Let's Get Greedy with Mechel Steel

One of my favorite investment axioms is “try to be fearful when others are greedy, and greedy when others are fearful.” Today you would be hard pressed to find a stock with more fear surrounding it than Russian Steelmaker Mechel (MTL).

The Fear

Mechel was obliterated when Putin suggested last Thursday that the Russian Anti Monopoly Committee look into the prices at which Mechel has been selling its products domestically and internationally. There was another panic selloff on Monday when Putin insinuated that Mechel had been evading taxes. Now the stock, which had traded for 46 dollars on July 16th, is trading for about 21 dollars. A lot of fear came from investors' memories of YUKOS, which was Russia’s biggest oil company before Putin bankrupted it with back taxes and sent billionaire owner Mikhail Khodorkovsky to a Siberian prison.

Why Putin Did it

While I cannot be sure how the mind of an autocrat works – Putin probably has many motivations for his attacks on Mechel. Firstly, Russia is experiencing Latin Americanese double digit inflation (10.6% and heating up). Putin feels that higher raw material costs are contributing to this rise in inflation and that by lowering Mechel’s domestic raw material prices he will curb inflation. In addition to that, Putin wants to remind the billionaires of Russia, like Mechel owner Igor Zyuzin, that he is in charge and cannot be crossed. Furthermore, Putin wants more control over “strategic” industries like steelmaking, mining and oil – so that he can get Russia’s military industrial machine going strong again.

The Reality

The fine – if Mechel is convicted of foul play – is, at most, 2% of revenue. Moreover, the rampant fear that Mechel is the next YUKOS is unwarranted. Deputy Prime Minister Igor Shuvalov said that the chances of Mechel becoming the next YUKOS are “a most unlikely scenario,” and that,” the most likely scenario is that the company will co-operate with the state authorities. We are intent on there not being any more stress.” Moreover, Mechel has already said that the company will cooperate fully with Russian authorities – which should speed up this process.
And finally, Russia still needs foreigners’ money. The Russian economy is not yet in a place where it can afford to shut out foreign investors. In fact, the Russian government needs to encourage foreign investors if it hopes to keep oil production at current levels, and Russian officials realize this.

The Plan

We will have the ruling from the Russian Anti Monopoly committee by August 26th, but I think it will come sooner as the authorities seek to soothe the recently volatile market for Russian securities. So I suggest buying the September or October out of the money calls. Depending on how you want to frame your risk/reward – I think the 25, 30 or 35’s are all a good way to play the August 26th ruling.

Simple Calculation

The way I see it, Mechel has two possible states in the next year – either the stock will go to zero or it will go back to its pre-drama fair value of about 60 dollars per share (see Deutsche Bank equity valuation report). Therefore, the risk neutral probability of insolvency is 63.25% using the current market value of equity, a discount rate of 5%, and the above future states. 63.5% even though the Deputy Prime minister said the chances of bankruptcy were very unlikely! That is fear for you!

Disclosure - Long MTL.

Comments

[Tarun:]

Very nice summary article for those who have little exposure to the Russian markets (I got into MTL at $17.40)

I do have some good news though:
"Medvedev Tells Authorities to Stop Scaring Business" - Bloomberg
www.bloomberg.com/apps...

"Medvedev Adviser Criticizes Putin Over Russia Stock Market Rout "
www.bloomberg.com/apps...

2008 Jul 31 10:01 AM

[Blue collar...:]

Demetry Medvedev had better watch what he says or he could be on the inside of Lubyanka looking out, either that or fishing with Polar Bears somewhere in Siberia. In the mean time, long on MTV is the way to go.

2008 Jul 31 12:10 PM

[Blue collar...:]

Oops! I have the wrong guy going to prison, should have said
Y. Jurgens....not the new Prime Minister.

2008 Jul 31 12:30 PM

[Urbane Gori...:]

I also read the Medvedev quote with interest this AM, and might even pick up a little on a dare. A better play might be Gazprom, which seems to have collapsed in sympathy.

And, also consider the issues surrounding BP and their partnership with Russia. They have been pretty much kicked out of the country in what would appear to be a money grab of BP's assets.

Russia is still working out it's post modernization issues and everything seems to be in flux.

jegan ;-)

2008 Jul 31 03:02 PM

[notsosmart:]

russia & china are still communist dictatorships. now if you have money to spare & possibly lose then by all means invest in these countries. be careful of the folks who advise you to do this as they might have an agenda.almost everyone that says invest here,invest there has one.think for yourself.

2008 Jul 31 03:26 PM

[Domenic Str...:]

Couldn't have said it better myself notsosmart

2008 Jul 31 04:33 PM

[Domenic Str...:]

I agree - always do your own research

2008 Jul 31 04:34 PM

[Domenic Str...:]

I agree - always do your own research and be wary of "sure things"

2008 Jul 31 04:34 PM

[Amvet:]

The risk of investing in Russia is a big press topic. Russia is bad!! What is not a big press topic is that the most damaging business scam of the century happened recently in the good old US of A and the majority of the damage caused by this fraud was outside the USA. America is good, no problem. Same situation with crimes: a few hundred thousand (maybe) dead in the Sudan...big news and a million dead (maybe) in Iraq, not worth mentioning even though the occupying country is legally responsible.

For investing, the important thing is to avoid the BS and worry about what is really going on. These days, that is difficult. Good investing.

2008 Aug 02 06:22 AM

[fxtrader07:]

the real issue to worry about is the tax evasion charge - not the anti-monopoly commission. the author mentions the tax evasion charge at the beginning but completely fails to consider it later on. all in all a poor article that basically sums up all the pros while omitting and keeping silent all the cons. gl to the author with that approach.
food for thought: the tax issue could be used by the govt to get mechel#s coal assets on the cheap or basically for free. well, that would change the investment thesis, no?
and regadring the need of foreign money: russia has never before been in such a comfortable position vs. foreign capital as it is today. and in the end, greed always has won over fear. western companies have literally sunk billions in russia - and still invest. go figure

2008 Aug 06 08:59 AM