Steel producer Evraz, which operates mainly in Russia, is again considering merging with Russian steelmaker Severstal. Some analysts have said that Evraz’ major shareholders are seeking to get rid of a number of Russian assets, while a merger with Severstal is needed to avoid the sale of Evraz’ Russian assets to foreigner investors...

The problem is that while debt-ridden Evraz’s benefits from a merger are obvious, Severstal’s possible benefits from the deal are unclear, market analysts said, adding that Severstal is more likely to seek a merger with a world leading steel producer.

Evraz shareholder and Chairman Alexander Abramov said in an interview with the Financial Times released on December 13 that uniting the company’s business with that of Severstal, with a combined market capitalization of 12 billion British pounds, would be a good idea. The merged company of Evraz and Severstal could be the world’s eighth largest steel producer, Abramov estimated. “I guess that this would have several advantages,” Abramov said without providing any details on how the tie-up would take place, including whether Evraz planned to make a bid for Severstal. Severstal declined to comment on the matter.

This is not the first time a merger between Evraz and Severstal has been discussed, investment company Alemar’s metals and mining analyst Vitaly Domnich said, adding that in 2007 it was reported that the government was interested in the merger with assistance from Evraz major shareholder Roman Abramovich, but Severstal’s owners denied having been in talks over a possible merger. The latest statement by Abramov “looks rather like a public announcement of Evraz shareholders’ readiness to consider the possibility of a merger,” Domnich said.

These are only speculations so far, and it is difficult to estimate the probability of a merger between Evraz and Severstal, investment company Aton metals and mining analyst Ilya Makarov said. “There is a chance, but it is unclear how big it is,” he noted, adding that one may come up with a number of reasons why this merger may take place, but all would depend on the will of the shareholders of both Evraz and Severstal.

The merger may be beneficial to Evraz, as the deal may lead to a reduction of Evraz’s huge debt, investment company Veles Capital analyst Airat Khalikov said, adding that the possible benefits for Severstal are unclear. “Severstal has excellent financials, while Evraz is debt-ridden; also Evraz has lately been an outsider among Russian steel producers, because it makes rolled stock for the construction industry, which was not in demand as much as flat rolled stock for car manufacturing produced by Severstal and other companies,” Khalikov said, adding that Severstal can hardly be interested in Evraz’ foreign assets, as Severstal itself has strong international assets.

In financial terms, a merger is more beneficial for Evraz than Severstal, investment company Investcafe analyst Pavel Yemelyantsev agreed, adding that Evraz is showing a decrease in production volume, while Severstal is increasing output. Also, Evraz had only U.S. $578 million spare cash as of late September, while Severstal had $2.085 billion, he noted.

One should not look for economic reasons for the companies to merge, Makarov from Aton said. If Severstal’s major shareholder, tycoon Alexei Mordashov, rejects an offer to merge, another tycoon may be asked to take part in the project, he added. The thing is that Evraz’ shareholders are apparently seeking to reduce their number of assets in Russia, Makarov from Aton said, adding that this can be seen in their recent initiatives. “Generous dividends of Evraz and Raspadskaya (which is 40%-owned by Evraz), as well as attempts to sell Raspadskaya, suggest that Evraz’ major shareholders are trying to pump out as much cash from Russian assets as possible and leave them,” he noted, adding that the country’s authorities, who are not interested in some foreign investors’ gaining control over Russian assets of Evraz, may ask Mordashov to take them from Abramovich by merging Severstal with Evraz.

Although Severstal may theoretically consider large deals, such as a merger with a European steel producer Arcelor discussed in 2006, Severstal is unlikely to merge with Evraz, investment company Troika dialog analysts said in a note to investors, adding that Severstal is likely to first consider a merger with the world’s leading steelmakers, while Evraz is likely to continue to distribute profit by paying dividends.

If Evraz finally merges with Severstal, this may bring some synergy in terms of product and geographical diversification of the business, Makarov from Aton said.

Potential benefits from the merger may include reduced expenditures, increased weight in the FTSE-100 index, in which Evraz has recently been included, and a strengthened position in negotiations over prices and volumes of steel supplies of the merged company, Alfa-Bank analysts Barry Erlich and Andrei Lobazov wrote in a research note.

Domnich from Alemar, however, said that the difference between the products made by Evraz and Severstal hardly creates opportunities for synergy from a merger. “The merged company will only gain diversification of production and distribution, which, on the other hand, may negatively affect the quality of management,” he added.

The potential synergy from the merger is unlikely to be significant, as the companies make different products, Khalikov from Veles Capital agreed, adding that the positive effect may emerge from optimization of logistic operations. Another key way to reduce costs is to cut duplicate personnel, but costs related to personnel usually account for a small part of metallurgy companies’ costs, so the positive effect from cutting personnel is unlikely to be considerable, he added.

A merger between Evraz and Severstal is unlikely to change drastically the Russian metals and mining industry, according to analysts. “The market is currently in fact monopolized, so it will be even more monopolized,” Makarov from Aton said.

At present, Russia’s six major steel producers have almost equal steel outputs, and the merged company of Evraz and Severstal theoretically could gain a more favorable position in terms of prices for its products and business margins, as it may produce significantly more steel products than its rivals, Khalikov from Veles Capital said, adding, however, that the fact that steel products made by Evraz and Severstal are different suggests that no radical changes are expected.

The Federal Antimonopoly Service (FAS) may, nevertheless, object to the merger, as the merged company would formally have a dominant position on the steel production market, Makarov from Aton said, adding however that the antimonopoly service is unlikely to prevent the merger from taking place if the powers that be support the deal.