Photo by Igor Tishenko
The panorama of the quarry is mesmerizing: seven kilometers from north to south and two from west to east. From the height of the observation deck, the excavators and dump trucks working on its slopes seem like insects. But up close, the machines are the size of a two-story house, with just one wheel twice the height of a man. The cost of one tire is more than $40,000, and the 220-ton dump truck itself is $3.5 million. To deliver one such colossus, which arrived from Japan via the Odessa port, to the quarry in parts, 18 trucks are needed.
The quarry belongs to the Poltava Mining and Processing Plant (PGOK), located in Komsomolsk in the Poltava region and operating two of the 10 deposits of the Kremenchug Magnetic Anomaly. Both the GOK and the licenses for eight more deposits are owned by the founder of the Finance and Credit group, Konstantin Zhevago. The enterprise in Komsomolsk is the main asset of the Swiss company Ferrexpo, which, in turn, forms the basis of the raw materials business of the billionaire.
Iron ore is mined here, but the company makes money by selling higher-value products – iron ore pellets. Ferrexpo is one of the largest producers in Ukraine and the fifth largest supplier to Europe.
In recent years, Ferrexpo’s turnover has been $1.5–1.7 billion. Since the company’s creation in 2001, it has never operated at a loss. At the peak of its share price in July 2008, capitalization exceeded $5 billion; now it is $1.34 billion.
Zhevago’s company has several notable differences from the raw materials and steel holdings of other Ukrainian billionaires. Of all the Ukrainian players in the mining and metallurgical complex (MMC), only Ferrexpo has placed shares on the London Stock Exchange. The company does not export iron ore raw materials (IOR) in their pure form, like Rinat Akhmetov’s and Vadim Novinsky’s Metinvest, but goes further along the technological chain. At the same time, the owner of Ferrexpo emphasizes that he intends to develop the company exclusively as a raw materials company.
It may seem that Zhevago is being disingenuous: since 2004, he has been trying to implement plans to develop the steelmaking direction. But the project was not very successful. And when he started the ore business, the entrepreneur did not think at all to stay in it for long.
The beginning of the iron road
The purchase of Poltava GOK shares was just one in a series of similar deals, recalls Zhevago. In the mid-1990s, during the period of voucher privatization, he, a graduate of the Kyiv State University of Economics (colloquially known as “Narxoz”), together with his classmate Sergei Cherep, participated in the purchase of securities in a company of aspiring entrepreneurs. Later, the “Narxozites” joined the group of influential businessmen Alexander Volkov and Alexei Kucherenko. The latter also acted as a partner in Igor Bakai’s barter gas schemes. Kucherenko, together with another of his “gas” comrades Sergei Veselov, helped Zhevago buy Poltava GOK shares. Firms friendly to the three – SP “Bari”, “Mega-Motors” and “Askania” – acquired 42% of the company’s shares in 1996. Kucherenko, however, told Forbes that he had never been a shareholder in the mining and processing plant and “never bought anything from Zhevago.” However, in November 2011, Kucherenko did not deny this information, nor did he deny that Zhevago had bought out the partners’ shares.
At PGOK they use both old BelAZs and new Komatsu. Igor Tishenko
The buyers did not disclose the amount paid for 42%. But at about the same time, other businessmen bought 21% of the shares through the PFTS exchange for 18.8 million hryvnia, or about $10.7 million.
The purpose of the purchase, Zhevago assures, was subsequent resale. “But there is nothing more permanent than temporary,” the businessman smiles. “We soon realized the potential of this asset.” According to him, it took about two years to realize the potential of the project.
“We analyzed the market and logistical advantages. And the solution came by itself,” Zhevago notes. The location of the mining and processing plant allowed it to successfully compete on the world market with Brazil, which supplied ore to China, Taiwan, South Korea, and European countries. Despite the fact that the ore in Ukraine is poorer (about 30% iron versus 60–65%), geography compensated for this weak point.
In 2001, Zhevago registered the management company Ferrexpo in Switzerland.
Dreams of integration
How did Zhevago come to the point of making Ferrexpo a public company? In 2007, his conflict with the Luzhniki people was widely known (see “Wars for the Mining and Processing Plant”), and many said that the main shareholder was trying to protect himself in this way. “Not at all. Protection from claims is only a small part of the advantage that a public company has,” the oligarch objects.
More pressing at that time was the issue of raising capital, notes one of the company’s former top managers. Back in 2002, Ferrexpo received a license to develop the Yeristovsky GOK, which is located north of Poltava. This is the largest iron ore deposit in Eastern Europe: reserves confirmed by international standards are 674 million tons. Due to the smaller size of the quarry compared to the Poltava quarries and shorter distances, the productivity of equipment here is higher, which means the cost of production is lower, explains Ivan Anthony, production director of Yeristovsky GOK. “The investor thinks ahead – the quarries of Poltava GOK have been developed for more than 30 years,” says the Ferrexpo top manager.
China and others
At the same time, in the early 2000s, the metallurgical history began. Zhevago thought about building an electric steelmaking plant near the mining and processing plant. “The problem of finding sales markets was the main reason for this,” notes one of the former top managers of the enterprise. In 2004, Vorskla Steel was registered in Switzerland – a management company that, according to the plan, was to manage steelmaking capacities in Ukraine and Europe. In Komsomolsk, they were going to produce metal, cast slabs from it (blanks for future rolled products) and export them to Europe.
There was an idea to create steel-rolling capacities, but closer to the consumer. Zhevago chose the town of Zahony in Hungary as a site. It was supposed to create an entire industrial park there. The design capacity was 2.5 million tons of rolled products per year. A little later, in the summer of 2007, the billionaire acquired an electric steel-making plant in Denmark with an annual capacity of 400,000 tons of commercial blanks. Analysts then said that the purchase, worth approximately $150 million, did not fit into the production chain of two other plants that had not yet been built. Nevertheless, it was included in Vorskla Steel.
The implementation of plans for the two plants required at least $1.5 billion in investment, and another $0.5 billion was planned to be invested in the modernization of the PGOK and the development of the Yeristovskoye deposit.
The main thing for the enterprise is to attract capital on favorable terms, Zhevago summarizes. In his opinion, for public companies the cost of money is always 2-3% lower. This was the main motivation for entering the London Stock Exchange (LSE) in 2007.
During the IPO, the company planned to achieve a starting capitalization of $2 billion, but it amounted to $1.67 billion (they received $460 million for the shares sold). Nevertheless, investment analysts assessed the IPO as successful. Zhevago hit the nail on the head with the timing of the placement – iron ore prices on world markets grew by 15-20% per quarter. By the end of 2007, Ferrexpo’s capitalization exceeded $3 billion.
Hard landing
All plans voiced by Zhevago’s group were estimated at $4.8 billion in 2007, and they were going to be implemented by 2018. Analysts noted that in tandem with its strategic partner Ferrexpo could well increase ore production by that date to 100 million tons per year, that is, increase it more than 10 times.
In the fall of 2007, the businessman realized that the money he had received from the IPO would clearly not be enough. “At that time, we had a line of Asian companies wanting to invest $2 billion in the Ukrainian iron ore mining project – China Minerals, South Korea’s Posco, India’s Tata Steel,” says a former top manager of the company. In addition, the continuation of the project with European assets also required investment: Zhevago decided to buy the Bulgarian metallurgical plant Kremikovtsy.
The company invested about 100 million euros in the plant, fulfilling the conditions for debt repayment, supply of raw materials and investment in equipment, and even promised the Bulgarian authorities to buy the loss-making Sofia football club CSKA. But alas. At first, other contenders for the asset put spokes in the wheels. And then the crisis hit. In 2010, the Bulgarian authorities had to decide to demolish the plant. The Bulgarians promised to return the money invested by Zhevago, but the process is still ongoing.
The businessman did not go for an alliance with his Asian colleagues. Instead, in early 2008, Zhevago received a $2.247 billion loan from JPMorgan Chase Bank using 73.1% of Ferrexpo shares as collateral.
The troubles were not over. In July, the company’s foreign managers, CEO Mike Oppenheimer and Development Director Denis McShane, sold their stakes in Ferrexpo. In October, both resigned. The main owner took over as CEO of Ferrexpo, which did not please minority shareholders: in one day, on October 29, the company’s shares fell by 25%. A margin call came. If the value of the pledged shares falls below the level at which they were valued when the loan was issued, the borrower must either pay extra or sell part of them. Zhevago chose the second option. With the help of JPMorgan, a buyer was found for 20.8% – the coal mining company New World Resources of the Czech billionaire Zdenek Bakaly. The investor harmoniously blended into the structure of Ferrexpo, Zhevago believes: “We have known each other for many years and did business in various projects in Central and Eastern Europe and in Ukraine.” For Bakala, the deal turned out to be quite profitable: he paid $177.5 million for the stake – according to analysts, half the fair price and about a third below the market price (later, Bakala increased his stake to a blocking stake). Zhevago’s stake in the company was reduced to 51%, the remaining shares are in free circulation on the stock exchange.
Ore weekdays
The passions boiling on the stock market are not felt on the vast territory of the Poltava Mining and Processing Plant. Here a UAZ pulls up to the central entrance of the administrative building, and a large box is unloaded from it. It is a parcel for Nikolai Stakhiv, the head of the Poltava Mining and Processing Plant museum. “The Voestalpine company sent us a gift for the exhibit – a wing of a Volkswagen Passat made of steel produced using our pellets,” the museum worker explains proudly.
Tens of millions of dollars are invested annually in modernization of the PGOK. Igor Tishenko
Poltava Mining and Processing Plant considers the quality of pellets to be its calling card. “After the 2008–2009 crisis, we began to focus on modernization issues in order to have high-class customers. Today, we have contracts with the leaders of the metallurgical industry – Voestalpine, Nippon Steel, JFE Steel, Kobe Steel,” says Vladimir Ivanov, First Deputy Chairman of the Board of Poltava Mining and Processing Plant.
The quality of Poltava pellets is really highly valued by foreign consumers, confirms Dmitry Zheltyakov, an analyst at the State Enterprise Ukrpromvneshexpertiza. According to him, Ferrexpo is the only manufacturer that exports 100% of its output. Ivanov is confident that the company would sell pellets domestically if the Ukrainian consumer was ready to pay the price that consumers in Europe, China and Japan offer.
Zheltyakov finds this argument dubious: “Today, the price per ton of pellets in China is about $120, of which Ferrexpo spends $25-40 on logistics. Severny GOK sells pellets to Ukrainian consumers for about $100 per ton.”
In fact, Ferrexpo’s competitor has slightly different goals. “Metinvest’s priority is deliveries to the domestic market,” reported the press service of the company, which unites two Ukrainian pellet producers: Severny and Central GOK. Of the 5.2 million tons produced by SevGOK in the first six months of this year, almost 4 million tons went to domestic consumers. There are a few of them: Yenakiyevo Metallurgical Plant, Azovstal, Alchevsk Metallurgical Plant, and Donetsk Metallurgical Plant. The first two are part of SCM and are friendly to SevGOK.
The goods from Komsomolsk were exported back in the days of the USSR. “Even then, the plant was focused on Europe – Czechoslovakia, Poland, Romania, Bulgaria. The pellets had to be repeatedly reloaded and delivered over considerable distances. To prevent them from breaking down, a special technology was required,” says Dmitry Vinivitin, deputy head of the technical department at PGOK. The technology was purchased from the American Allis-Chalmers. “Ferrexpo’s technology differs from ours, all other things being equal, in that the pellets have higher physical and mechanical properties,” they agree at Metinvest.
But these developments are not enough today. “15 years ago, many were satisfied with pellets with an iron content of 60%, but now even 62% is not enough for them,” Ivanov shares. At the end of 2002, Poltava GOK began producing goods with an iron content of 65%, and during this year, it launched two new flotation lines, which allow raising the share of 65% pellets in production from 50 to 100%.
Investments in the opening of sections No. 2 and No. 3 of the flotation finishing, launched this year, amounted to about 860 million hryvnia ($70 million).
The ultimate goal of all these improvements is the same: to retain the consumer. In addition, the cost of a ton of 65% pellets is about $20 higher than 62%. This is very important in the realities of today’s market. If in 2013 the average price for 62% Australian ore (benchmark) in China was $136.6 per ton, then at the beginning of 2014 it fell to $130, and in July-August it was already fluctuating at $90-97. “This does not look like a new crisis, but rather like a reality that iron ore producers need to get used to living with,” notes Concorde Capital analyst Roman Topolyuk.
The fall in prices has not yet affected Ferrexpo’s financial indicators. For the whole of 2013, the company showed an 11% increase in net income, to $1.6 billion, and a 22.3% increase in net profit, to $263.8 million. And for January–June 2014, net income fell by 2% compared to the same period last year, but net profit increased by 62.5%, to $208 million. “Of course, we gained in base cost due to the fall of the hryvnia,” explains Chris Mo, Ferrexpo’s financial director.
The increase in ore extraction at the Yeristovskoye deposit, where work began in 2012, will allow producing more than 65% pellets at lower costs. This cost the shareholder about $400 million in investments. According to Zhevago, this is the first mining and processing plant built from scratch in the CIS since the collapse of the Soviet Union. The ore at Yeristovskoye is richer, with 33.7% iron, not 30% like at PGOK.
The shareholder and his management team regularly face the problem of “more or better?” For example, Konstantin Zhevago personally participates in the selection of suppliers of dump trucks and excavators.
According to Ivanov, a more powerful car is not only more expensive to buy.
Its current operation costs more money: one tire for a dump truck with a lifting capacity of 110 tons will cost about $20,000, for a “two hundred and twenty” – already $40,000, for a “three hundred and sixtieth” – $120,000. Will Ferrexpo be able to afford such expensive purchases in the conditions of a weak metallurgical market? Zhevago believes that it is the focus on the implementation of the best Western corporations’ practices that will allow the company to maintain its current positions. “We are increasing quality and selling to the most expensive, most promising, most stable, viable markets, such as Japan and Germany,” explains the billionaire.
But vertical integration clearly did not work out. The main shareholder resolutely separates Ferrexpo from the so far failed holding Vorskla Steel. These are completely different businesses, and no integration is planned, he assures: “Mining companies pay for the mining business. Investors will only discount a company that has some relation to steel production.”
Today Zhevago dreams of a place among the giants of the global mining industry – BHP Billiton, Rio Tinto, Vale, whose capitalization amounts to tens of billions of dollars. Ferrexpo’s iron ore reserves allow it to strive for leadership. For example, the Brazilian Vale has confirmed reserves of 17.5 billion tons, while the Australian-British BHP Billiton has 2.9 billion. Ferrexpo estimates the total resource potential of the group’s deposits at 20.5 billion tons, although by international standards only a little more than half has been confirmed. And in the three deposits under development, there is even less – 1.5 billion tons.
Wars for the Mining and Processing Plant
In the early 2000s, the attractiveness of PGOK was appreciated not only by Konstantin Zhevago
According to Oleksandr Prityka, former director of the state holding Ukrpolimetally (state-owned stakes in a number of mining companies were transferred to him), the head of the Finance and Credit group and his partners intended to buy out the blocking stake in the mining and processing plant that remained with the state at par value. But another group of shareholders, who had previously bought out about 9% from the state, then the blocking stake, and in the meantime managed to buy up more shares, interfered.
Behind the buyers were representatives of the Moscow “Luzhniki” business in Ukraine – partners of the Russian oligarch Alexander Babakov and Mikhail Voevodin. Their interests in Ukraine were represented by Mikhail Spektor, who headed the Slovak management company VSE, and businessman Maksim Kurochkin (“Maks Besheny”, killed in 2007). The state “ripened” to sell the remaining shares, only 6.6%, at open auction in 2001. By that time, the package had acquired strategic importance, so the price for it soared at auction to $14.8 million (73 par value). Zhevago lost this battle. In 2002, he had to negotiate a deal with competitors and buy out 40% of the shares from them for $27 million. Thanks to this, his share in the company exceeded 85%.
Three years later, the sellers changed their minds and decided to return the mining and processing plant. The parties have repeatedly gone to court in Ukraine and London. “We want to restore the status quo, when our companies owned 40.19% of the mining and processing plant each,” Spektor, head of International Ukraine, previously explained to Forbes. The initiators of the litigation believe that there are grounds to invalidate the agreement, and with it all share issues since 2002. Zhevago is sure that the reason is far-fetched, and calls the other side raiders. “I also sold an apartment in 1999 for $70,000, which is now worth $700,000. But I don’t go to the new owners and tell them to pay extra,” he was indignant.
The investigation continues.
Ekaterina GREBENIK, InvestfoundS
