Research Notes

By late July 2008, Mechel is to hold an IPO for its preferred shares. The owners of preferred shares are able to receive a fixed share of the company’s profit. The volume of dividend payoffs will amount to 7.93% of Mechel’s consolidated net profit. In accordance with the company’s announcement, the IPO is to finance Mechel’s investment programs. In line with our estimates, the investors that will participate in the IPO may expect the dividend yield at 12%.

In 2007 and early 2008, Mechel acquired a number of mining and coal assets, which led to a considerable rise in its debt load. On April 30, 2008, Mechel EGM adopted amendments to the company’s charter, which became effective on May 7. According to the amendments, the company was allowed to issue 138,756,915 inconvertible preferred shares with a par value of RUB 10 each. On May 14, 2008, the BoD partly utilized the new amendments and authorized an increase in the charter capital by issuing 55 million preferred shares with a par value of RUB 10 each.

To estimate the appropriate bid to participate in the IPO, we evaluated the preferred shares under the required dividend yield approach. We established the target price for Mechel prefs at 29.7 USD per share, which implies a discount of nearly 24% to the current price of the common shares on the RTS. Therefore, the IPO may raise 1.6 bn USD, which is almost equal to the acquisition of Oriel Resources in the spring of 2008, which was 1.5 bn USD. Oriel Resources owns nickel and chrome production and processing assets in Russia and Kazakhstan.

In our opinion, the company will be able to demonstrate steady growth in the next few years due to favorable pricing conditions on the raw materials and basic metals market. High prices and strong demand for input materials, backed up by an upturn on Asian markets and global trends, will boost Mechel’s margins and increase interest in its shares.

The book is to be closed on July 22, and the placement price should be determined the next day. Meanwhile, it has become known that Mechel plans to float the shares in the range of 50.5-60.5 USD per preferred share. In our opinion, this range is overstated in comparison with its fair value. Based on our evaluation of the fair value of Mechel prefs, our recommendation is to BUY the shares at the IPO at a price no higher than USD 29.7 per share.

Sulinov Aleksey

* Short overviews of equity research reports and sector reports are posted on the website http://www.finamrus.com with a 1-day delay after their full versions are emailed to the company’s clients. To get overviews on the day of their release, please contact your manager at Finam to sign up for full versions of research reports.