Nicholas Watson in Prague -

New World Resources plans to call an extraordinary general meeting toward the end of April to present shareholders with a proposal to buy a 25% stake in Ukrainian iron ore producer Ferrexpo. With Ukraine's economy in a tailspin and global demand for iron ore depressed, the transaction is proving a hard sell. But NWR management insists it's good deal that makes strategic sense.

Like most things today, the proposed deal came about as a direct result of the financial crisis. As the world's stock markets went into freefall in September, the majority owner of Ferrexpo, Kostyantin Zhevago, suddenly found himself unable to meet margin calls on loans for which he had used his 75% stake in Ferrexpo as collateral. Zhevago was until a few months ago Ukraine's youngest billionaire, ranked 327 in Forbes 2008 rich list with a net worth of $3.4bn; in Forbes' 2009 list published on March 12, his name didn't appear at all.

The bank that had made the loans to Zhevago, JP Morgan Chase, asked another of its clients, NWR, whether it would be interested in buying the stake in Ferrexpo that was on offer. Given the rush that Zhevago needed the cash, the publicly listed NWR couldn't get the deal approved in time, so it turned to its parent RPG Industries, the private equity firm headed by Czech tycoon Zdenek Bakala which owns 64% of NWR, to help. RPG secured a 25%-plus-one-share stake in Ferrexpo at a total cost of £126.6m (€163.2m), or 86 pence per share.

Shareholders of NWR will now be asked to approve the purchase of the 147m Ferrexpo shares for the same amount from RPG. Because this is a related-party transaction, RPG won't be able to vote, so it will be left to NWR's institutional and retail investors to decide on, who make up about 36% of the shareholder base. Hence the current roadshow in Europe and the US by CFO Marek Jelinek and his team to convince investors about the wisdom of the deal ahead of the vote, which they insist will go ahead regardless of the reception they get over the next few weeks.

The trouble is that shareholders are in an ugly mood. The Dutch-based NWR, a holding company of several mines and coking facilities including the Czech Republic's giant coalmining firm OKD, went public only last May, pricing its shares at CZK425.83. The shares soared as high as CZK620 before falling back to earth as oil and commodity prices fell. By March, the shares were still plumbing new depths, down by about 85%. As such, shareholders will need a lot of convincing.

Big prize, small price

At the heart of management's pitch to the shareholders is that NWR is getting at a good price a piece of a global player, which will help it to expand its own activities in Ukraine.

With about 20bn tonnes of iron ore, Ferrexpo has the fourth-largest reserves and resources of the metal in the world after market leaders CVRD of Brazil, Rio Tinto and BHP Billiton. Other large mining firms have both coking coal and iron ore assets, so NWR believes it can benefit from selling its coking coal along with Ferrexpo's iron ore to global steelmakers, as there's a significant amount of customer overlap between the two.

Ferrexpo had been targeting a nearly four-fold increase in its production of approximately 9m tonnes per year by 2018 before the crisis struck and kyboshed those plans. "This target is not some sort of dream - the company has been around for about 30 years and have been there in production terms before things contracted after the fall of the Soviet Union, so you can see the potential there," says Jelinek. "On a global scale it's a very meaningful player, a huge asset, and we are trying to get exposure to that by buying a 25% stake."

The acquisition will also bring with it a natural Ukrainian partner for NWR. The Czech financier Bakala's whole rationale for establishing NWR in 2005 with the Czech coalmines at its heart was the idea that Central and Eastern Europe's coal industry - particularly in Poland, Ukraine and Russia - is ripe for consolidation and a well-managed outfit like NWR could take the lead on this. "We want to establish ourselves in Ukraine; to do that we need a strong local partner and feel that Ferrexpo is exactly that type of partner," says Jelinek.

Josef Nemy, an analyst with Komerční banka, agrees that this is an advantage of the deal. "A benefit from this deal in the future could be that it is opening doors in Ukraine to other acquisitions - of some coal mines perhaps. This might be easier if NWR would already be present on the market," he says.

Having a local partner is no doubt a good strategy when searching for acquisitions, yet some question why it's necessary to become financially entangled with them. "I see very little synergies between the two companies. I understand that Ferrexpo could be a local partner for NWR to explore opportunities in the coal mining business, but I don't think it's necessary to have an ownership stake in your partner," says Dan Karpisek of UniCredit Group.

Worse for those investors wary of getting too involved in a country that's teetering on the verge of bankruptcy is NWR's stated desire to deepen this relationship. "We are in the first step trying to acquire this 25% stake, but for us this is not the ultimate goal. We think there is a strategic logic for some sort of combination of the companies. We don't have a detailed plan on how to get from 25% to some other combination, but we won't sit on 25% forever," says Jelinek.

Jelink stresses that while there may be legitimate investor concerns about Ukraine itself, the Swiss-based and London-listed Ferrexpo isn't even a Ukrainian company. In fact, while most of its assets may be in Ukraine, only 15% of its revenues are derived from there, the rest being in Asia and emerging Europe. "Ferrexpo is a completely transparent company, it has the right standards and systems of corporate governance. We have done our due diligence on this and we are satisfied," says Jelinek.

The cost of the acquisition looks cheap or expensive depending on where you stand. When RPG snapped up the stake in October, it did so at about a 30% discount to Ferrexpo's market value at the time. "The expected multiples show the offered price is relatively cheap at 3.7 times 2009 net profit," says Nemy.

The problem is that since then, Ferrexpo's shares have continued to fall along with the rest of the Ukrainian market and are now 40% below the acquisition price. "I doubt that minority shareholders would be happy to pay for Ferrexpo at a significant premium to current market price," says Semyon Mironov, an analyst at Credit Suisse.

Funding the deal shouldn't be a problem given NWR has some €700m sitting on its balance sheet. But some question whether this money might be better horded and spent elsewhere. "Although it is a good long-term investment, I think it would be better to keep cash for investments into its own mines or for the acquisition of troubled competitors," argues Petr Bartek, an analyst with Erste Group's Ceska Sporitelna. "If the situation does not improve in 2010, NWR could need the money spent on Ferrexpo."

In fact, this issue of the short term/long term is key to whether shareholders will approve or nix the deal. Many like Marek Hatlapatka, head of research at Cyrrus, regards the Ferrexpo acquisition as a very interesting opportunity in the long run, but that must be set against the drawbacks in the short term, such as the current price of Ferrexpo shares, arguably lower dividends to pay for it, and with difficult times ahead, a bad environment in which to make acquisitions. The trouble is that shareholders are in an even more short-term mood than they normally are; thinking long term is a luxury few can afford right now. "I feel some uncertainty about the result of shareholder vote. Shareholders may prefer the short-term view," says Hatlapatka.

Jelinek himself acknowledges this when he says that the one question he is always asked by shareholders is, "why now? Why not wait for six months to a year?"

Aside from anything else, Jelinek says RPG simply won't wait for an indefinite period of time while NWR shareholders make up their minds. "I don't have any insight into the financials of RPG, but it's very easy to figure out that they have already lost a significant amount of money because of the sterling/euro performance. Every shareholder that asks that question about sitting on the asset has already benefited from RPG's generosity - they've been financing the deal since October 2008, it's now March so we are talking seven, eight months of a free ride."

Send comments to The Editor