CENTRAL ASIA'S GOLD PLAYERS PROLIFERATE: THE CASE OF KAZAKHGOLD

ALMATY, May 27, 2009 (AsiaPulse via COMTEX) -- OPYGY | Quote | Chart | News | PowerRating -- Negotiations are dragging on between Russia's gold mining giant Polyus Gold and Kazakhstan's family-run miner KazakhGold over the latter's business' takeover by the former.

Synergies seem in place, as KazakhGold suffers from overcapacity in processing facilities, whereas Polyus needs the extra refining business if it wants to meet its projected production targets. KazakhGold's painful financial situation only intensifies the bear-bull relation.

By mid May this year, KazakhGold had still not published its complete figures for 2008, missing the deadline imposed by watchdogs over the London Stock Exchange on which the company is listed. Glimpses of what could be behind the delay have popped up this month, prompting Fitch Ratings to downgrade the enterprise only a week after it had reaffirmed its - already negative - assessment. The company rating went down from CCC to C, while unsecured debt worth US$200 million was rated RR4.

"The downgrade follows KazakhGold's failure to make a coupon payment of US$9.735 million on its 200 million senior unsecured notes which was due on 6 May 2009," a comment by Fitch dated May 20 read, which dismissed the "technical reasons" given by the company for the delay and its promise to pay up within 30 days.

UNDER A SINGLE UMBRELLA

KazakhGold goes back in history to the dark days of Stalin's collectivization wave which swept through Kazakhstan from 1928. The following year, the discovery of new deposits in the North and the Northeast of the country led to the formation of a new, centrally controlled entity intended to boost further exploration and development. Originally, each new deposit had its own team, but in the course of the 1950s the business was consolidated under a single umbrella on the order of Nikita Khrushchev, leading to an annual output of almost a quarter million oz per annum.

Today, KazakhGold is under control of a Kazakh family by the name of Assaubayev, headed by clan-leader Kanat Assaubayev. An overwhelming majority of the members of the board consists of his relatives. The first attempt by the cash-strapped Government to privatize the enterprise failed and the new owner went bankrupt in 1996. Most of the Assaubayevs have degrees in both engineering and economics, which explains how they could make the enterprise survive.

SENDING NET PROFIT DOWN

KazakhGold's resources (presumed) and reserves (assumed), all categories included, amounted to 59.8 million troy ounces when calculated by former Soviet standards in January 1, 2008. The company has raised money and also spent a substantial part of its revenue over the last couple of years on processing plants, which work through so-called carbon-in-pulp as well as heap-leaching treatment, and a process brought in from Western countries called flotation technology. Technical progress, however, has sent mining and treatment costs soaring - even though flotation in the longer run is meant to save costs.

The investments required to optimize output from existing operations seem to have put a brake on new exploration activities. In summer 2005, five more licenses were obtained from the Kazakh government for exploration and development. The most promising projects are Azkhal in the area of Semipalatinsk in the central-east of the country acquired in July, and Kaskabulak and Akshatau in the area of Karaganda in the central part of Kazakhstan.

Finally, Yuzhd-Karaultaube and Kyzylorskoye were added to the list of future assets, both located in the Northern province of Aktobe. Heap-leaching at Kaskabulak, an abandoned mine from Soviet times, has yielded minor quantities of gold, but further exploration and modernization of logistics and processing facilities requires funding which KazakhGold seems unable to free from its own financial resources.

MODEST-LOOKING INCREASES

Meanwhile, bills keep accumulating at a time when financial support is harder and harder to come by. KazakhGold's financial expenses went up from US$2.57 million in the first half of 2007 to just over US$9 million in the first six months of the subsequent year. Tax bills have been soaring as well, tripling between the same periods of time to more than US$9.3 million, sending net profit down by 25 per cent on-year to no more than US$3.5 million. Gold production from KazakhGold's own mines, set against rising costs, went down from 81,531 to 66,853 troy ounces on-year in the first half of 2008.

By purchasing ore and non-refined gold for processing, the company has nevertheless managed to increase its gold sales for the first half of the year to 76,211 ounces from 67,588 in the same period of 2007. By increasing ore provisions for processing from external sources, KazakhGold hopes to reach its output target in the order of one million oz by 2011, for which around 14 million tonnes of ore are needed. This is an ambitious target which poses "major challenges" in present-day euphemist business jargon when it comes to the investment side.

HOLDING OUT ON DIVIDENDS

Given higher prices on open world markets, the rise in sales income despite modest-looking increases in final output as reported by the company can easily be explained. Gold prices in the middle of 2008 came close to a US$1,000 per ounce which is almost twice its market value one year earlier, and confirm sales revenues as reported by KazakhGold. In the first half of 2008, the company's average sales price of gold amounted to US$832 per troy ounce - up by 42 per cent on-year, KazakhGold's half-year report reads.

Yet, finances are known to be tight - to the extent that over the summer of 2008 the board proposed to shareholders that they keep holding out on dividends - "...until the plant modernization program has been completed and our facilities reach their designed output capacity," in the report's words. This, together with the present trouble regarding paper pay-off, points at bottlenecks in terms of liquidity availability. Shares in KazakhGold have not done well of late on the LSE, whereas those in Polyus Gold have been soaring and the company's default rate has been all but eliminated. The fact that the miners' appeal to the Kazakh Government for the same support as the banking sector has received a lukewarm response, except for a warning against mass lay-offs, is also yet one more encouragement for both parties to combine forces.

INTO INDUSTRIAL DEVELOPMENT

The mutual attraction between KazakhGold and Polyus Gold can also be easily read from the latter's balance sheet and commercial results. From 2003 through to last year, sales revenue more than tripled from just below US$300 million to - for the first time - just topping US$1 billion in 2008. For the first time since 2003, the company worked debt-free, thanks to cautious short-term investments of only US$285 million, down from US$1.271 billion in the previous year. Polyus is sitting on 72.3 million troy ounces of gold, meaning a cash realization in the order of around US$65 billion at current open market prices. Three-quarters of its output of well over a million ounces per annum (1.222 million in 2008) come from the two fields Olympiada and Tyryada, both located in the vicinity of Krasnoyarsk, not far from the Eastern section of the border between Russia and Kazakhstan. Other fields in operation include those in the regions of Irkutsk, Magadan, Amur and Sakha, all further to the East.

A WIN-WIN SITUATION

The big dilemma for the Kazakh government, which is among the authorities whose green light will be needed if a merger agreement between the two would-be partners is to be reached, is whether to stick to the patriotic principles on its agenda or to go along with globalization arm-in-arm with its mighty neighbor to the North. It looks, in all, very much as though the need for financial resources should prevail over sentiments. The fact that populations in the areas where KazakhGold is operating have large ethnic Russian proportions only adds to the need for stability on the labor front which can only materialize through strong productivity outlooks.

From the point of view of an investor, KazakhGold seems to have but little choice either. It is hard to see how, with its current negative ratings, the company can build up a solid financial portfolio through more syndicated loans abroad, while domestic banks in Kazakhstan are in no position to jump in. Raising capital on open markets through stock issuing is also a remote option.

Takeover options hanging over the markets, like that of KazakhGold, may tempt some traders to buy into paper with little other motive than profit-taking after the operation. This momentarily raises capital value, but it does not raise capital. In all, one could label KazakhGold shares "sell" should a deal with Polyus fall through (unless a white knight appears on the scene which seems unlikely) and "hold" with the outlook of a deal being clinched. As for Polyus, given the company's sheer size, stock assessments are unlikely to be influenced much by the issue. This means that in these current negotiations, the Russian party finds itself in a win-win situation.

(TCA)

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