Costly mistakes in Russian goldToe in the water, foot in the mouth – costly mistakes in Russian gold
By: John Helmer
Posted: '28-OCT-05 13:56' GMT © Mineweb 1997-2004
MOSCOW (Mineweb.com) -- According to the traditional wisdom of Russian villagers, it is as easy to teach a fool as it is to cure a corpse.
It is not that Russian goldmining is a corpse that makes it is necessary to point out several costly mistakes that have been committed, from which no-one, not even those who committed them, appear to have learned useful lessons, except perhaps how to induce shareholders to forgive or forget them.
At present, Russia’s goldmines are producing between 3.2 million and 3.3 million troy ounces per year, retreating from last year’s peak, but still ranking 5th or 6th in the world. One-third of that production comes from one company -- Polyus, Norilsk Nickel’s gold subsidiary, shortly to be spun off as a separate company. And two-thirds of Polyus’s gold comes from a single mine, Olympiada, in the Krasnoyarsk region of central Siberia. According to the wishful thinking at Polyus, its production will surpass Kinross, Placer Dome, and Barrick Gold by 2008, quadrupling current output. Only none of that gain can come from Olympiada.
In Russian goldmining, mistake-making -- that is wishful thinking compounded by the disappearance of large sums of cash -- is not confined to domestic miners. In terms of the cash to wish ratio, Polyus’s chief executive Evgeny Ivanov probably leads at the moment.
He was challenged this week by an oil trader but novice in gold-mining, Suleiman Kerimov.
But big mistakes may also have been committed by international goldminers, AngloGold Ashanti and Barrick, when Tye Burt was in charge. As goldminers know, these companies are the world's largest producers of gold after Newmont. Newmont spent a long time assessing Russian projects, carefully burying its cash in reports that did not encourage wishful thinking. Having committed to nothing, its record for mistakes is clean. To be sure, when computing the cash to wish ratio, it may be unfair to be premature. Lost opportunities can be mistakes too, but only with long hindsight.
Richard Duffy, the executive in charge of AngloGold’s Russian projects, was one of several bidders in line to acquire the gold assets of Investment Group Alrosa (IGA) and its UK-listed partner, Celtic Resources. Barrick – without Burt, who had moved to head Kinross – bested AngloGold’s offer, but was then bested itself by an all-cash bid from Polyus last month. For months in parallel, Duffy has also been bidding for Polymetal, the second-ranked Russian goldminer.
Polymetal, owned by a group of St.Petersburg shareholders led by Alexander Nesis, is currently producing 18% more gold this year than last year, and 1% more silver. In gold-equivalent the company’s output is approaching 320,000 oz. for 2005. Its financial reports for the first half of this year indicate that EBDITA was $41 million, and after-tax income $7 million. It claims reserves of 4.7 million oz of gold, plus 633 million oz of silver. Duffy’s contacts with both IG Alrosa and Polymetal have been part of a ‘toe in the water’ strategy for Russia.
Polymetal is being sold, because its owners believe they lack the capital-raising energy, the political clout, and (what amounts to almost the same thing these days in Moscow) the cash to prevail in the fight for Russia’s major unmined gold deposit, Sukhoi Log. They also believe that now is the optimum time for them to capture the multiplier effect of the rising gold price. Having already sold out their ship-building assets, the Nesis group is preparing to exit with a very large payout. They have been considering expressions of interest, due diligence, and offers from AngloGold, Barrick, and others, including a secretive Russian businessman and member of parliament, Suleiman Kerimov.
According to a report, planted in a Moscow business newspaper on Wednesday, and amplified by a local brokerage, Kerimov has bought Polymetal for $900 million.
To the local brokerage, valuing Polymetal at 18 times EV/EBDITA, this was a steal – roughly half the valuation. Relating the purported price to Polymetal’s reserves, this appears significantly higher than benchmark prices already paid for Russian gold assets of Highland Gold, one of Barrick’s mistakes – I mean, investments – and Peter Hambro Mining.
However, Polymetal shareholders immediately told Mineweb the report is false. Kerimov is one of several bidders, they acknowledge, but there is no deal yet. However attractive the price may sound, the Polymetal shareholders characterize it as “the product of the reporter’s imagination”. A Russian goldminer termed it crap. Kerimov, however, is reportedly so wealthy – from converting oil trading proceeds into Moscow real estate and shares of such companies as Gazprom – he could afford the reported bid. But he is so secretive, his business secretary will not even confirm his title, while his parliamentary telephone rings without answer. The latter indicates his political representativeness, the former his corporate accountability.
One line of speculation in Moscow is that Kerimov has been persuaded to apply his cash to creating a commodity and resource trust which he would then try to list publicly at a multiple of the value spent on acquiring the stakes. If he succeeds at this, Kerimov could be making a mistake to top those of Maxim Finsky and Yevgeny Ivanov, the duo who have put together the Polyus portfolio.
Another theory is that Kerimov wants to buy Polymetal in order to flip it quickly. If true, Duffy may soon be in negotiation with him, along with Greg Wilkins of Barrick. Do they both risk another mistake?
In Russia, Duffy is best remembered for spending £17.6 million (about $30 million) to acquire a 29.9% stake in Trans-Siberian Gold (TSG), a London-listed junior managed by Jocelyn Waller. The transaction was first announced on July 1, 2004, and the money spent in tranches. The assets bought were three gold deposits in prospecting or development in Russia – Asacha (Kamchatka region), Veduga (Krasnoyarsk), and Bougunay (Krasnoyarsk). Despite warning of rising costs at the Asacha project, Duffy announced last December that he remained “committed…We will continue to make resources available to TSG…” A pre-conditional financing did not materialize, and the condition was waived by AngloGold when it poured a second tranche of cash into TSG. AngloGold is persisting in the belief that, with time and effort, Asacha can be mined profitably.
Much worse news, or more wishful thinking, has come from Veduga. According to an announcement by TSG on October 17, the initial mining plan must be modified significantly, or else the project will be too costly to mine. Another option referred to in the announcement involves “discussions with third parties.” This is a coy way of speaking about selling the project to someone else.
What has been missing from the TSG investment for AngloGold was a Russian partner of significance. IG Alrosa and Polymetal have been obvious candidates to fill that gap. Kerimov likewise, if he does eventually acquire Polymetal, and then looks for a strategic mining partner in exchange, say, for AngloGold shares. In that scenario, Duffy could look to Burt and Barrick for a recent precedent for such a deal.
In October 2003, Barrick announced that it would pay up to $159 million for a 29% stake in Highland Gold. The down-payment was $43 million for a 10% stake, bought from Highland Gold’s principal cash cow at the time, Harmony Gold. In the preceding half-year, Highland declared that it had mined 90,133 oz, and earned net profit of $8.5 million. Reserves (“resources”) at the time were loosely estimated to 9.9 million oz. No international miner had ever paid so much for a minority stake in a Russian miner, nor promised to pay so much before.
The due diligence came later, and when it did, Barrick decided to cut its commitments substantially. Instead of taking up 29% of the company, it bought 21%. But at the instant of the transaction, Barrick was persuaded that in buying into Highland Gold, it was acquiring none other than Roman Abramovich, the Kremlin’s favourite oligarch, as their silent Russian partner. One month earlier, Abramovich had god-fathered the sale of the Maiskoye gold project in Chukotka to Highland Gold, sweetening the licence terms as governor, in order to collect the payoff as the hidden owner of the asset.
Maiskoye is still under exploration, but it is estimated to add 2.6 million oz to the company’s balance-sheet. Mnogovershinnoye, however, has fallen well short of its promise. According to company releases, in the first half of 2005, this mine, based in Magadan region, produced just over 63,000 oz, while the cash cost of doing so jumped from $212/oz to $349. The 33% fall in gold output registered on the balance-sheet as a loss of $6.9 million. Abramovich has moved on to much more lucrative business since the Barrick deal, and so has Tye Burt, then of Barrick, now of Kinross. Roddie Fleming has been unable to sell out, and he is stuck with a 20% stake. Ivan Kulakov, the Abramovich protégé who currently controls Highland’s management, holds about 15%.
Barrick’s CEO Greg Wilkins admits that foreign goldminers have made mistakes in Russia, only he claims they were not his, or Barrick’s. The company has never responded to Mineweb’s questions regarding its acquisition of Highland Gold. But recently Wilkins suggested that Barrick’s Russian strategy is nothing more than a low-cost ‘toe in the water’, like AngloGold. Wilkins told Mineweb: "My whole sense here [in Russia] is that I am just positioning Barrick. No big rush. I just think that it is an area with great endowment, that I am in the right place." Regarding others’ mistakes, he added: “They think that, when the industry opens up, they are going to sweep it. That they are going to be in development. That they are going to do all this stuff, and they are not doing any preparatory work." Wilkins has yet to clarify how the preparatory work Barrick did on Highland Gold firstly cut its financing commitment, and secondly, missed the collapse of Mnogovershinnoye’s production.
Wilkins even tried to tell Mineweb readers that in Russian goldmining, it is the Americans who are the mugs. "I used to laugh when Americans would fly in, try to do a deal and fly out. ...Except for the mature international U.S. companies who understand it, a lot of guys, who do not have that experience, think they are going to do a deal over there like they do a deal here. But, it is not about commercial terms. With these guys [Russians], it is about relationships and trust.” However, last month when IG Alrosa decided it did not trust Barrick’s offer of shares and cash for the IG Alrosa-Celtic goldmine at Nezhdaninskoye, plus other gold assets in the same region, opting instead for an all-cash bid by Polyus, Wilkins claims Polyus did not know what it was doing.
"These guys are so new to what they are doing, they did this deal sight unseen,” Wilkins claims. “They have not done a lot of due diligence.” Referring to a luncheon in Moscow Wilkins hastily sought with Polyus’s co-owner, Vladimir Potanin, after Barrick had been beaten, he now claims: “When I actually had a conversation with some of the principals, I said, `You know guys, I am not going to compete with you. I am going to let you guys have at it'. They have not yet figured out that they are going to have another enormous amount of capital to develop it. Where are they going finance that? Are they going to the capital markets to finance that? I don't think so, because they do not have credibility in the divested capital, U.S. capital, or foreign capital markets. So guess what is going to happen? They are up to here with capital commitments and nothing to show for it. It's a classic case."
Wilkins has yet to explain what he has to show for Barrick’s spending on Highland; and also what he has lost in Barrick’s purchase of Celtic shares, as a result of a failure to know what little asset backing there was to the acquisition price. In reality, Wilkins paid $30 million for a minority stake in a gold asset portfolio that was missing at least $100 million in value he thought was there. Polyus may have made mistakes in amassing its asset portfolio, but its acquisition of the IG Alrosa assets didn’t repeat the mistake that Wilkins had made, but ungenerously omits to identify.
“All I need is a small wedge of that industry,” Wilkins claims – and all he has to show is a small wedge, for which he has so far paid $120 million in the space of 24 months. IG Alrosa, meanwhile, the seller who told Wilkins no, is busy using the funds from its deal to refill its gold portfolio with fresh assets, and strengthen its position in the diamond fields of northwestern Russia. The shares in Celtic which Barrick’s offer would have provided are now worth a fraction.
Depending on whose foot it is, mistakes like that may be either a toe in the water, or a foot in the mouth. Barrick’s shareholders have not learned enough to judge for themselves.