Mechel tumbled 38% on Thursday after Russia “Prime Minister” (more like ex–KGB autocrat) Vladimir Putin said that the Russian Anti Monopoly Service should pay special attention to the fact that Mechel (NYSE:MTL) has been selling its raw materials for twice as much domestically. This is bad news for the company’s chief executive and main shareholder, billionaire Igor Zyuzin. Last time a billionaire who ran a “strategic” company (like Mechel) crossed Putin was in 2003. The guy was Mikhail Khodorkovsky, and he is now serving an 8 year sentence in Siberia for tax evasion. Burr.
I know what you are thinking – isn’t Dmitry Medvedev the president of Russia? Yes he is – but Putin is the dictator and the dictator always trumps any democratically elected president. (Incidentally you may remember Medvedev from his brief stint as Kermit the frog on the popular TV show The Muppets. A puppet – get it?)
So this investigation could prove disastrous for Zyuzin and MTL shareholders. Putin is trying to prevent foreign investment in what he considers to be “strategic industries.” This pretty much means energy and commodities. Mechel is a large player in the steel, coal, nickel and energy industry (though I think its energy segment is lackluster at best). The company is (was) very strong, posting steroidal earnings growth for the past four quarters, up 160% in the most recent quarter. Plus the company operates in one of the most attractive industries right now (steel, commodities, infrastructure) and has the vertical integration needed to keep input costs low. This is a great company and after today’s death slide trades at a ridiculously low forward earnings multiple of 4.2.
So here is how you can make money on this one. I wouldn’t buy the underlying – the stock could go to zero if Putin pushes foreign investors out and slaps Mechel with a company ending fine. As my Belarusian friend Alex told me earlier this week, “Don’t invest in Russia.” I would not short Mechel either; it could double quickly if these monopoly charges do not materialize.
So here is what I recommend – go long volatility. The easiest way to do this is to buy a straddle – let’s say the Jan 09 25 straddle which is comprised on a Jan 09 25 call and a Jan 09 25 put. The debit here is about 12.90 – so Mechel must deviate 12.90 from the strike price of 25 dollars by the third Friday in January for this strategy to pay off. I like it because I believe Mechel will go bankrupt or to 50 in the next few months. Or – if you want to take a directional bet – then buy calls or puts for Oct of Jan with a delta of around 20 (at tonight’s price that would be the Jan 20 puts or the Jan 45 calls). They are cheap and if you are right direction (up or down) then you will realize a disproportionately large gain. I say why risk having to pick the direction – play it safe and go long volatility – buy the straddle.
As for investing in Russia’s “strategic” industries – I would say stay away, or adopt a short term strategy. Russians have historically been very suspicious of foreigners – and very corrupt. These two traits making investing in Russian companies very dangerous for all but the most risk tolerant investors.
Remember – In Soviet Russia television watches you!
Disclosure: Long MTL options.