Understanding the Attack on Mechel

mechelputin072808.jpgThe photo to the left shows Vladimir Putin, along with Viktor Khristenko and Governor Valery Shantsev, arriving last Thursday to Nizhny Novgorod to meet with the country’s top metals producers (source: AP). A few hours later Putin would surprise everyone by singling out the steel and coal giant Mechel (not a common practice), and using unusually harsh language to attack their pricing policies, causing losses of more than $6 billion to the company and crashing the RTS at a particularly inopportune moment. Since Putin’s attack, Mechel has apparently put into place the standard operating procedure for nearly any company about to face obliteration by the Kremlin: agree with everything the state says, and reiterate your willingness to carry out whatever instructions the government may have at the expense of your shareholders (it worked so well for BP, didn’t it?). Case in point, unimpressed with Mechel’s statements that they would cooperate with the government, Putin shaved another 25% off in Mechel’s value today by accusing them of tax evasion. Naturally, analysts are already using the Y-word to describe these events. But what is behind this sudden attack against Mechel and its billionaire owner, Igor Zyuzin, who up until last week was known to maintain fairly positive if not close relations with the government? I put in a call to a trusted colleague of mine, who has a long history of working closely with the Kremlin to get some insider insight. What follows are some of his thoughts on the matter, outlined in four key questions we should be exploring to understand the possible motives behind the Mechel fiasco.

1. Where is the problem coming from? The episode has “Igor Sechin” written all over it. Contrary to the conventional wisdom in the West, Sechin is currently as powerful as ever. His formal position as vice Prime Minister belies his de-facto powers as the Russian economic Czar. In a series of little noted decrees, Sechin was given powers in the economic sphere hitherto vested in Prime Ministers Fradkov and Zubkov. The fact that Mechel’s affair originated from Sechin was strongly hinted at by notorious (and charming) Oleg Mitvol, the scourge of the Western oil and gas companies in Russia, who recently has been very publicly outed as Sechin’s creature. Of course, the whole episode took lace under Sechin’s watchful eyes.2. How was the attack delivered? It could have been taken at face value, as an indignation of traditionally paternalistic Russian leader. However, the choice of accompanying words is significant. Observe that Putin has chosen to frame the issue as a matter of “respect”. He indicated that the failure of Mechel’s owner, Mr. Zyuzin, to attend a meeting under the pretext of illness was seen as indication of lack of personal respect. Putin promised to send to Mr. Zyuzin a “doctor” to “mop up the problem.” Lest the last phrase be lost in translation, note that Putin used here the same highly specific Russia word – zachistka – that is used to describe the punitive anti-terror sweeps of Russian spetsnaz in Chechnya. Zachistka often starts with tossing a live grenade into the living room of a suspect house. Putin’s choice to deliver the attack on Mechel as a gangster-style warning (the attack, I repeat, was framed as an issue of personal “respect” with a clear hint of extra-legal violence as a due retribution), was not a spur of moment emotional decision. It was intended to send a signal that Mechel is placed beyond the pale of law and is a fair game for predators.3. How is the market reacting? The market clearly understood that the implicit promise to limit a political asset grab to YUKOS was again breached. The immediate crash of the Russian stock market is also a sentence on the Russian judicial and legal system. The market understands that the verdict on the hapless Mechel has been already passed and any subsequent legal formalities, including possible judicial deliberations, would be for show only.4. What are the implications for foreign businesses? Any auditing and/or due diligence report coming from Russia should include a clear warning that the Russian legal and judicial system offers no protection for the foreign investor, that any assets in the Russian territory are subject to a sudden arbitrary expropriation. Failure to include such a warning, when the inevitable comes, should constitute a cause of action for any foreign investor against its institutional advisers. Any lending that foreign banks do to companies that operate in Russia should reflect this reality. Once we begin to see the lending rates begin to catch up to the updated risk premium, we are going to see potentially significant changes that not even the Yukos case provoked.

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