Russia Sees Birth of Aluminum Giant

Producers Rusal and Sual reportedly will team with Swiss Glencore to form the world’s top aluminum producer, beating Alcoa for the No.1 spot

The deal was openly rumored for weeks, and now it appears to be real. On Oct. 4, according to leaks in the Russian media, Russia’s two largest aluminum producers, Rusal and Sual, and Swiss commodities trader Glencore International, will team up in a merger to create the world’s largest aluminum producer.

The impending merger will be worth almost $30 billion, with Rusal likely owning 64.5% of the combined company. Sual and Glencore will pick up 21.5% and 14%, respectively. The combined colossus, to be called Rusal, will have annual revenues of more than $9 billion and yearly output of some 4 million tons of aluminum. That’s even bigger than New York-based Alcoa (AA), currently the world’s No. 1 with output of 3.7 million tons and a market capitalization of $24 billion.

The Rusal deal is just the most recent example of a trend toward consolidation in Russian industry. In sectors from energy to aerospace, dominant companies are emerging with strong backing from President Vladimir Putin’s Kremlin. These so-called national champions are seen as Russia’s answer to consolidation in global industries, preserving Russian ownership while simultaneously creating megacorporations fit to match the global giants.

NOT KREMLIN LACKEYS. It’s clear that the main parties to the merger””Rusal owner Oleg Deripaska and core Sual shareholders Viktor Vekselberg and Leonard Blavatnik””were careful to get Putin’s backing for their plans. Still, there are key differences between this deal and state-backed consolidation in other sectors.

“The national champions idea is a bit of a generalization,” says Rob Edwards, metals analyst at Moscow investment bank Renaissance Capital. “The ownership isn’t going to change, so the state can’t directly steer what the company is or isn’t going to do.”

Far from being mere Kremlin lackeys, the key players are among Russia’s toughest and most aggressive tycoons. The new company will remain 100% privately-owned, and its creation has been driven more by sound commercial considerations than state concerns. “From the point of view of synergies, the deal certainly makes sense,” notes Vladimir Katunin, an analyst at Moscow brokerage Aton Capital.

THE IPO QUESTION. Rusal and Sual complement each other nicely. Analysts note that Rusal has plenty of aluminum refining capacity, but a shortage of raw materials. Sual, on the other hand, has plenty of raw materials in the form of bauxite ore, but needs somewhere to process it. Other synergies will come from combining financial resources and easier access to capital. The two companies are reckoned to be worth at least $2 billion more combined than they are worth separately.

Despite these advantages, in the weeks leading up to the transaction there was serious speculation that the deal could collapse. The key question concerned the openness of the new company to outside investment.

Whereas Sual shareholders are keen to move quickly towards an international initial public offering, Rusal’s Deripaska wants to keep the new company closed to outside investment for the time being, and has reportedly requested a three-year delay on IPO plans. Signs are that the two sides have now settled their differences, though how and when the company comes to market still remains to be seen.

WATCH OUT, ALCOA. An even bigger question for the outside world is what the creation of the new giant means for the global aluminum industry. On the face of it, the big Western producers, Alcoa and Montreal-based Alcan (AL), shouldn’t have too much to worry about. That’s because while Russian producers traditionally export raw ingots, both Alcoa and Alcan focus on processed aluminum products.

“The Western companies derive most of their revenues from the sale of value-added products, not primary aluminum,” says Vladimir Zhukov, an analyst at Alfa-Bank in Moscow. “This is a completely different business.”

But Alcoa and Alcan would be wise not to be complacent. Russia’s mighty new aluminum producer is likely over time to move its product offerings up the value scale. In a sign of its growing sophistication, Rusal is already having success selling aluminum through direct contracts with customers, instead of via the London Metals Exchange. And since 2004, the company has supplied aluminum ingots directly to U.S. automotive producers.

ELECTRIC ADVANTAGE. “That was a big breakthrough,” says Renaissance Capital’s Edwards. “They are making good progress as a”¦quality supplier of aluminum products.”

If the trend toward greater sophistication continues, some analysts speculate that the Russians could end up poaching customers from Alcoa and Alcan. And if such a face-off were to occur, the Russians enjoy a huge cost advantage, thanks mainly to cheap electricity. That day isn’t here yet, but Russian aluminum’s mega-merger has undoubtedly laid the groundwork for another national champion to take its place on the global stage.