Ben Aris in Berlin -

Vladimir Potanin

Russian oligarch Vladimir Potanin needs to come up with $15.7bn on December 21 if he wants to keep control of his cash cow of the last decade Norilsk Nickel. He is almost certain to miss the deadline and Norilsk will become the latest addition to ZAO Kremlin as Russia's new metals national champion.

Exactly a month previously his long-time partner Mikhail Prokhorov offered Potanin his 25%+1 stake in the world's largest producer of nickel that the two men have run since they gained control of the miner during the infamous loans-for-shares deal in 1996.

The asking price is high say analysts. Prokhorov's offer values the company at about $330 per share when the stock is currently trading at about $255 per share. However, Prokhorov almost immediately offered the same stake to United Company RusAl at a considerable discount if Potanin didn't exercise his pre-emptive rights to buy the stake first.

In an unusually complicated deal for Russia, Prokhorov offered RusAl the same stake for about $12bn sum and 11% of RusAl's shares plus a seat on RusAl's board. Analysts estimate this deal to be worth an equivalent of about $285 per Norilsk share - about where the stock was trading in September before the market got wind of the deal.

Potanin had a month to accept the deal and come up with the money - a deadline that expires Friday.

"He has been looking for the money and not finding it," says one banker with close ties to the company that didn't want to be named. "It is a combination of the turbulence on the international credit markets, but his task was made harder because of the politics of this deal."

According to reports on Thursday, December 20, Potanin's last hope faded after Citigroup announced that it had failed to secure a $10bn facility for Potanin that would have financed the purchase.

Barring some last minute knight in white armour with billions of dollars to spare, it looks almost certain that Oleg Deripaska, who controls RusAl, will gain a blocking stake in Norilsk and in effect return control of the company to the state's interests.

Done deal

No one will be surprised, but minority shareholders in the company are worried about what will happen to them in the hand over.

Analysts are extremely cautious and few wanted to talk on record about what was driving this deal, but they all agree that RusAl's was a done deal and the pre-emptive offer was little more than window dressing. Having taken control of the oil sector, the shadowy siloviki, the securities services fraction in the Kremlin, have moved onto the metals sector.

"Metal is the last strategic sector in the Russian economy that has not been consolidated. Every other sector has a state-owned or state controlled national champion, but the bulk of the metallurgical sector remains in private hands," says one analyst.

The assault on Norilsk should come as no surprise. Potanin himself said earlier this year that a return of the company to the state would be "no tragedy." And the process was already well underway after fellow aluminium producer SUAL cancelled plans to IPO in London and, under Kremlin pressure, agreed to merge with RusAl earlier this year.

Prokhorov also indicated the writing was already on the wall in an interview with Russian daily Vedemosti on November 27, a week after he made the offer to Potanin, saying: "Norilsk Nickel's prospects in its current state are limited. Its competitiveness on the world market will decline because of the inevitable growth in costs and the consolidation of global players. I think a merger [with RusAl] would be the best option."

The trick has been to engineer a process where Potanin could be eased out of Norilsk without causing an international furore that followed the Kremlin's break up of oil company Yukos. The difference between the two valuations was nicely judged and the brouhaha on international credit markets caused by the US subprime debacle has provided a useful smoke screen.

While minority shareholders will complain, there are many in the Kremlin that will be pleased to see the company in the hands of a loyal ally such as Deripaska, who is working in lock step with the state's plans to build up a set of companies that act as much for Russia's benefit as in their own commercial interests.

Deripaska is having no trouble raising money. On Wednesday, December 19, RusAl announced it was launching a $4.5bn syndication to pay for the Norilsk block. According to a company press release, they expect the deal to be closed in January.

"The syndication of a two-year loan has been launched. Interest in the first three months will be LIBOR+1%, rising to LIBOR+1.25% in the next three months, LIBOR+1.5% in the following six months and LIBOR+2% in the second year," a source told Interfax.

However, this deal is more than simply returning goods "stolen" during the loans for shares deals of the 90s: the Siloviki want to create a multinational company that is big enough to hold its own on the international markets and continue buying assets international that will increase Russia's global economic reach. Indeed, RusAl is already arguably Russia's first true multinational, as it already owns assets on every continent on earth.

The Gazprom of Metals

Analysts say that the deal with RusAl will most likely not benefit minority shareholders in Norilsk and may end with their stakes being diluted. Norilsk has been one of the best performing stocks on the Russian exchanges this year, but the share has been hit by a double whammy in the last months of the RusAl deal and the cancellation of the spin off its energy assets.

Prokhorov and Potanin announced at the start of the year that they would part company. Potanin was to keep Norilsk and Prokhorov set up the Onexim holding company that would take over the company's energy assets. Those assets were supposed to be spun off at an EGM this month, but Prokhorov put the decision on ice, saying that it was up to the new owners of his stake - which ever party bought his 25% stake - to decide on the spin off.

Investors were buying into Norilsk's stock in anticipation of the spin off, but the stock tumbled as it became clear the spin off has been delayed until January at the earliest and two men's divorce has been getting increasingly messy.

Attention is now turning to what comes next. Market participants widely assume that at the end of the day RusAl and Norilsk will be merged into a new super-company - a Gazprom of Metals. The trouble is how to get there from here? The spanner in the works is that RusAl is a private company and Norilsk is a publicly listed company.

Analysts assume that if RusAl buys Prokhorov's stake then Potanin will also be persuaded to sell his stake to RusAl, giving the latter a 50%+1 share in Norilsk. However, in order to finance the deal RusAl wants direct access to Norilsk's massive cash flows to finance these deals.

Norilsk is likely to generate close to $12bn in EBITDA in 2007 while RusAl may only generate $6.2bn but just owning a controlling stake in Norilsk doesn't mean RusAl can simply help itself to the cash. Moreover, the real value of the deal is if the two companies are combined as the merged group will be re-rated by investors and banks as it becomes one of the biggest diversified mining companies in the world with all the market clout that implies.

Reversing control

Analysts at UralSib see three possible scenarios: the two companies remain separate; RusAl IPOs and the two listed companies own shares in each other; but the most likely scenario is that RusAl engineers a reverse takeover of Norilsk.

"Under this scenario the best that minority shareholders in Norilsk Nickel can expect is that the dilution of their stakes will be offset by a re-rating of the combined group," UralSib said in a report.

The first option where nothing changes is unattractive as apart from the fact that neither company enjoys the re-rating that comes with a merger, RusAl will have huge problems tapping into Norilsk's cash. If it uses dividend payments to get cash out then half of this money will be 'wasted' on payouts to the minority shareholders. The alternative is to create a lot of complicated inter-company structures that avoid dividends.

In the second option RusAl would list as a diversified mining group with control of 50%+ of subsidiary Norilsk Nickel, with the aim of achieving a global diversified miner's rating. RusAl would then offer its higher-rated paper to Norilsk Nickel minorities in exchange for lower-rated Norilsk shares.

The trouble with this is that Norilsk's minorities could reject the offer and force RusAl to offer them the same shares at a premium. And this solution still doesn't make it any easier for RusAl to tap Norilsk's cash flow.

Under a third scenario, RusAl engineering a reverse takeover of Norilsk Nickel, which would then issue new shares to RusAl. As controlling shareholder RusAl can vote this decision through without having to ask the minority shareholders' permission. RusAl would then reverse list into Norilsk Nickel's current listing, leaving minorities with exposure to the enlarged RusAl/Norilsk group, who would be diluted after the issue of new shares by Norilsk to acquire RusAl at a higher multiple. In this case Norilsk's cash flows are consolidated into the bigger company and RusAl's board has direct control of this money without having to ask shareholder's permission.

The big question in this case is by just how much the minorities will be diluted. Analysts say while there is a real risk that minority shareholders could be abused in the deal the chances are that they will be offered an acceptable, if not brilliant, deal.

Although Deripaska doesn't have a great corporate governance record as RusAl has plans to float sometime in the next three years, he has to worry about his reputation with shareholders. Moreover the power spin-off will probably happen next year, which also depends on the good will of international investors. The bottom line is abusing shareholders now could save money in the short term but will cost him dearly in the long term.

Minorities will probably accept some discount - estimates of 10-20% have been mooted - as any dilution will be eventually offset by the increase in value the combined company will enjoy from simply becoming a lot bigger.

"The reverse takeover scenario is less painful for Norilsk minorities as the re-rating of the group offsets the dilution of issuing new shares to acquire the higher rated Rusal. Assuming the new shares are issued at $285/share, we calculate that EBITDA/share would be diluted by 12%. However, assuming the combined group re-rates to trade at an EV/EBITDA multiple of 7.2 (not guaranteed), a multiple below that of BHP Billiton, Rio Tinto and CVRD but above Anglo American and Xstrata, the share price would remain at $285/share. Thus minorities would not lose anything, but wouldn't gain anything from the re-rating either," says UralSib analysts.