Sketchbook from Moscow - Amtel-Vredestein and Sibur Russian Tires

By David Shaw, ERJ editor

Moscow - I was wrong. A few months ago I blogged from Geneva saying that I thought the rumoured discussions between Amtel-Vredestein and Sibur Russian Tires (SRT) amounted to little more than a meaningless sham. I was wrong. Those discussions are real and deadly serious.

The word here in Moscow is that a deal could be finalised over the Summer months.

I've been asking around and found who is likely to benefit most from such a deal. That would be the banks. Currently, Amtel-Vredestein is deep in debt, has run out of credit and has publicly admitted it will face cashflow problems in May, which are likely to mean it is unable to buy enough raw materials to keep its factories running. Last time it needed around $20 million credit to buy rubber, steelcord and carbon black. There's no reason to think the May cash call will be significantly different.

The company faced a similar situation in February, and Sibur, a key supplier of raw materials, granted it favourable credit terms. The same is likely to happen later this month, when A-V's bank balance runs dry once again.

A-V and its financial backers face the same problem, month after month, unless a long-term solution can be found.

The only alternative available to an isolated management is to declare the company bankrupt and break it up, selling off the two jewels in the crown - the Vredestein operations and the almost-complete Voronezh II factory. They might find buyers for the other factories, but the total asset value is, at best comparable with the current debt burden. In the current climate, the asset value may well be considerably less than the debt.

Neither option is attractive. The only  possible positive outcome is to find a partner which can take on the existing debts under a new structure.

The banks and the financial wizards in charge of salvaging the wreck that was once Amtel have found a willing partner in Sibur Russian Tires.

The deal is not yet done and will not be done for at least a couple of months. Whatever is being discussed, it has to be a complicated deal, taking into account the requirements of banks, shareholders and two sets of strong management.

On the Sibur side, there is a desire to see the deal complete, but not at any price. The Amtel side, however, is desperate. If they can see any way to structure a deal which permits tyre operations to continue, provides some form of return for the shareholders and most importantly, brings the risk of defaulting on the debts back within acceptable limits, then I strongly suspect they will go for it.

So the issue is not so much the price SRT will have to pay to acquire the assets of Amtel-Vredestein; it is the ability of the financial wizards to structure a deal which keeps the banks and shareholders happy and gives SRT what it wants.

The key question, then is what SRT wants. SRT wants a number of things. The first is extra capacity for mid-range car tyres to sell to the Russian market. That's an easy one: A-V has excess capacity at its Kirov plant which although old by western standards is advanced by the standards of SRT.

Furthermore, A-V has the near-complete modern factory at Voronezh-II. Unfortunately, the company ran out of money before it was able to install the mixing lines. It has bought the machinery and refurbished a suitable building, but that building lies empty.

The company could make tyres using compound from other factories, but the plant is designed to make advanced tyres using silica mixes, and (outside Enschede) neither A-V nor SRT has mixers or compounding engineers capable of doing that. Sources close to the deal suggest the Voronezh II plant needs a further $30 million to bring it on stream. This seems a bit high to fit out a mixing room and install the equipment (which was bought before A-V hit the really hard times), so the figure almost certainly includes some working capital to buy raw materials in order to get the plant up and running, and possibly some other costs as well.

SRT also wants tyre technology expertise to develop all-steel radial truck tyres and to further develop its passenger car tyres. The SRT people would be very keen to acquire the team of engineers at Vredestein's headquarters in Enschede, and augment it with a squad of recently-retired engineers from various western tyre makers. SRT currently spends a great deal of money on such experts acting as consultants, and it would be happy to divert that money into a formal research lab based in Western Europe.

An added extra, which SRT finds attractive in the A-V package is a listing on the London stock exchange. A year ago the company was looking at an IPO in the 2009 - 2010 period. Given the state of the markets, that deal is off, but the company would still like the status afforded by a stock market listing.

Finally, A-V also has the Vredestein brand, which includes the associated brand awareness and brand management skills. SRT knows it needs high-profile brands to lift the selling price of its tyres, but does not think it can lift the brand image of its newly-established Cordiant brand into the premium sector.

An additional complication is the fact that Sibur is undergoing a transformation. Sibur the chemicals company is currently owned by the State-owned Gazprom. But Sibur management is in the process of de-merging from Gazprom. Part of that deal will be for Sibur to sell non-core activities back to a financial company owned by Gazprom. Sibur Russian Tires is almost certain be included in that aspect of the deal.

Given this background, A-V; SRT and a series of banks and shareholders are working very hard to structure a deal which is satisfactory to all sides.

SRT is largely debt-free. So the thinking goes that a newly-created company which combines the assets of SRT and A-V together with a relatively limited injection of cash will have an acceptable level of gearing and debt cover, and will be able to exploit the Russian tyre market to generate enough cash to service the debt, pay off the loans and still have enough left over to modernise and expand factories in line with expanding demand.

While that is a tall order, it is not impossible. Both Russian companies are strongly cash-generative and achieve good prices on their tyres, which sell in the mid-range sector at a healthy margin. SRT cannot make enough tyres to meet this mid-range demand, while A-V has employed the Vredestein brand to carve a niche in the premium sector, giving the proposed new company a clear upgrade path to the premium segment.

The fly in the ointment, if there is one, is Vredestein. Vredestein management has told anyone who will listen that they want out of the Amtel package. They have had enough of being managed by outsiders, and are in close contact with Dutch private equity funds who are ready and willing to buy them out of the Amtel operation, allowing Vredestein to continue its own path to financial security and success.

However, Amtel does not want to sell off the Vredestein operations. They form a key part of the prospective Sibur-A-V survival package. Without Vredestein, the package cannot work.

I can see a clear financial logic here. Though I suspect it will take a considerable effort to make it work in practice.

This is not a marriage made in heaven. And it is not just between two parties. First, there are the banks who will want to make sure their interest and capital payments continue to flow once the joint company has been created. Second, the management team at A-V is a specialist deal-making team, which has one purpose in life: conclude a successful deal. A new team will come in to supervise the operations once the salvage deal has been concluded. Third, Vredestein would dearly love to be independent. While they might not have much choice in the matter in the short term, their active and willing participation is critical to making the deal successful in the mid-term.

Finally, however, and this, I think is the most difficult challenge, getting the Amtel people to work with the SRT people and getting both of them to work with the Vredestein people will be a serious man-management and motivational challenge.

SRT has inherited some of the caution and centralised management thinking of the State-owned Gazprom. Amtel, by contrast, has developed a fast-acting, responsive style which in the past has led to serious errors. Both, however, are Russian in character, which tends to mean a strong, charismatic leader who demands total control.

Bringing two such organisations together would be tough. Add to that challenge the democratic, thoughtful, prudent style of the Dutch, and then add to that pressure from the banks to deliver strong cashflow and there is a challenge to daunt even the most optimistic manager.

So the final question over this proposed new company is who has the calibre to lead such a diverse organisation. My feeling is that he (or she) has to have Russian as native tongue, but also has to be capable of balancing the expected financial pressures from the banks against the short- and mid-term investment needs of the tyre activity. Those needs are considerable.

In the short term, the Voronezh II plant needs to be completed and brought on stream as a matter of priority. Simultaneously, there will need to be a recruitment drive for tyre engineers in Western Europe.

In the mid-term, there is a desperate need to update equipment at the old SRT factories. A lot of that can be bought on the second-hand market, but there will still be a considerable cost and management time needed to re-engineer the old Soviet plants. Although the SRT management has done a great job at keeping them running, SRT has not invested as much as the plants really need to improve productivity and quality. While those upgrades can be delayed for a year or two, they cannot be delayed forever.

In short, then, both Amtel-Vredestein and Sibur Russian Tires want this deal to go forward. The banks have almost no other option. So in the end, I think the aggressive teams within both Russian companies will iron out any difficulties and will draw up an agreement which appears to be - on paper at least - beneficial to all sides. That is likely to be completed within two or three months.

As to what happens after that, only time will tell, but I wish them all the very best of luck.