Poland's copper-bottomed sale

By bne IntelliNews January 20, 2010

Jan Cienski in Warsaw -

The Polish treasury's sale of 10% of copper miner KGHM in January raised PLN2bn (€500m) for the cash-strapped government, but that step is being denounced as too timid by advocates of more rapid privatisation.

After the sale, the treasury still controls 32% of KGHM, Europe's second-largest copper extractor. "Incomplete privatisation is most often a pseudo-privatisation, because the fundamental power over the company remains in the hands of politicians, and being ruled by politicians does not serve any business well," Leszek Balcerowicz, former finance minister and architect of Poland's post-communist economic reforms, told the Gazeta Wyborcza newspaper. "I don't see any reason why KGHM should continue to remain under political control."

Even the company's management admits that the sale will have little impact on KGHM's day-to-day operations. "It won't have any influence on management," says Herbert Wirth, the company's CEO. "The state will continue to exert control over the company."

And there is no sign the current government is willing to brave the storm of protest that would result in any bid to give up control of KGHM. In the past, that control has had a baleful influence on KGHM. Top managers have lasted an average of only 14 months before being forced out, usually because political parties in Warsaw wanted to put their team in charge after elections or confrontations within coalition governments.

Years of such rapid change has left KGHM bloated and inefficient, despite racking up fat profits due to the soaring international price of copper, mainly thanks to a rebound in Chinese demand. Expectations are that profits for 2009 will be higher than the previously forecast PLN2.25bn, and that results will be similar for this year. That has made KGHM one of the best-performing stocks on the Warsaw Stock Exchange in 2009, with shares more than quadrupling their value over the year.

Labour pains

At the same time, though, KGHM has one of the highest costs per tonne of extracted copper in the world. "We are one of them most expensive producers in the world," says Wirth. "We inherited a socialist cost structure."

One reason is rapidly multiplying labour unions and other labour organisations - 49 at least count - which makes reaching any kind of a wage deal with workers enormously difficult. "The unions are anti-modernisation," says the CEO. The unions were strongly opposed to January's share sale, worrying that a reduction in the size of the government stake could weaken their bargaining power.

Another is that KGHM's copper lies more than 1 kilometre underground, which makes it much more expensive to dig out than in open-cast copper mines in places like Australia. In recent years the thickness of the copper deposits has also shrunk. "We have to dig out a lot of extra rock which also has to be milled and treated," says Wirth. "We need new technology to be competitive."

Last year the company invested about PLN1.2bn last year in modernising production, part of its drive to increase annual production from 500,000 tonnes to 700,000 tonnes.

Wirth, who took over KGHM last summer, has also continued his predecessors' cost-cutting programme, a rare example of management continuity. Normally, new CEOs tend to scrap whatever previous management was working on, spend several months working on their own ideas before being replaced by yet another new team.

Furthermore, Wirth is completing the pull-out from KGHM's loss-making investment in the Democratic Republic of Congo, which cost it $40m without producing any gains. Instead, Wirth is looking to shore up KGHM's deposits - which he estimates at 1.2bn tonnes - by buying as many as four small Canadian companies this year.

One problem is that, while KGHM is very conservative in its copper price forecast for this year, predicting a price of about $5,000 a tonne, the actual price is about $7,400 a tonne, which means that the valuation of the Canadian companies is likely to be much higher than what the Poles are going to be willing to pay, says Andrzej Knigawka, an analyst with ING Securities.

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