Mechel: Putin’s Remarks Create Opportunity for an Attractive Volatility Play

Mechel tumbled 38% on Thursday after Russia “Prime Minister” (more like ex–KGB autocrat) Vladimir Putin said that the Russian Anti Monopoly Service should pay special attention to the fact that Mechel (MTL) has been selling its raw materials for twice as much domestically. This is bad news for the company’s chief executive and main shareholder, billionaire Igor Zyuzin. Last time a billionaire who ran a “strategic” company (like Mechel) crossed Putin was in 2003. The guy was Mikhail Khodorkovsky, and he is now serving an 8 year sentence in Siberia for tax evasion. Burr.

I know what you are thinking – isn’t Dmitry Medvedev the president of Russia? Yes he is – but Putin is the dictator and the dictator always trumps any democratically elected president. (Incidentally you may remember Medvedev from his brief stint as Kermit the frog on the popular TV show The Muppets. A puppet – get it?)

So this investigation could prove disastrous for Zyuzin and MTL shareholders. Putin is trying to prevent foreign investment in what he considers to be “strategic industries.” This pretty much means energy and commodities. Mechel is a large player in the steel, coal, nickel and energy industry (though I think its energy segment is lackluster at best). The company is (was) very strong, posting steroidal earnings growth for the past four quarters, up 160% in the most recent quarter. Plus the company operates in one of the most attractive industries right now (steel, commodities, infrastructure) and has the vertical integration needed to keep input costs low. This is a great company and after today’s death slide trades at a ridiculously low forward earnings multiple of 4.2.

So here is how you can make money on this one. I wouldn’t buy the underlying – the stock could go to zero if Putin pushes foreign investors out and slaps Mechel with a company ending fine. As my Belarusian friend Alex told me earlier this week, “Don’t invest in Russia.” I would not short Mechel either; it could double quickly if these monopoly charges do not materialize.

So here is what I recommend – go long volatility. The easiest way to do this is to buy a straddle – let’s say the Jan 09 25 straddle which is comprised on a Jan 09 25 call and a Jan 09 25 put. The debit here is about 12.90 – so Mechel must deviate 12.90 from the strike price of 25 dollars by the third Friday in January for this strategy to pay off. I like it because I believe Mechel will go bankrupt or to 50 in the next few months. Or – if you want to take a directional bet – then buy calls or puts for Oct of Jan with a delta of around 20 (at tonight’s price that would be the Jan 20 puts or the Jan 45 calls). They are cheap and if you are right direction (up or down) then you will realize a disproportionately large gain. I say why risk having to pick the direction – play it safe and go long volatility – buy the straddle.

As for investing in Russia’s “strategic” industries – I would say stay away, or adopt a short term strategy. Russians have historically been very suspicious of foreigners – and very corrupt. These two traits making investing in Russian companies very dangerous for all but the most risk tolerant investors.

Remember – In Soviet Russia television watches you!

Disclosure: Long MTL options.

Comments

[User 195759]

How call you suggest buying straddles/strangles on a company whose options trade with such ridiculous spreads??? Even if your thesis turns out right, all your paper gains will be erased by terrible entry and exit fills...

[User 195759]

***How can...***

[Hefaistos]

User 195759, your comment is spot on - these positions only work in the schoolbook. Maybe you can achieve something similar with warrants, though, they are more liquid.

[Bluehorseshoe_Loves_Visa]

Straddles???

Why complicate things?

I bought premarket and got a $23.80 price. Stock hit $28 for over 20% profit.

I make money using the K.I.S.S. principle.

[domenic]

User 195759 and Hefaistos the amount of liquidity for the options does not matter as long as you exspect the position to have intrinstic value as I do.

[John Egan]

"This is bad news for the company’s chief executive and main shareholder, billionaire Igor Zyuzin." ... Could be worse... If he was Chinese, they'd take him out back and shoot him.... Now, that's what I call an incentive program!

jegan ;-)

[broaderhorizons]

typical russophobic bore...puppet joke is as old as the author's travel toothbrush (does not get out much...get it?) Meanwhile smart investors are right where they were since 1992 - in the most expensive city in the world keeping one of the best kept secrets. If you don't have balls for this go write something about your grandma's dog

[DaveW]

x2 K.I.S.S.!

[300mph]

broader horizons, if there's a lot russophobia flying around lately maybe that's because Mr. Putin is creating it with his logic that ties up and rapes us. Let's see... defensive missiles said to be offensive and therefore require massive military buildup... sucking up to Hugo Chavez or any other perverted dictator that happens to hate the U.S. For Russia the list is very long and spans many centuries. You also need to get out more, a trip to the library to read Russian history is in order.

[notsosmart]

any trust worthy countries left? mabe scandanavia.now who would you trust? china,russia,usa,the brits,the french,pakistan,india,... them,i would like to know & why.thanx

[notsosmart]

name them

[albina]

I came across this article published mid June this year at the time MTL had been htting all-time high. This is now best understood in the hindsight of what happened to MTL recently (disaster).

www.adrfactory.com/sho...

Let's not blame Russia or MTL, or Putin. The market has always been sensitive to Acts of God, politics, wars, etc. What is unfortunate is that when things look bright and promising you can't somebody who stands out from the crowd and says:"These are the facts that are bound to terminate MTL's bullish trend." Full stop.

I especially liked this passage:

"When Russia starts something seriously you can't stop her. Treat it as a hostile tax takeover, Putin's Russia is going to win and disintegrate coal-and-steel empires like Mechel perfectly pieced together from the Soviet heritage of territorial production complexes. Vertical integration will become a house of cards."