Trepca Mining and Metallurgical Complex Could UNMIK privatize Trepca?

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Trepca Mining and Metallurgical ComplexCould
UNMIK privatize Trepca?

• February 23, 2006
• BA 456

Ervin Dervisevic Anu Gurung Nikhil
Kejriwal Santhosh Thiruthimana
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Agenda

• Case Introduction
• Background
• Project Description
• Our Analysis
• Recommendation
• Questions?

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Introduction

• Kosovo, a province of the former Yugoslavia,
  is currently administered by the United Nations
  Mission in Kosovo (UNMIK). Trepca Mining and
  Metallurgical Complex has been operating in
  Kosovo since the 1920s. As of 1996, Trepca was
  Kosovos largest company and exporter. Given the
  continuing conflict in the former Yugoslavia,
  Trepca has in effect ceased functioning and faces
  an uncertain future. UNMIK is considering
  privatizing Trepca in order make use of its
  capital resources and spur economic development
  in conflict-ridden Kosovo.

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Kosovo

• Province of Serbia and Montenegro

• Previously autonomous, currently administered by
  UNMIK
• Population
• 90 Albanians
• 8 Serbians
• Long history of ethnic conflict between Serbs
  and Albanians

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Trepca Mining and Metallurgical Complex
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Trepca Mining and Metallurgical Complex

• Assets categorized according to geographic
  location
• Focus on Northern Chain
• Belo Brdo Mine (Lead, Zinc and Silver)
• Crnac Mine (Lead, Zinc and Silver)
• Leposavic Concentrator
• Zuta Prlina Mine (Lead, Zinc and Silver) - CLOSED
• Northern Chain located on administrative boundary
  between Kosovo and Serbia
• Average Production
• Belo Brdo 100,000 tons of Pb, Zn and Ag ore
• Crnac 100,000 tons of Pb, Zn and Ag ore
• Although Lead and Zinc prices are high, Trepca is
  operating at a trough

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Rationale for Privatizing Trepca

• UNMIK does not have the technical expertise to
  run Trepca
• More efficient if privatized
• Generate valuable tax and royalty revenues for
  Kosovo
• Second privatization of mining operations in
  Kosovo since 1999
• In November 2005, a Swiss Company bought Feronikl
  metallurgy complex, one of the largest nickel
  processors in Europe, for 30.5 million

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Key Issue

• Institutional Investor Country Credit Rating for
  Serbia used as a proxy for IICCR for the project
  because
• Kosovo is not a country
• Mines are located in Northern Kosovo which is
  under the control of Kosovo Serbs

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Risk Analysis - Sovereign

• Currency risk is mitigated substantially in this
  project since the majority of cash inflows and
  outflows are in Euros which is the currency in
  Kosovo (vs. local currency for Serbia)
• Expropriation risk mitigated because of UNMIK
  involvement. However, some risk of creeping
  expropriation through potential change in tax
  structure
• Multi-lateral agency partners such as World Bank
  Group, EU and EBRD are likely to be involved in
  the project
• Susceptibility to strikes is slightly higher than
  average

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Risk Analysis Financial

• Political Risk Insurance from (potential) World
  Bank Group involvement

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Cost of Capital

• U.S. Risk Free (20 Year)
  4.76
• U.S. Risk Premium
  3.75
• Current U.S. Country Credit Rating
  92.50
• Serbias Country Credit Rating
  28.90
• ICCRC
  29.35
• Country Risk Premium 20.59
• ADJUSTMENTS
• Industry beta adjustment
  - 0.04
• Currency (direct, e.g. convertibility)
  - 5.77
• Currency (indirect, e.g. political risk caused by
  crisis) - 1.44
• Expropriation (direct, indirect, creeping)
  - 0.93
• Commercial International Partners
  - 0.00
• Involvement of Multilateral Agencies
  - 0.93
• Sensitivity to strikes, terrorism
  0.51
• Resource Risk - 0.00
• Technology Risk - 0.00
• Probability of Default - 0.21

Sovereign
Operating
Fin.
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Term Structure of Cost of Capital and WACC
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Cash Flow Analysis
Valuation with WACC Applied to FCF
(in US millions)
2006
2007
2008
2009
FCF with salvage value
4.11
12.62
13.67
15.49
D Value of Debt
22.35
22.35
19.87
17.38
D
32
32
28
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d(1-T) --gt 15 (1-20)
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12
12
12
E
68.24
68.32
71.59
74.26
CCCountry Cost of Capital (ICCRG calculator)
21.07
21.07
21.07
21.07
E(RA) (dD)(CCE)
19.1
19.1
19.3
19.5
E(RL)E(RA)(E(RA)-d)D/EL)
21.07
21.07
21.07
21.07
18.19
WACC
18.20
18.49
18.74
V L Levered Value
70.37
70.55
69.93
67.54
EL Equity Value Levered Value - Debt
48.02
48.20
50.06
50.16
Cash flows analyzed through 2020 (assuming that
the mine only has sufficient ore to last till
then)
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Real Options

• Option to expand
• Increase the extraction of ores from the mines by
  50
• Option to shutdown
• If the price of Lead and Zinc ores fall below
  extraction cost, potentially optimal to
  temporarily shutdown mines

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Stakeholder Analysis
Interestin Trepca
Influence
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Economic Analysis

• Examining transaction from the perspective of the
  economy as a whole
• Discount rate should include economic opportunity
  cost
• Example

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Socio-economic issues

• Distributional effects
• Total 500 employees
• Minimal economic multipliers in mining
• Tradables vs. non-tradables
• Conflict issues
• Control over resources
• Static vs. Dynamic Growth
• Resource Curse?

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Environmental concerns

• Tailing pond
• Old pond would be operational for 2-3 years
• Security needs to be increased
• New pond needs to be made
• Mine closure major issue
• Planning for closure should be made within the
  start-up stage
• Costs could be high

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Risk Mitigation

• Involve Multi-lateral agencies e.g. World Bank
  Group, EU and EBRD
• Get political risk insurance from MIGA
• Maintain good relations with both Kosovar and
  Serbian governments
• Establish long-term contracts
• Ensure adequate safeguards for environmental
  protection

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Discussion Question

• Could UNMIK privatize Trepca?