Photo by Igor Tishenko
The quarry's panoramic view is breathtaking: seven kilometers from north to south and two from west to east. From 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 tire twice the height of a man. A single tire costs over $40,000, and the 220-ton dump truck itself costs $3,5 million. It would take 18 trucks to transport one such colossus, arriving from Japan via the port of Odessa, to the quarry in sections.
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 PGOK and licenses for eight more deposits are owned by Konstantin Zhevago, founder of the Finance and Credit Group. The Komsomolsk facility is the main asset of the Swiss company Ferrexpo, which, in turn, forms the basis of the billionaire's raw materials business.
Iron ore is mined here, but the company makes its money by selling higher-value products—iron ore pellets. Ferrexpo is one of the largest producers of these pellets in Ukraine and the fifth-largest supplier to Europe.
In recent years, Ferrexpo's turnover has been $1,5–1,7 billion. Since its founding in 2001, the company has never operated at a loss. At its peak share price in July 2008, its market capitalization exceeded $5 billion; it currently stands at $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 mining and metals companies, Ferrexpo is the only one to list its shares on the London Stock Exchange. The company does not export iron ore raw materials (IRR) in their pure form, like Rinat Akhmetov's and Vadym Novinsky's Metinvest, but rather moves further up the production chain. At the same time, Ferrexpo's owner emphasizes his intention to develop the company exclusively as a raw materials company.
It might seem like Zhevago is being disingenuous: since 2004, he'd been trying to implement plans to develop the steelmaking business. But the project wasn't particularly successful. And when he started the mining business, he never expected to stay in it for long.
The beginning of the iron road
The purchase of Poltava Mining and Processing Plant shares was just one in a series of similar deals, Zhevago recalls. In the mid-1990s, during the voucher privatization era, he, a graduate of the Kyiv State University of Economics (colloquially known as "Narxoz"), along with his classmate, Sergei Cherep, participated in a group of aspiring entrepreneurs buying up securities. Later, the "Narxoz" men joined the group of influential businessmen Alexander Volkov and Alexei Kucherenko. The latter also acted as a partner in Igor Bakai's gas barter schemes. Kucherenko, along with another of his "gas" comrades, Sergei Veselov, helped Zhevago buy Poltava Mining and Processing Plant shares. Firms allied with 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 that Zhevago had bought out his partners' shares.
The PGO uses both old BelAZ trucks and new Komatsu trucks. Igor Tishenko
The buyers did not disclose the amount paid for the 42% stake. However, around the same time, other businessmen purchased 21% of the shares through the PFTS exchange for 18,8 million hryvnias, or approximately $10,7 million.
The purpose of the purchase, Zhevago assures, was for resale. "But nothing is more permanent than something temporary," the businessman smiles. "We soon realized the potential of this asset." He says it took about two years to realize the project's potential.
"We analyzed the market and logistical advantages. And the solution came naturally," Zhevago notes. The mining and processing plant's location allowed it to successfully compete on the global market with Brazil, which supplied ore to China, Taiwan, South Korea, and European countries. Although the ore in Ukraine is poorer (about 30% iron versus 60–65%), its geography compensated for this weakness.
In 2001, Zhevago registered the management company Ferrexpo in Switzerland.
Dreams of integration
How did Zhevago come to the decision to take Ferrexpo public? In 2007, his conflict with the Luzhniki group was widely publicized (see "Wars for the Mining and Processing Plant"), and many said the main shareholder was trying to protect himself. "Absolutely not. Protection from claims is only a small part of the advantage of being a public company," the oligarch counters.
A more pressing issue at the time was raising capital, notes one of the company's former top managers. Back in 2002, Ferrexpo received a license to develop the Yeristovsky Mining and Processing Plant, located north of Poltava. It is the largest iron ore deposit in Eastern Europe, with confirmed reserves according to international standards of 674 million tons. Due to the smaller size of the quarry compared to the Poltava mines and the shorter distances, the equipment here is more productive, which means lower production costs, explains Ivan Anthony, Director of Production at Yeristovsky Mining and Processing Plant. "The investor is thinking ahead—the Poltava Mining and Processing Plant's quarries have been in production for over 30 years," says a Ferrexpo top manager.
China and others
It was then, in the early 2000s, that the metallurgical history began. Zhevago began considering building an electric steelmaking plant near the mining and processing plant. "The primary impetus for this was the need to find markets," notes one of the company's former top managers. In 2004, Vorskla Steel was registered in Switzerland as a management company, intended to manage steelmaking facilities in Ukraine and Europe. The plan was to produce metal in Komsomolsk, cast it into slabs (the blanks for future rolled products), and export them to Europe.
There was also an idea to create steel-rolling facilities, but closer to the consumer. Zhevago chose the town of Záhony in Hungary as a site. An entire industrial park was planned there. The design capacity was 2,5 million tons of rolled steel per year. A little later, in the summer of 2007, the billionaire acquired an electric arc furnace mill in Denmark with an annual capacity of 400,000 tons of commercial blanks. Analysts at the time stated that the purchase, costing approximately $150 million, did not fit into the production chain of the other two plants, which had not yet been built. Nevertheless, it was also included in Vorskla Steel.
Implementation of plans for the two plants required at least $1,5 billion in investment, with another $0,5 billion planned for modernization of the PGOK and development of the Yeristovskoye field.
Zhevago summarizes that the company's primary goal is to attract capital on favorable terms. He believes that the cost of capital is always 2-3% lower for public companies. This was the primary motivation for listing on the London Stock Exchange (LSE) in 2007.
The company's initial market capitalization (IPO) was planned at $2 billion, but it fizzled out at $1,67 billion (it raised $460 million from the shares it sold). Nevertheless, investment analysts deemed the IPO a success. Zhevago's timing was spot-on: iron ore prices on global markets were growing by 15-20% quarterly. By the end of 2007, Ferrexpo's market capitalization exceeded $3 billion.
Rigid landing
All plans announced by Zhevago's group were valued at $4,8 billion in 2007 and were expected to be completed by 2018. Analysts noted that, in tandem with its strategic partner, Ferrexpo, it could easily increase ore production to 100 million tons per year by that date, a more than tenfold increase.
In the fall of 2007, the businessman realized the proceeds from the IPO would clearly not be enough. "At that time, we had a line of Asian companies willing to invest $2 billion in the Ukrainian iron ore mining project—China's China Minerals, South Korea's Posco, and India's Tata Steel," says a former top company executive. Furthermore, the project's continuation with European assets also required investment: Zhevago decided to buy the Bulgarian Kremikovtsi metallurgical plant.
The company invested approximately €100 million in the plant, fulfilling conditions regarding debt repayment, raw material supply, and equipment investment, and even promised the Bulgarian authorities to buy the loss-making Sofia football club CSKA. But alas. At first, other suitors for the asset thwarted the deal. Then the crisis struck. In 2010, the Bulgarian authorities were forced to demolish the plant. The Bulgarians promised to repay Zhevago's investment, but the process is still ongoing.
The businessman ultimately decided against entering into an alliance with his Asian colleagues. Instead, in early 2008, Zhevago received a $2,247 billion loan from JPMorgan Chase Bank, secured by 73,1% of Ferrexpo shares.
The troubles weren't 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 majority owner took over as CEO, which displeased minority shareholders: in a single day, on October 29, the company's shares plummeted 25%. A margin call ensued. 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 additional money or sell a portion of them. Zhevago chose the latter option. With the help of JPMorgan, a buyer was found for the 20,8% stake—New World Resources, a coal mining company owned by Czech billionaire Zdeněk Bakala. The investor seamlessly integrated into Ferrexpo, Zhevago believes: "We've known each other for many years and have done business together on various projects in Central and Eastern Europe and Ukraine." The deal proved quite lucrative for Bakala: he paid $177,5 million for the stake—according to analysts, half the fair value and approximately a third below the market price (Bakala later increased his stake to a blocking stake). Zhevago's stake in the company was reduced to 51%, with the remaining shares being publicly traded.
Ore weekdays
Within the vast grounds of the Poltava Mining and Processing Plant, the passions raging in the stock market are barely noticeable. A UAZ truck pulls up to the central entrance of the administrative building, and a large box is unloaded from it. It's a package for Mykola Stakhiv, the head of the Poltava Mining and Processing Plant museum. "Voestalpine sent us a gift for the exhibit—a Volkswagen Passat fender made from steel produced using our pellets," the museum worker proudly explains.
Tens of millions of dollars are invested annually in modernizing the PGO. Igor Tishenko
Poltava Mining and Processing Plant considers the quality of its pellets its calling card. "After the 2008–2009 crisis, we began to focus on modernization to attract high-quality customers. Today, we have contracts with industry leaders such as Voestalpine, Nippon Steel, JFE Steel, and Kobe Steel," explains Vladimir Ivanov, First Deputy Chairman of the Board of Poltava Mining and Processing Plant.
The quality of Poltava pellets is truly highly valued by foreign consumers, confirms Dmitry Zheltyakov, an analyst at the state-owned enterprise Ukrpromvneshexpertiza. According to him, Ferrexpo is the only pellet producer that exports 100% of its output. Ivanov is confident that the company would sell pellets domestically if Ukrainian consumers were willing to pay the prices offered by consumers in Europe, China, and Japan.
Zheltyakov finds this argument dubious: "Currently, the price per ton of pellets in China is around $120, of which Ferrexpo spends $25-40 on logistics. Severny GOK sells pellets to Ukrainian consumers for approximately $100 per ton."
In reality, Ferrexpo's competitor has slightly different objectives. "Metinvest's priority is supplying 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. These are a small number: Yenakiieve Steel Works, Azovstal, Alchevsk Iron and Steel Works, and Donetsk Iron and Steel Works. The first two are part of SCM and are allied with SevGOK.
Komsomolsk's products were exported back in the Soviet era. "Even then, the plant was focused on Europe—Czechoslovakia, Poland, Romania, and Bulgaria. Pellets had to be repeatedly reloaded and transported over considerable distances. To prevent them from breaking down, a special technology was required," explains Dmitry Vinivitin, deputy head of the technical department at the PGOK. The technology was purchased from the American company Allis-Chalmers. "Ferrexpo's technology, all other things being equal, differs from ours in that the pellets have superior physical and mechanical properties," Metinvest agrees.
But these developments are insufficient today. "Just 15 years ago, many were satisfied with pellets with an iron content of 60%, but now even 62% is no longer suitable," Ivanov shares. At the end of 2002, Poltava Mining and Processing Plant began producing products with an iron content of 65%, and during this year, it launched two new flotation lines, which allow it to increase the share of 65% pellets in production from 50 to 100%.
Investments in the opening of flotation processing sites No. 2 and No. 3, launched this year, amounted to approximately 860 million hryvnias ($70 million).
The ultimate goal of all these improvements is the same: to retain customers. Furthermore, the price per ton of 65% pellets is approximately $20 higher than 62% pellets. This is crucial in today's market conditions. While in 2013, the average price for 62% Australian ore (the benchmark) in China was $136,6 per ton, by early 2014 it had fallen to $130, and in July and August it was already hovering around $90–97. "This doesn't 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 price decline hasn't yet impacted Ferrexpo's financial performance. For the full year of 2013, the company saw net revenue grow by 11%, to $1,6 billion, and net profit by 22,3%, to $263,8 million. For the January-June 2014 period, net revenue decreased by 2% compared to the same period last year, while net profit increased by 62,5%, to $208 million. "Of course, we gained in base costs due to the depreciation of the hryvnia," explains Chris Mo, Ferrexpo's CFO.
Increasing ore production at the Yeristovskoye deposit, which began operations in 2012, will enable pellet production above 65% at lower costs. This represented a shareholder investment of approximately $400 million. 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, containing 33,7% iron, up from 30% at the PGO.
The shareholder and his management team regularly face the question of "bigger or better." For example, Konstantin Zhevago personally participates in the selection of suppliers for dump trucks and excavators.
According to Ivanov, a more powerful car is not only more expensive to buy.
Its current operation is expensive: one tire for a 110-ton dump truck costs approximately $20,000, for a 220-ton truck – $40,000, and for a 360-ton truck – $120,000. Will Ferrexpo be able to afford such expensive purchases in a weak metallurgical market? Zhevago believes that focusing on implementing best practices from Western corporations will allow the company to maintain its current position. "We are improving quality and selling to the most expensive, most promising, most stable, and most viable markets, such as Japan and Germany," explains the billionaire.
But vertical integration clearly didn't work out. The main shareholder firmly separates Ferrexpo from the as-yet-failed holding company Vorskla Steel. These are completely different businesses, and no integration is planned, he asserts: "Mining companies pay for their mining business. Investors will only discount a company that has any connection to steelmaking."
Today, Zhevago dreams of joining the global mining giants—BHP Billiton, Rio Tinto, and Vale—whose market capitalization amounts to tens of billions of dollars. Ferrexpo's iron ore reserves allow it to aspire to become a leader. For example, Brazil's Vale has 17,5 billion tonnes of proven reserves, while Australia-British BHP Billiton has 2,9 billion. Ferrexpo estimates the total resource potential of the group's deposits at 20,5 billion tonnes, although by international standards, only slightly more than half has been proven. The three deposits currently under development hold even less, at 1,5 billion tonnes.
Wars for the Mining and Processing Plant
In the early 2000s, the attractiveness of the PGOK was appreciated not only by Konstantin Zhevago
According to Oleksandr Prityka, former director of the state-owned holding company Ukrpolimetall (which was given state-owned stakes in several mining companies), the head of the Finance and Credit group and his partners intended to buy the blocking stake in the mining and processing plant, which remained in the hands of the state, at par value. However, another group of shareholders, who had previously purchased approximately 9% of the state's shares, then the blocking stake, and managed to acquire additional shares in the interim, intervened.
Behind the buyers were representatives of Moscow's Luzhniki business in Ukraine – partners of Russian oligarch Alexander Babakov and Mikhail Voevodin. Their interests in Ukraine were represented by Mikhail Spektor, who headed the Slovakian management company VSE, and businessman Maxim Kurochkin (Max Besheny, killed in 2007). The state "matured" to sell its remaining shares, a total of 6,6%, at public auction in 2001. By then, the stake had acquired strategic importance, so its price soared at auction to $14,8 million (73 times the par value). Zhevago lost this battle. In 2002, he was forced to negotiate a deal with competitors and buy out 40% of the shares for $27 million. This brought his stake in the company to over 85%.
Three years later, the sellers changed their minds and decided to return the mining and processing plant. The parties have repeatedly litigated in Ukraine and London. "We want to restore the status quo, when our companies each owned 40,19% of the mining and processing plant," Spektor, head of International Ukraine, previously explained to Forbes. The initiators of the litigation believe there are grounds to invalidate the agreement, and with it, all share issues since 2002. Zhevago is confident that the pretext is far-fetched, calling the opposing party corporate 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 more," he complained.
The investigation continues.
Ekaterina GREBENIK, InvestfoundS
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