that could dampen the company's profits is Kazakhstan's planned extraction tax for metals companies, as it attempts to mine a larger share of the revenues from the country's natural resources. While nothing has yet been formally announced, Kazakh Deputy Finance Minister Daulet Ergozhin said in a recent interview with Bloomberg that the extraction tax "will definitely be imposed" and that an export duty for metals is likely.

Perry says it's too early to say what the impact of this will be on ENRC. "We're in constant dialogue with the Finance Ministry and other government organisations, which I think is a positive thing," he says. "If that decision was being taken behind closed doors, we would be slightly more concerned. However, it's too early to tell."

National champion

The building blocks for ENRC were several large metals companies that had their origins in the Soviet era. Kazchrome, Aluminium of Kazakhstan and SSGPO, all major businesses in their own right, were bolted together after privatisation with the aim of creating a global giant. As well as its metals and energy divisions, the company has set up ENRC Logistics, which last month won a $900m contract to build and operate the China Gateway Project. In total, its operations account for around 4% of Kazakhstan's GDP.

Today, the owners of the privatised companies - oligarchs Patokh Chodiev, Alexander Mashkevich and Alijan Ibragimov - each hold a 14.6% stake in ENRC. The other main shareholders are the copper producer Kazakhmys and the Kazakh government.

In December, ENRC listed on the London Stock Exchange. It is the only Kazakh company in the FTSE 100, with a market capitalisation of just under £1.8bn. "We are listed alongside other international mining companies, which are a good peer group for us. We also have to adhere to good standards of corporate governance and transparency," says Perry. This included bringing on board independent non-executive directors such as venture capital pioneer Sir David Cooksey and Sir Richard Sykes, rector of Imperial College London, as well as formulating a strict corporate social and environmental responsibility policy.

The company says it's heavily involved in the social infrastructure of the communities where it operates, and recently set up the ENRC Komek Corporate Foundation to do this more effectively. "The majority of our people are in fairly remote locations where our production entities, because of their size, are typically the leading industry. We therefore have an obligation to make sure that the local communities are well supported," says Perry. "We also make sure that any new equipment complies with international environmental standards, and serve on a number of governmental working groups that are trying to improve environmental legislation."

The LSE listing was followed in March 2008 by a listing on the Kazakhstan Stock Exchange (KASE). The Kazakh government, as a shareholder in the company, pushed for the second listing mainly as a means of injecting new life into the KASE. According to Perry, the government is planning to sell a small part of its shareholding in a retail offering, again with the aim of stimulating the KASE.

ENRC has now launched a $3.6bn capital expansion programme, to be carried out over the next three to four years. The company is talking a three-pronged approach, investing in the renewal of existing operations, brown-field expansion and M&A. "This investment programme confirms our belief in a positive future for each of our core commodities the future is positive, and our expectation that price rises will continue for the foreseeable future," says Perry.

The company has already started exploring potential productivity gains within its iron ore division, and will overhaul the rest of its business in order to increase operating efficiency and productivity.

The main element of its brown-field expansion programme are the growth of its ferrochrome production by a minimum of 100,000 tonnes, an expansion of iron ore production by a minimum of 400,000 tonnes, and the completion of the second phase of the aluminium smelter which will raise aluminium production from 125,000 tonnes today to 250,000 tonnes. ENRC plans to increase both alumina production and its energy generation capacity in order to supply its aluminium smelter.

It is also making infrastructure investments to deliver its products to world markets. The capex programme includes a $900m investment in the China Gateway Project - the largest-ever private investment in Kazakhstan's infrastructure sector. The project includes the construction and operation of a 300-kilometre railway line. "As part of our extra production plan, we recognised that we need to increase our logistics capacity and secure an export route into the captive Chinese market," said Perry. "Clearly, with the increasing volume of trade infrastructure needs to be upgraded, in particular between Kazakhstan and China."

The third element of ENRC's expansion policy, M&A, has gotten off to a shaky start. In March, it emerged that ENRC was planning to acquire another Kazakhstan's largest copper producer Kazakhmys. Two months of frenzied speculation came to an end on May 9, when Kazakhmys announced it was turning down ENRC's £15.50 a share offer.

Indeed, the attempted takeover may have backfired on ENRC, since on June 10 Kazakhmys announced it was increasing its stake in ENRC from 14.6% to 22.24% through a share swap with the Kazakh government. The transaction makes Kazakhmys ENRC's single largest shareholder, followed by the Kazakh government with 15% and ENRC's three founding shareholders with 14.6% each.

The move was a surprising one, given that Kazakhmys had previously said that its shareholding in ENRC did not fit with its long-term strategy. In fact, it was widely expected to sell its stake once the holding period expired. However, the decision to increase its holding in ENRC will make it more difficult for any potential buyer to make a cash offer for Kazakhmys. In addition, it puts Kazakhmys very close to the 25% plus one share it would need to hold a blocking minority holding in ENRC.

A merger of the two Kazakh metals and minerals companies would have created a massive national champion in the natural resources sector. "In terms of strategic rationale, Kazakhmys would have provided certain advantages. It would have enabled us to diversify away from steel related commodities, and it would have reduced some of the competition for similar assets within the region," says Perry.

But having forced ENRC to declare its intentions, Kazakhmys turned down its offer. There was surprise in various quarters that the proposal, which valued Kazakhmys at around $8bn, had not been higher. However, Perry insists the offer wasn't necessarily that low. "If you compare the offer to Kazakhmys' share price at the time when the dialogue began between our respective chairmen, I think the 15.50 represented a reasonable premium.

"Secondly, we prepared the evaluation on the basis of publicly available information that was available to us at the time. We offered a period of more extensive due diligence which may have helped us to get the price up, but to be honest the response from Kazakhmys indicated that we were far apart in terms of the valuation expectations. Clearly, there was a gap."

Perry considers that ENRC made the right decision to walk away from Kazakhmys once it became apparent the two companies had very different price expectations. "Just because we have a significant cash fund available at the moment, it doesn't mean we are going to overpay for assets. We decided we were not going to overpay for Kazakhmys and I think our shareholders will ultimately be grateful for that. We demonstrated we were prepared to exercise financial discipline. Now we have drawn a line in the sand and are moving on."

ENRC has already made several smaller, though still substantial, acquisitions, snapping up a controlling stake in Russian ferrochrome producer Serov for $210m, 50% of Brazilian iron ore miner Bahia Mineração Limitada for $300m and 50% of Xinjiang Tuoli Taihang Ferro-Alloy for $14.5m. "We're looking to pursue a policy of regional consolidation within Eurasia, which we define as China, Mongolia, Russia, Kazakhstan and the Central Asian republics," says Perry. "We are also expanding internationally, where we believe we can enhance our current positions with our existing commodities with deals like our Brazilian transaction, Bahia Mineração Limitada, which we completed earlier this year. That will effectively enable us to double our iron ore output in 2011."

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