Metropol, a Moscow brokerage and investment fund manager, has issued a report recommending buying Alrosa shares with the promise of a 72% upside in value.



But there is a catch. According to Metropol ‘s head of research, Mark Rubinstein: “You must be a shareholder to buy or sell the (Alrosa) shares," he told Polished Prices.



Rubinstein and Metropol’s diamond analyst Andrei Lobazov insist that over-the-counter trading of the diamond supplier's shares is going on; and according to Lobazov, “the volumes are quite high. There are legal ways to trade over the counter.”



The brokerage estimates that of the total Alrosa share issue of 272,726 shares, all but 9%, or 24,545, are owned by the Russian federal government (51%), the Sakha republic government (32%), and the uluses (districts) of the Sakha republic (8%).



What remains, according to Metropol’s report, is 4.8% of the share issue, or 13,091 shares, held by legal entities; and 11,455 shares (4.2%) held by individuals.



Alrosa documents refer to the latter shareholders as mostly current management and retirees.



Asked what the volume of turnover of these 24,545 shares is to warrant calling it a free float, Rubinstein said: “I don’t know exactly,” he replied.

Par value of the shares at present, according to the Alrosa charter, is Rb13,502.50 ($436).



Metropol’s report, dated September 8, claims the current Alrosa share price in the market is $9,500.



The target price the brokerage calculates is almost double. “We initiate coverage of diamond producer Alrosa with a DCF-based fair value of USD 16,345 per share, pointing to 72% upside potential for 2011 year-end.



Even when applying fairly conservative price assumptions for rough diamonds – a 3% CAGR in 2010-2016 – the stock looks undervalued in our view.”



“After an IPO, Alrosa will likely remain under government control, with 50% plus one share split equally between the federal government and the regional authorities of Yakutia,” said the Metropole report.



This means that Metropol believes there will be a 49% free float of Alrosa shares. In other words, on top of the current 9%, another 40% will be sold from the shareholdings of the federal government, the Sakha government, and the Sakha districts. The dilution will be from 51% to 25% for the federal government; from 40% to 25% for the Sakha entities.



In an interview, though not in his report, Lobazov for Metropol concedes that for the price of Alrosa shares to take off, such a sale by the two governments “isn’t the only driver." Evidently, if the opposition of the Sakha region proves to be an obstacle, those in Moscow now promoting privatization would like to demonstrate how much money the federal and regional governments would earn if they agree to let go of their shares.

Applying Metropol’s valuation to the Sakha-held shares, for example, the Andreyev sell-off would earn about $1.8 billion.



A big number for the Yakuts - but far from enough to persuade them to accept a minority stake of 25% minus one share, and loss of control over their native company forever.



Alrosa’s future profitability looks assured, Metropol reports, because no one in the rest of the diamond industry is discovering anywhere near enough new diamonds to meet the expected demand.



Alrosa claims to be holding one-third of global diamond reserves (numbers remain secret); and in terms of 2009 production and sales, Alrosa has a global market share of 30% of volume; 25% of value of the diamond trade.



“According to our estimates, a steadily declining mineral reserve base and a continued lack of new major discoveries suggest that production will remain relatively flat going forward. Under conditions of rising demand, this could mean a diamond deficit as soon as 2012, which would drive rough diamond prices higher,” writes Lobazov.



“According to our estimates, global demand (measured in 2008 prices of USD 86.9/carat) could reach USD 16.9bn by 2016, while global supply could lag USD 2.2bn behind at approximately USD 14.7bn, causing rough diamond prices to rise approximately 16% from current levels. Overall, we conservatively estimate that rough diamond prices will increase at a 3% CAGR in that period.”



Alrosa chief executive Fyodor Andreyev told Metropol for the report that “Alrosa’s 2010 results promise to beat pre-crisis levels in terms of volumes shipped, revenues and profits…We anticipate 2010 revenues will increase by 71% y-o-y to RUB 120bn (USD 4.1bn). Adjusted EBITDA is expected to reach RUB 42bn (USD 1.4bn) with net income at RUB 18bn (USD 607mn).”