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Liquidation of ALROSA-Nyurba or saving at the expense of the reputation

14 october 2019

Over the past few years, ALROSA has done a lot to improve the reputation of a responsible diamond market player. ALROSA's corporate culture and its interaction with shareholders have also improved, not only with the Federal Property Management Agency and Yakutia, but also with the minority shareholders, whose interests are represented by two of 13 members of the company’s Supervisory Board. ALROSA adopted a predictable dividend policy and tied bonuses paid to its managers to their performance, its top managers exhaustively answer the investors' questions at quarterly conference calls.

So, it looks quite strange on this background that one of ALROSA’s recent initiatives differs widely from the best corporate practices, although it is positioned as a means of “management efficiency improvement and structural optimization.” In early September, ALROSA actually announced the start of the liquidation of its subsidiary ALROSA-Nyurba, 2.51% shares of which belong to the minority shareholders. The news was an unpleasant surprise for them and can threaten the investment attractiveness of ALROSA itself. The transaction made by the company’s “own reasoning” too obviously smacks of damage to the minority shareholders due to unfair acts on the part of the majority shareholder to be unnoticed.

ALROSA-Nyurba is the holder of licenses for the Nyurbinskaya and Botuobinskaya kimberlite pipes discovered in the mid-1990s. “The future of ALROSA was rather vague then. The idea of ​​ splitting diamond production and sales was seriously considered - similar to the Soviet era when Yakutalmaz did not sell its products. Another option was to make some of the mining divisions self-sustained, primarily the Udachninsky Mining and Processing Plant. In this situation, the decision to spin off new license areas into a separate legal entity was a kind of political insurance,” Sergey Goryainov, Rough&Polished, says.

Now, this pattern is no longer relevant, Goryainov says. The entire production cycle is carried out by ALROSA’s structural divisions - primarily by the Nyurba Mining and Processing Division - on a contract basis. ALROSA-Nyurba employs 30 people, mainly the management personnel. The reorganization of the subsidiary, which does not conduct operating activities but owns the licenses for two fields, which now account for about 26% of the ALROSA Group’s diamond production, is explained by decreasing the administrative costs and eliminating duplicate functions. The logic of the process is to own assets directly, without a bureaucratic “interlayer”. So what is the problem?

As usual, the devil is in the detail.

TWO PRICES FOR DIFFERENT SHAREHOLDERS

The liquidation mechanism assumes that the settlement will be first achieved with creditors, the major of which is ALROSA, after which the remaining parts of the ALROSA-Nyurba liquidation fund will be distributed among the shareholders in proportion to their shares. The calculations look rather sad for the minority shareholders. The value of ALROSA-Nyurba's net assets at the end of the first half of this year, based on the quarterly report, is 2 times lower than the current capitalization (₽27.36 bn against ₽55 bn). In case of liquidation, about ₽34,000 accrue to one share. After the announcement of the Nyurba forthcoming liquidation, its shares fell 16% down to ₽63,200, although they later partially recovered and, according to the data as of September 30, the share price is about ₽69,000.

But this price is more than 2 times lower than the price at which ALROSA bought a 10% stake in Nyurba last September from the government of Yakutia (the republic is also a major shareholder of ALROSA). Then, one ALROSA-Nyurba’s share, based on the valuation report, was valued at ₽150,000, based on the valuation of 100% of the company’s stock at ₽120 bn. According to Interfax sources close to the ALROSA Supervisory Board, the independent directors considered this price too high at that time.

Now, ALROSA’s independent directors, Maria Gordon and Oleg Fyodorov, have demonstratively abstained from voting at the meeting of the Supervisory Board because of a refusal to make an offer to the minority shareholders. ALROSA did not bring up the issue of the offer publicly, although after a pause, it announced that the share buyback could be considered by the Supervisory Board in the event of an appropriate directive from the Russian government.

Meanwhile, according to Alexei Moiseev, Deputy Minister of Finance of the Russian Federation and a member of ALROSA’s Supervisory Board, the shares of minority shareholders should be bought at a fair price. “From the point of view of the buyback, of course, the buyback should be made at a fair price,” Moiseev said in his interview with Interfax. Fair pricing can be verified by the Central Bank as a supervisor, Moiseev added.

In the event of a buyback, the price may not be lower than the weighted average for 6 months, excluding the day of the liquidation announcement (that is, in the range of ₽70,000–75,000).

In a more optimistic scenario, the price for the buyback shares from Yakutia could be just as fair - ₽150,000, a manager of a large fund familiar with the situation believes. “Any other price will raise questions about why it is less than [the buyback value] from Yakutia,” he says.

ALROSA could buyback the minority shares at precisely this price as part of a compulsory offer, since as a result of a deal with Yakutia it crossed the 95% threshold in Nyurba, which by law entails a compulsory repurchase of the remaining securities. But the fact is that for an offer, a package of 10% should be collected through a voluntary offer to buy shares back. But ALROSA and Yakutia’s unit Ric Plus entered into a buy and sell agreement, thereby avoiding a mandatory offer. At first, it was difficult to believe that the further development would be so unpleasant for the minority shareholders. But, as it turned out later, the dynamite was already there and it remained to wait for lighting the fuse.

ACTUAL AFFILIATION BUT WITH DAMAGES TO MINORITIES

According to the Russian law on joint-stock companies, liquidation, unlike reorganization or delisting of shares, does not give shareholders the right to demand the buyback of their shares.

In case of liquidation, the shares of a company are delisted from the stock exchange, but the general meeting of shareholders is not obliged to make their decision on delisting simultaneously with taking their decision on the liquidation, explains Ekaterina Spakhova, senior lawyer on the corporate practice at the KIAP Law Office. The agenda of the ALROSA-Nyurba extraordinary shareholders meeting, which will consider the liquidation on October 31, does not really contain an item on the approval of delisting. “In accordance with the rules of the Moscow Stock Exchange, such a decision is made by the exchange itself within 5 days from the date of disclosure of the information on liquidation. And the exchange’s decision on delisting does not give shareholders the right to demand a mandatory repurchase of shares,” Spakhova says.

In case of liquidation of ALROSA-Nyurba, in fact, we are talking about reorganization in the form of affiliation, lawyers say.

“Based on the main trend in the law enforcement practice, substance prevails (legal instruments should reflect the economic essence of operations), affiliation seems to be the most suitable tool in this case,” Anton Samokhvalov, a KIAP’s partner, says.

“Liquidation is an optimization of the company business as a whole, and its purpose is not to liquidate the company, but rather to actually reorganize it,” Alexander Petrov, a lawyer at Art de Lex, agrees.

But the way of the “actual reorganization made in the form of liquidation” chosen by ALROSA deprives Nyurba’s minority shareholders of their right to repurchase their shares.

“If it is planned to liquidate a company through the legal mechanism of liquidation, and not through the reorganization via, for example, affiliation, then shareholders have no right to demand the repurchase of shares in principle. The intention to buy shares from the minority shareholders of the company, therefore, can only be the goodwill of the management team,” Alexander Petrov, a lawyer at Art de Lex, says.

“If in this situation a decision was made to affiliate, the minority shareholders who voted against such a decision would have the right to apply for the repurchase of their shares, which will not happen when deciding on the liquidation of the company,” Anton Samokhvalov from KIAP says.

“And if we assume that the shares of the company in case of affiliation would be bought back at a market price that exceeds the liquidation quota in case of liquidation, it turns out that using an inappropriate mechanism would result in losses for the minority shareholders who disagree with the majority shareholder’s decision,” Samokhvalov said.

The destruction of the Nyurba oasis

One unknown remains in this story - ALROSA-Nyurba’s free float structure. Historically, the company’s shares were received by the veterans who discovered the kimberlite pipes of the Nakynsky field and the company's employees. At the end of June 2019, according to the quarterly report, ALROSA-Nyurba had 651 shareholders. But, according to the informed sources, the vast majority of the shareholders have 1-2 shares in their hands, and the former management team of the subsidiary has collected large share packages. The shares were purchased for symbolic ₽25, which brought fantastic profits. In the period from 2007 to 2018, ALROSA-Nyurba paid about ₽100,000 of dividends per share. ALROSA supported the high dividend yield of Nyurba mainly because Yakutia was among the shareholders until 2018, but not only budgetary institutions of the republic became beneficiaries, but also a narrow circle of people, and such generosity towards them may be considered excessive.

ALROSA’s management decided to stop the artificial mega-enrichment scheme of Nyurba’s former chiefs. It was the existence of this scheme that became the catalyst for the unexpectedly harsh decision about the liquidation. “This transaction is made by the company’s “own reasoning” and not according to the corporate governance code,” says a source familiar with the motives of ALROSA's top management in this matter.

But, even taking into account this circumstance, the situation as a whole does not change. Besides the considerations of liquidating the source of exorbitant profits used by the former chiefs of Nyurba, there is also the aspect of reputation and investment attractiveness of ALROSA itself. Perhaps that is why the independent directors of ALROSA, having all the information about the "Nyurba oasis", still offered to buy back the shares of the minority shareholders.

REPUTATIONAL RISKS

“ALROSA is playing rather foul. Of course, the right market way is to declare - after buying a 10% stake from Yakutia - the squeeze out at the same price as the one offered to Yakutia. No questions would have arisen. The value that they would have lost is not comparable with the reputational risks for a large public company that claims to be the foremost among the state-owned companies,” says the manager of a large foreign fund investing in the Russian shares.

In his opinion, the story is just beginning to develop and so far, not all the consequences are seen. “After this liquidation, lawsuits from the minority shareholders may follow. All this will be in the public spotlight, lawsuits will be constantly thrown in face. These are long and unpleasant PR consequences,” he thinks. Analysts have already asked the ALROSA top management questions about their future steps regarding the 2.51% stake in Nyurba, the story is unlikely to go under the radar, regardless of whether several former heads of the subsidiary or a large investment fund suffer from the liquidation.

The situation may result in a conflict similar to the one that Mechel had with the minority shareholders of the Korshunovsky Mining and Processing Division. The parent company controlling over 90% and able to control its cash flow, sees no reason to share the dividends that were last paid in 2008. In response, the minority shareholders are constantly trying to challenge various transactions made by the Mining and Processing Division in court, including issuing guarantees to the Mechel creditors as part of their debt restructuring. Mechel canceled conference calls with investors because of the insistent questions about the Korshunovsky Mining and Processing Division’s dividends.

The story with the Nyurba minority shareholders may affect the ALROSA investment case itself, the representative of one of the organizations agrees who specializes in protecting the rights of stock market investors. “You can’t be a little pregnant. If they did anything once in one place, who prevents them from doing the same thing in another one?” he says.

The price of the issue with Nyurba’s minority shareholders is high. Depending on the outcome, ALROSA might pay either ₽3 bn or ₽683 mn (for comparison, we took the evaluation of 2.51% for a deal with Yakutia and a hypothetical estimate in case of the liquidation according to the balance sheet for the first half of the year). But will ALROSA ensure peace of mind by this kind of saving? Would it not look like a waiver “of defending the interests of all shareholders, regardless of their interest in the charter capital?” * We are far from moralizing and understand the line of thinking of the company’s top management. It only remains to hope that they have unambiguous answers to these questions.

* the quote is taken from the ALROSA corporate website, as applied to the company’s shareholders.

Igor Leikin, Rough&Polished