Trepca Mining and Metallurgical Complex Could UNMIK privatize Trepca?

1. Trepca Mining and Metallurgical ComplexCould UNMIK privatize Trepca? February 23, 2006 BA 456 Ervin Dervisevic Anu Gurung Nikhil Kejriwal Santhosh Thiruthimana

2. 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 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.

3. 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

4. Trepca Mining and Metallurgical Complex

5. 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

6. 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

7. 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

8. 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

9. Risk Analysis –Financial • Political Risk Insurance from (potential) World Bank Group involvement

10. 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 • Serbia’s 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% • Political Risk Insurance - 0.21% Project Cost of Capital 21.07% Sovereign Operating Fin.

11. Term Structure of Cost of Capital and WACC Term structure of CC and WACC 22% 20% 18% 16% Interest rates 14% 12% 10% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 WACC Year Country cost of capital

12. Cash Flow Analysis Valuation with WACC Applied to FCF 2006 2007 2008 2009 (in US$ millions) 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% 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% 18.19% WACC 18.49% 18.20% 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)

13. 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

14. Stakeholder Analysis Kosovar Govt UNMIK Kosovar Miners Serbian Govt World Bank EU Kosovar Population Interestin Trepca Influence

15. Economic Analysis NPV to project ($ mn) 48 Opportunity cost of Capital (willingness to p ay - %) 5 - 10% Environmental costs (% of operating) 30% Opportunity cost of assets ($ mn) 22.35 NPV to Kosovo ($ mn) 6.43 • Examining transaction from the perspective of the economy as a whole • Discount rate should include economic opportunity cost • Example:

16. 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?

17. 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

18. 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

19. Discussion Question • Could UNMIK privatize Trepca?