Trepca Mining and Metallurgical

Complex

Could UNMIK privatize Trepca?

February 23, 2006February 23, 2006

BA 456BA 456

Ervin DervisevicAnu Gurung

Nikhil KejriwalSanthosh Thiruthimana

IntroductionIntroduction 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 Kosovo’s 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.

KosovoKosovo

Previously autonomous, currently Previously autonomous, currently administered by UNMIKadministered by UNMIK

PopulationPopulation 90% Albanians90% Albanians 8% Serbians8% Serbians

Long history of Long history of ethnic conflict ethnic conflict between Serbs and between Serbs and AlbaniansAlbanians

Province of Serbia and MontenegroProvince of Serbia and Montenegro

Trepca Mining and Metallurgical Trepca Mining and Metallurgical ComplexComplex

Trepca Mining and Metallurgical Trepca Mining and Metallurgical ComplexComplex Assets categorized according to geographic Assets categorized according to geographic

locationlocation Focus on Northern ChainFocus on Northern Chain

Belo Brdo Mine (Lead, Zinc and Silver) Belo Brdo Mine (Lead, Zinc and Silver) Crnac Mine (Lead, Zinc and Silver)Crnac Mine (Lead, Zinc and Silver) Leposavic ConcentratorLeposavic Concentrator Zuta Prlina Mine (Lead, Zinc and Silver) - CLOSEDZuta Prlina Mine (Lead, Zinc and Silver) - CLOSED

Northern Chain located on administrative Northern Chain located on administrative boundary between Kosovo and Serbiaboundary between Kosovo and Serbia

Average Production Average Production Belo Brdo — 100,000 tons of Pb, Zn and Ag oreBelo Brdo — 100,000 tons of Pb, Zn and Ag ore Crnac — 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, Although Lead and Zinc prices are high, Trepca is operating at a troughTrepca is operating at a trough

Rationale for Privatizing Rationale for Privatizing TrepcaTrepca

UNMIK does not have the technical UNMIK does not have the technical expertise to run Trepcaexpertise to run Trepca

More efficient if privatizedMore efficient if privatized Generate valuable tax and royalty Generate valuable tax and royalty

revenues for Kosovorevenues for Kosovo Second privatization of mining Second privatization of mining

operations in Kosovo since 1999operations in Kosovo since 1999 In November 2005, a Swiss Company In November 2005, a Swiss Company

bought Feronikl metallurgy complex, one of bought Feronikl metallurgy complex, one of the largest nickel processors in Europe, for the largest nickel processors in Europe, for €30.5 million€30.5 million

Key IssueKey Issue

Institutional Investor Country Credit Institutional Investor Country Credit Rating for Serbia used as a proxy for Rating for Serbia used as a proxy for IICCR for the project becauseIICCR for the project because Kosovo is not a country Kosovo is not a country Mines are located in Northern Kosovo Mines are located in Northern Kosovo

which is under the control of Kosovo which is under the control of Kosovo SerbsSerbs

Risk Analysis - SovereignRisk Analysis - Sovereign Currency risk is mitigated substantially in Currency risk is mitigated substantially in

this project since the majority of cash this project since the majority of cash inflows and outflows are in Euros which is inflows and outflows are in Euros which is the currency in Kosovo (vs. local currency the currency in Kosovo (vs. local currency for Serbia)for Serbia)

Expropriation risk mitigated because of Expropriation risk mitigated because of UNMIK involvement. However, some risk of UNMIK involvement. However, some risk of creeping expropriation through potential creeping expropriation through potential change in tax structure change in tax structure

Multi-lateral agency partners such as World Multi-lateral agency partners such as World Bank Group, EU and EBRD are likely to be Bank Group, EU and EBRD are likely to be involved in the projectinvolved in the project

Susceptibility to strikes is slightly higher Susceptibility to strikes is slightly higher than averagethan average

Risk Analysis –FinancialRisk Analysis –Financial Political Risk Insurance from Political Risk Insurance from

(potential) World Bank Group (potential) World Bank Group involvementinvolvement

U.S. Risk Free (20 Year) U.S. Risk Free (20 Year) 4.76% 4.76% U.S. Risk PremiumU.S. Risk Premium 3.75% 3.75% Current U.S. Country Credit RatingCurrent U.S. Country Credit Rating 92.50 92.50 Serbia’s Country Credit RatingSerbia’s Country Credit Rating 28.90 28.90 ICCRCICCRC 29.35% 29.35% Country Risk PremiumCountry Risk Premium 20.59% 20.59%

ADJUSTMENTSADJUSTMENTS Industry beta adjustmentIndustry beta adjustment - 0.04% - 0.04% Currency (direct, e.g. convertibility) Currency (direct, e.g. convertibility) - 5.77% - 5.77% Currency (indirect, e.g. political risk caused by crisis)Currency (indirect, e.g. political risk caused by crisis) - 1.44% - 1.44% Expropriation (direct, indirect, creeping) Expropriation (direct, indirect, creeping) - 0.93% - 0.93% Commercial International PartnersCommercial International Partners - 0.00% - 0.00% Involvement of Multilateral AgenciesInvolvement of Multilateral Agencies - 0.93% - 0.93% Sensitivity to strikes, terrorismSensitivity to strikes, terrorism +0.51% +0.51%

Resource RiskResource Risk - 0.00% - 0.00% Technology RiskTechnology Risk - 0.00% - 0.00%

Probability of DefaultProbability of Default - 0.21% - 0.21% Political Risk InsurancePolitical Risk Insurance - 0.21% - 0.21%

Project Cost of CapitalProject Cost of Capital 21.07% 21.07%

Cost of CapitalCost of Capital S

overe

ign

O

pera

ting

Fin.

Term Structure of Cost of Term Structure of Cost of Capital and WACCCapital and WACC

Term structure of CC and WACC

10%

12%

14%

16%

18%

20%

22%

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Year

Inte

rest

rat

es

WACC

Country cost of capital

Cash Flow AnalysisCash Flow Analysis

Cash flows analyzed through 2020 (assuming that the mine only has sufficient ore to last till then)

Valuation with WACC Applied to FCF (in US$ millions) 2006 2007 2008 2009

FCF with salvage value 4.11 12.62 13.67 15.49D = Value of Debt 22.35 22.35 19.87 17.38D % 32% 32% 28% 26%d(1-T) --> 15% (1-20%) 12% 12% 12% 12%E % 68.24% 68.32% 71.59% 74.26%CC=Country Cost of Capital (ICCRG calculator) 21.07% 21.07% 21.07% 21.07%E(RA)= (d*D%)+(CC*E%) 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%

WACC 18.19% 18.20% 18.49% 18.74%V L = Levered Value 70.37 70.55 69.93 67.54EL = Equity Value = Levered Value - Debt 48.02 48.20 50.06 50.16

Real OptionsReal Options Option to expandOption to expand

Increase the extraction of ores from the Increase the extraction of ores from the mines by 50%mines by 50%

Option to shutdownOption to shutdown If the price of Lead and Zinc ores fall If the price of Lead and Zinc ores fall

below extraction cost, potentially optimal below extraction cost, potentially optimal to temporarily shutdown minesto temporarily shutdown mines

Stakeholder AnalysisStakeholder AnalysisInterestin Trepca

Influence

UNMIK

World Bank

Serbian Govt

Kosovar Miners

Kosovar Population

EU

Kosovar Govt

Economic AnalysisEconomic Analysis Examining transaction from the Examining transaction from the

perspective of the economy as a wholeperspective of the economy as a whole Discount rate should include economic Discount rate should include economic

opportunity costopportunity cost Example:Example:

NPV to project ($ mn) 48

Opportunity cost of Capital (willingness to pay - %) 5-10%

Environmental costs (% of operating) 30%

Opportunity cost of assets ($ mn) 22.35

NPV to Kosovo ($ mn) 6.43

Socio-economic issuesSocio-economic issues Distributional effectsDistributional effects

Total 500 employeesTotal 500 employees Minimal economic multipliers in mining Minimal economic multipliers in mining Tradables vs. non-tradablesTradables vs. non-tradables

Conflict issuesConflict issues Control over resourcesControl over resources Static vs. Dynamic GrowthStatic vs. Dynamic Growth

Resource Curse?Resource Curse?

Environmental concernsEnvironmental concerns

Tailing pondTailing pond Old pond would be operational for 2-3 Old pond would be operational for 2-3

yearsyears Security needs to be increased Security needs to be increased New pond needs to be madeNew pond needs to be made

Mine closure major issueMine closure major issue Planning for closure should be made Planning for closure should be made

within the start-up stagewithin the start-up stage Costs could be highCosts could be high

Risk MitigationRisk Mitigation

Involve Multi-lateral agencies e.g. Involve Multi-lateral agencies e.g. World Bank Group, EU and EBRDWorld Bank Group, EU and EBRD

Get political risk insurance from MIGAGet political risk insurance from MIGA Maintain good relations with both Maintain good relations with both

Kosovar and Serbian governmentsKosovar and Serbian governments Establish long-term contractsEstablish long-term contracts Ensure adequate safeguards for Ensure adequate safeguards for

environmental protectionenvironmental protection

Discussion QuestionDiscussion Question

Could UNMIK privatize Trepca?Could UNMIK privatize Trepca?