ALROSA entered the summer of 2009 in a very grave condition: the company had a net debt of $5 billion at full absence of market sales. In the course of last six months the situation changed: ALROSA is currently devising a sales policy under long-term contracts, re-structuring its debt, has restored its credit ratings, plans two releases of bonds this year, and is going to attract investors to its affiliated companies. All this is not only the evidence of a recovery in the diamond market, but points to an opportunity of ALROSA's prompt transformation into a public company. In any event, this week it was the first time when this possibility was discussed by a state official and not only by ALROSA’s management.

This will happen soon

“In the near future there will be taken harmonizing actions and the company will be transformed into an open joint-stock corporation,” Yury Medvedev, deputy head of Rosimuschestvo (a Russian federal agency in charge of state property), said in his speech in the State Duma on Wednesday.

Within the frames of the company’s federalization Rosimuschestvo turned to be the owner of 50% + 1 share of ALROSA, while the Ministry for State Property Management of Yakutia got 32% and the eight uluses (districts) of Yakutia appropriated a total of 8%.

According to Yury Medvedev, at the moment Rosimuschestvo did not reach understanding on this question with Yakutia. At the same time, he emphasized that the current situation with the Russian Federation owning a stake in a closed joint-stock company is inadmissible.

Rough&Polished expert Sergey Goryainov explains that making ALROSA public is at variance with a current legal obstacle: there is a law of the Yakut Parliament passed in 2005 saying that organizationally and legally preserving ALROSA as a closed joint-stock company meets Yakutia’s state interests.  The document was passed before the conclusion of the amicable agreement approving the distribution of shares between the federal government and Yakutia, but formally it is still in force. Accordingly, the first thing to be done to make the company open is to amend this law.

In the end of last December, a source in the government of Yakutia informed Interfax that the working group established by ALROSA’s major shareholders was already preparing draft documents for such transformation.

Reducing debt is of high priority

Both experts and the company’s management agree that turning ALROSA public would improve, among other things, its investment appeal and decrease the amount of its debt.

Before the crisis, ALROSA was actively seeking credit resources for construction of underground mines, each worth up to $1 billion. Besides, while the company did not sell to the market, it had to use credits to finance its current operations. As a result, by August 1, 2009 ALROSA’s net debt reached 162.1 billion roubles, of which 115.3 billion roubles were short-term debts.

Since July, 2009 ALROSA renewed its operations on the market and due to this could start to repay debts. Besides, it managed to redeem a significant part of debt selling its non-core gas assets to VTB Capital for $620 million. By the beginning of 2010 the company decreased its debt down to 113.3 billion roubles, of which 92 billion roubles were short-term.

According to the company’s president Fyodor Andreyev, the main purpose of their credit policy in the current year is to increase the share of long-term credits and lower the cost of loans. By the start of 2011, ALROSA is set to reduce the volume of its liabilities to a level of 102.1 billion roubles, including 26.4 billion as a short-term debt.

As a result of negotiations with its creditors (VTB, Alpha-Bank and Bank of Moscow), the company made it possible to decrease the average interest rate for the existing credits. According to the company’s data available at Interfax, from the beginning of this year the ALROSA Group has already lowered the average interest rate for its debt from 12.39 % to 8.08 %.

“We came across a situation when our interest rates during the crisis increased and were 14-15% in roubles while in foreign currency they were also up to 10-12%,” Fyodor Andreyev remarks. “The earning power of our credit notes in circulation reached a 23-percent peak, but by now it is down to 7.2 %. Certainly, it is in line with the market dynamics. However, this is actually a pre-crisis level of earning power. Accordingly, we negotiated this with all our creditors.”

He said that due to decreased interest rates for their credits the company has already saved about 3 billion roubles. “I think that for us and for anyone else this is quite a big amount of money, and of course the work done to re-structure our debt and to make its terms longer is of vital importance for our company.”

The company’s general financial strategy suggests decreasing their debt to $2.075 billion in 2014.

Sometimes they come back

In the opinion of the company’s president, any further steps taken to handle the debt will be backed up by the restoration of ALROSA’s credit ratings. Last week, after a more than six-month silence the company received updated ratings from three largest agencies at once – S&P, Fitch and Moody's.

Officially, ALROSA’s cooperation with Standard & Poor's stopped in the middle of last year when the agency declared that the company submits insufficient information related to its financial and operational performance and development prospects. The company, in turn, criticized the agency for opacity of its technique of rating calculation. As a result, S&P stopped monitoring ALROSA’s rating, but noted that it can reconsider the move if it will receive necessary information.

In the beginning of February, almost 10 months later, S&P returned to work with the company - the agency reinstated long-term and short-term credit ratings of ALROSA at ‘B+’/‘Â’, Positive. S&P also reinstated their ‘B+’ rating on ALROSA’s $500 million Eurobond and ‘B’ short-term rating on ALROSA’s commercial paper program. “The reinstatement followed S&P’s receipt of sufficient financial and operating data to analyze the company and assess its ratings,” the agency said in its press release. S&P reinstated the ratings at a higher level than they were last April - then the company’s long-term rating was ‘ÂÂ-’.

S&P was followed by Fitch which gave its own estimation of the company. For the first time, Fitch rated ALROSA in May, 2009 when the company had to search for some replacement to the rating withdrawn by S&P. Last week, Fitch raised ALROSA’s long-term foreign currency Issuer Default Rating (IDR) from ‘B’ to ‘B+’. It is noteworthy that initially the company’s rating was on the Rating Watch Negative List, but now it is off that list and the outlook of its new rating is ‘Stable.’ Fitch has also upgraded ALROSA’s senior unsecured rating to ‘B+’ from ‘B’ and removed it from RWN. ALROSA’s short-term IDR is affirmed at 'B'. The recovery rating for the senior unsecured debt is ‘RR4’.

The last to reinstate ALROSA’s ratings was the third-largest world ratings leader, Moody's. After a long break it restored ALROSA’s long-term liabilities rating at its former level of ‘Ba3 Negative.’

On the whole, analysts from investment banks agree with the opinions of these rating agencies though some of them consider their optimism excessive. ALROSA did not enter into large-scale refinancing deals since last May and increasing the rating of the company whose debt/EBITDA leverage is around 0.5, to tell the truth, is too sharp a change,” the Troika Dialog review says. “Probably, it would have been enough just to exclude the company’s rating from the list of candidates for revision. Nevertheless, it is pleasant to see competitive struggle going on between the rating agencies.”

In diamond we trust?

The above agencies provided similar substantiation for their ratings. Speaking about ALROSA’s current state of affairs they first of all point to the gradual restoration of the market, successful actions to reduce the company’s debt and reliable support of the Russian government.

The ‘B+’ long-term rating is based on ALROSA’s stand-alone credit profile, which we assess at ‘CCC+’, as well as on our opinion that there is a “high” likelihood that the government of the Russian Federation would provide timely and sufficient extraordinary support to ALROSA in the event of financial distress,” said Standard & Poor’s credit analyst Andrey Nikolaev.

The agency’s assessment of the likelihood of government support is further underpinned by support provided in 2008-2009 through substantial loans from state-owned JSC VTB Bank and ALROSA being able to sell its diamonds to Gokhran.

At the same time, according to Fyodor Andreyev, the marketing policy of the company is now sufficiently successful, while the observed recovery of the market proves that Gokhran’s assistance to ALROSA may no longer be needed this year. “We plan sales to Gokhran in the current year at a level of $870 million, but right now we are discussing the expediency of this step with the Finance Ministry since in our estimation if there will be no second wave of crisis we shall manage to sell all this on the market with a rather high efficiency. We shall also discuss this matter at the Board of Directors,” he says.

According to him, rough diamond prices are now briskly recovering - the average price for carat has a bit decreased in comparison with the average indicator in the fourth quarter of 2009, but the company is building up direct cooperation with India where consumers’ demand is mainly focused on cheap small-size rough. However, general forecasts for this market look bright and Fyodor Andreyev does not exclude a rise in rough prices by 10% within this year.

The Fitch experts also point to a market recovery. According to the agency’s forecasts, in 2010 global demand and prices for diamond jewelry will stabilize at the levels of the second half-year of 2009. Besides, the agency expects that re-stocking will continue which may result in a higher demand for rough diamonds in 2010 pushing it up 25-40% year on year.

“The restoration of ALROSA’s ratings may indicate some interest on the part of money markets towards operating with diamond-mining companies,” Rough&Polished expert Sergey Goryainov believes. “This is proved by reports about successful re-structuring of De Beers’ $1.5 billion debt and the coming increase in capitalization of this company by $1 billion.”

He explains there are two fundamental factors underpinning the rise in diamond prices: depletion of diamond deposits and growing demand from China and India. According to some estimates, by 2013 the existing mineral base may potentially yield no more than 120 million carats of diamonds a year to the market (mind that in 2006 which was considered successful for the industry its global output reached 175.54 million carats).

“By 2012, global diamond output in carats will decrease by about 20-25% in comparison with the present level,” Nikolay Pokhilenko, Director of the Russian Academy of Sciences (Siberian Branch) Institute of Geology and Mineralogy, believes. “For the last decade there were no serious discoveries anywhere in the world, including Russia, and a similar situation is in Africa and Canada. In Yakutia, the Nakyn Kimberlite Field will not be able to meet the shortage to be developed in the nearest 5-7 years due to exhausted reserves in the Udachnaya Diamond Pipe. Canada, too, will not cover the shortage in global diamond output.”

“During the last decades no one in the world discovered any large diamond deposits,” Fyodor Andreyev agrees. “Accordingly, even if any will be opened in the nearest years the construction cycle will take about six years. All the companies will switch to underground mining. Right now there is a shortage of rough diamonds and such a little bit surprising instance of fast recovery in demand, in my opinion, may be explained exactly by this.”

Road to eurobonds

Further measures to repay the debt have already been outlined as well: in 2010, the company plans to release two issues of bonds – rouble bonds and eurobonds. ALROSA will issue its rouble bonds in the first six months of this year. The company’s Supervisory Board has already decided to place a three-billion-rouble loan. The total amount of rouble securities to be released may exceed 30 billion roubles up to the end of this year. The following step will be to issue eurobonds, a matter on which the Board of Directors will take its decision in the second half of this year. ALROSA plans to place eurobonds to an amount of $1 billion for the term of 10 years.

“After ALROSA’s  S&P rating was reinstated and its Fitch rating upgraded the company has a perfect opportunity to enter the eurobonds market this year,” according to the analytical report published by Renaissance Capital, saying this may happen after the company will post its audited report for 2009.

Long debts – long investments

“Why the company would need a long-term debt? Our investments into underground mines will virtually go on till 2016,” Fyodor Andreyev explains. “Aikhal and Mir are to be completed in 2014, while Udachny will be finished in 2016. But all the same, until 2016 the actual amount of investments in view of these mines and in view of Severalmaz will reach about 10 billion roubles a year – this is a great amount and great debt.”

In 2009, ALROSA’s investment program was run at 12.039 billion roubles and for 2010 it is planned to reach 11.195 billion roubles. In particular, 1.779 billion roubles will be invested in developing underground mining at Aikhal, 1.996 billion roubles are earmarked for Mir, and 2.827 billion roubles for Udachny.

The financial plan of ALROSA until 2014 assumes that annual investments will be maintained at approximately the same level.

IPO and seeking for ‘strategists’

To attract additional sources to fund its investment program ALROSA is exploring the possibility of placing shares of some of its affiliates at the stock exchange or selling them to a strategic investor.

In particular, since the last year the company has been discussing the idea of selling some of the stake held by ALROSA in its iron ore project in Yakutia where the company owns 4 deposits. According to Fyodor Andreyev, negotiations are under way with investors. “Of course, first of all there is interest on the part of Chinese companies - in view of geography and their policy to invest in resources,” he said. “We are ready to sell no more than 49%; this is the position of the government and the market understands it,” the company’s CEO noted.

Besides, ALROSA considers a possibility of placing shares of its subsidiaries among which the most probable candidates are OAO ALROSA-Nyurba (the biggest “sister” of ALROSA), Catoca in Angola, and OAO Severalmaz based in Arkhangelsk.

According to preliminary forecasts of investment banks, which evaluated the feasibility of such projects (the document is available at Interfax), selling these subsidiaries may give ALROSA up to 20 billion roubles to finance its investment program.

The greatest stake which may be sold by ALROSA is in OAO Severalmaz - 45% minus 1 share. According to investment bankers’ forecasts, this package may cost from 10 to 12 billion roubles.

Severalmaz is the most problematic of ALROSA’s sister companies. From the moment it was purchased the company never posted profit and now it is annually in the total red to about 1 billion roubles.

Severalmaz was established with an eye to predicted global deficiency of rough diamonds. The market expected that the number of diamond fields on this planet would be exhausted and in case there will be opened new ones mining conditions there would be very difficult. “Generally, it was a sweaty project. But diamond prices grew, and the company expected that in 2009 Severalmaz would be able to turn a money earner. However, there was no one around to predict this crisis,” Sergey Goryainov explains.

Severalmaz’s current mining cost is about $70 per carat, while its production may be sold at a price not exceeding $50 per carat.

However, Fyodor Andreyev remarks that despite this Severalmaz is the most probable candidate for selling some of its shares, and investors are taking utmost interest towards this opportunity. “Such interest is obvious. Everyone sees that this is not a simple project and it will reach the break-even point in 10-14 years. But in view of the above mentioned shortage and price prospect, I think that Severalmaz is not so hopeless and most likely during this year we shall set ourselves the task of attracting a strategic investor. An IPO there is unreal, but a good ‘strategist’ – holding from a golden share and up to 49% - is a real thing,” he believes.

According to Fyodor Andreyev, any big-scale manufacturer may play the role of such a strategic investor, and major Western investors are also considered for this opportunity.

ALROSA has already spent one year for a feasibility study to develop Severalmaz which suggests transition from an experimental factory to industrial-scale operation and processing 3-4 million tons of ore per year. About $400-500 million worth of investments will be required to build a factory. “Our estimates show that it is real to make this project commercial in view of its ore content. The deadline for turning it profitable is 2014. Certainly, this is not tomorrow, but prospects are good,” the company’s president said.

He also noted that some investment banks and the companies will submit their proposals related to a possible placement of shares held by ALROSA’s subsidiaries. “Then we’ll choose a bank and charge it with a task to complete the whole affair before the end of the year. Usually a bank is given six months for this procedure,” Fyodor Andreyev added.

According to Fyodor Andreyev, the idea of an IPO made by ALROSA proper is now discussed at the level of the company’s management and has already been offered to shareholders. “We believe that going public or virtually releasing up to 25% of ALROSA’s stock to the market is the most efficient solution for further development of the company that is for implementing its investment programs, preserving jobs and reducing debts,” he emphasized.

In anticipation of profit

So far it is unclear what time will be needed to turn the company public and place its shares on the market. But the company is geared for close cooperation with the investment community. “It is important, that in the current year we wish to accept a strategy till 2018 and be strict in shaping up a financial pattern and what the company will be. This is similarly important for rating agencies, for bonds, for IPO, but first of all for ALROSA itself,” Fyodor Andreyev said.

The plan of the company’s activity in 2010 has already been drawn. During the current year ALROSA intends to recover 33.54 million carats of diamonds – up 2.3 % vs 2009. The company’s proceeds are expected to reach 92.374 billion roubles in comparison with 63.467 billion roubles one year ago. The company plans to increase its proceeds first of all by way of selling its accumulated stocks of rough which at the end of 2009 was estimated as being worth $1.326 billion.

The company’s profit before taxes (by Russian Accounting Standards) for the year is expected at 6.436 billion roubles (up 2.35 times). However, tax payments will increase up to 3.78 billion roubles in comparison with 446 million roubles in 2009. Due to this ALROSA’s net profit in 2010 will be less than in 2009: 2.656 billion roubles against 3,183 billion roubles.

The company also expects positive results evaluated by IFRS. Tentatively, ALROSA’s net profit by IFRS in 2009 is $379 million against a pure loss of $1.318 billion in 2008. In 2010, ALROSA expects an increase in its profit up to $562 million by IFRS.

Preliminarily, ALROSA’s EBITDA in 2009 is $846 million ($799 million in 2008). In 2010, the company expects EBITDA at a level of $1.39 billion.

Interfax