KAP PROJECT June 2004 1 Privatization strategy Kombinat aluminijuma Podgorica DRAFT June 2004

KAP PROJECTJune 2004

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Privatization strategy

Kombinat aluminijuma Podgorica

DRAFT

June 2004


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Privatization strategy of Kombinat aluminijuma Podgorica

Section

Executive Summary

Objectives of the Government of Montenegro 1

Investors’ rationale and concerns 2

Key issues 3

Target investors’ group 4

Eligibility and selection criteria 5

Principles of tender process 6

Timetable of privatization 7

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Executive summary


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Executive summary

Privatization Strategy of KAP and its main features result from understanding of key objectives of the Government of Montenegro in privatization of KAP the analyses mentioned in the Diagnostic Report and sale prospects arising out of the Preliminary Market Assessment

The launch of the sale proces of 65,5270% shares of KAP assumes that favourable answer is given to the key privatization issues identified during the initial stages of the work. We believe that recommendations offer the best possible equilibrium between different objectives and constraints of the transaction, while taking into account the real world feedback which determines the feasibility of the transaction.

The proper solutions of these key issues, in line with market constraints and expectations should be treated by the Government of Montenegro as a condition of sine qua non of successful privatization and given the highest possible priority.


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Executive summary

Under the assumption of satisfactory solution of key issues, we believe that the tender procedure will yield a sufficient market interest as to offer reasonable chances of transaction closing, providing the negotiations between potential bedders and Major Creditors.

Current market conditions are favourable to the potential transaction even if high aluminium prices have had a negative effect on the level of potential discount Major Creditors may consider granting to potential investors as well as on Major Creditors’ Willingness to get out of the company.

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Section 1

Objectives of the Government of Montenegro


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Any transactions is structured in order to fulfil and/or maximize the legitimate objectives of the seller while taking into account at all times the situation and specificities of the asset offered for sale, as well as the market feedback and reality, reflected by the level of interest-or lack thereof-from potential investors.

The seller’s objectives naturally influence the transaction structuring and are usually reflected in the eligibility and selection criteria of the tender.

In accordance with proposal of Advisor which was formed on the basis of communication with Tender Commission and Working Groups, the following elements may be considered as main objectives of the Government in the privatization of KAP:

Survial and long-term development of KAP

Being the country’s largest company and representing one of the pillars of the economy with strong influence on the GDP, employment and financial situation of Montenegro, the target of the privatisation of KAP for the Government of Montenegro is to ensure survival and long-term development of Company. The objective is to atract a solid investor who will secure the position of KAP on international markets, improve its competitiveness and allow rehabilitation of production tool by introduction of new technologies and international standards of business and management with possible further increase of capacities.


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Survival and long-term development of associated businesses

The privatisation of KAP is also understood by the Government of Montenegro in the context of KAP’s interdependence with Rudnici Boksita, the EPCG, the Railway Company, the Port of Bar and many other companies in Montenegro.

Addressing of social issue

Given the fact that KAP and the bauxite mine rudnici Boksita are overstaffed employing over 4900 employees, the objective of the Government is to preserve to the extent possible the level of employment, to include a social plan as an integral part of privatisation program and to secure a certain minimum level of social commitments to be undertaken by the incoming investor.

Settlement of the obligations of the DRA

The complex debt situation of KAP resulting primarily from the past economic sanctions on the former Yugoslavia requires an active approach of the Government of Montenegro in debt restructurings with the Major Creditors. It is therefore necessary that through privatisation of KAP settles the obligations arising out of DRA, including those resulting from the GoM letter of guarantee for the part of debt related to investments and to the working capital facility.


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Addressing environmental issues

One of the main issues which should be salved in KAP concerns the environmental pollution. The privatisation is considered as a way to encourage the transfer of new technologies and improvement of the operations, leading to progressive reduction of the gap between the level of past and ongoing pollution so the KAP can respect all ecological, healthy and protection standards of Montenegro and European Union..

Attracting foreign investment

Foreign direct investments are a key driving factor for economies in transition, having positive impact on sustainable GDP growth, exports and general economic stability of the country. The privatisation of KAP, even if it will not represent significant inflow of foreign capital, will be perceived, due to its size, as a catalyst for other investments of foreign investors in Montenegro.

Timing

Privatization strategy was prepared having in mind that efficiency and successful closing of process is of paramount importance to the Government of Montenegro.


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Public image

One of the key concerns is to run a process that will be fair and transparent and also will be perceived as such. The strategy described hereafter is aimed at ensuring the credibility of the privatisation process and will contribute strongly to building investors’ confidence towards the country.

The successful completion of the transaction will definitely have a strong positive impact on the perception of Montenegro as an investor-friendly environment and should encourage further development of the foreign direct investment. Properly run tender process, perceived as fair and transparent, shall have a positive impact on public acceptance of the transaction and shall reduce the scope of potential criticism.

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Section 2

Investors’ rationale and concerns


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The main objective of the privatisation strategy is to attract strong and experienced strategic investors to invest and manage KAP over the logn-term. In order to attract such investors and ensure that the sale process generates sufficient demand from investors, the sale strategy should take into account investors’ rationale and concerns.

In that sense different recommendations of financial Advisor arising out of the Diagnostic Report were based on knowledge and understanding of the company, but more importantly, on knowledge of the market and constant dialogue with potential buyers, understanding of their strategy and constraints.

On such basis, the key limitations of potential investors including the following issues are being identified:

Control of management decisions

Strategic investors want to ensure that they would be able to control and largely influence the key management decisions concerning issues such as purchasing, labour, capital investments, organisation and other issues. In general, investors prefer not to undertake strict privatisation obligations resulting in a limitation or loss of control over various issues.


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Return potential

Prospective investors will analyse carefully the operations of KAP in order to assess: (i) KAP’s profit generating potential; (ii) the potential for cost savings and other efficiencies; (iii) the levels of capital expenditures required in future years. It is therefore necessary to carefully decide on the priorities of the Government in the context of the above-mentioned return potential factors: specifically, given high level of up-front investment expected from the investors in relation to the DRA debt. It is critical for the transaction success to create favourable conditions for the potential investor in order to guarantee/secure an expected return.

Purchase of bauxite

KAP’s dependence of Rudnici boksita – Nikšić for the purchase of bauxite if a major concern for investors and could represent a significant barrier in the privatisation if secure long-term supply of bauxite on fair terms is not ensured. Investors that were familiar with the situation often understood common ownership of KAP and Rudnici boksita as the most convenient option. It means that the bauxite price and general rules of operation of two companies should not be imposed upon the incoming investor but can be established post-transaction.

Supply of electricity

Adequate conditions of the purchase of electricity, representing one of the highest cost items of KAP, are essential for the long-term development of the company. The investors stressed the fact KAP will be competing with its products on the world-wide market and cost should therefore be competative. It is crucial to secure not only a favourable price level but also this price to be applied for longer period of time.


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Employment and social aspects

Some of investors contacted in the market assessment phase were to a large extent familiar with the employment and social situation of KAP, being aware of the heavy overstaffing and invalids issue. Naturally, their preference in connection with the privatisation is to preserve control over their restructuring plans, yet would be able to accept an adoption of a reasonable social programme. On the other hand, all investors consider the invalids being on the payroll of KAP as a heavy burden and believe it should by treated by the Governmental social schemes.

Debt

The debt issue has a specific position not only because of the heavy indebtedness of KAP but also due to the fact that some of the Major creditors are also interested in the privatisation. Key potential acquirers are aware of the complex debt situation and recognize that they are in better position than the GoM to negotiate a debt settlement.

Long-term visibility

Among the objectives of the privatisation of KAP is the maximisation of funds of capital to be spent by the incoming investor in order to secure the survival and long-term development of the company. Within their evaluation of the investment opportunity, investors shall prepare business plans based on which a discounted cash flow model is made. The longer the visibility of the economic environment of the target and its main parameters, the less uncertainty is reflected in the discount factor of their valuation. Therefore, investors’ price calculations are maximised when based on solid parameters over a sufficient time period. This applies especially to the visibility of the price of key inputs (power, bauxite)


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Competition from similar transactions

International strategic investors will compare the investment opportunity in KAP together with the related conditions, with other privatisation or sale projects ahead or underway, as well as with possible green-field projects. Competing or forthcoming opportunities could potentially pose a problem of timing and perception of KAP’s relative attractiveness. In this respect, key drivers for attracting potential investors rely on an attractively structured and “uncertainty-proof” transaction.

Respect of the announced sale process, timetable and transparency

Regardless of the sale method that will be retained by the Government, bidding rules, bidding assumptions and selection criteria should be specified up-front and strictly adhered to. Investors expect that the conditions, based on which they form their price offers, would remain unchanged and be respected in practice. Any change of rules may deter potential investors leading to their withdrawal. In fact, many bidders will participate in tenders only if they believe that they bave a real chance of winning, so much that submitting a bid represents for the bidders a financial cost that may well exceed EUR 1 milion.

Country risk perception

Perception of Montenegro’s political stability, the Government’s economic policy and the country’s relative positioning among the countries in the region is will be a significant factor behind the investors’ decision to invest or not in KAP. The country risk element will determine the level of prospective bidders’ valuation of KAP either through the multiples range which would be applied to these transactions or as a risk spread included in the discount factor used for calculationg the net present value of KAP’s free cash flows. It is however fair to say that international acquisition policy of potential bidders can be affected by country risk incidents elsewhere in the world.

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Section 3

Key issues


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Main privatisation issues

By means of market assessment we have analysed the interest, the perception and major concerns of the investors in connection with the forthcoming privatisation of KAP. Results of examinations are given in the Diagnostic report identifying following key issues for the transaction:

- Debt to Major Creditors (Debt restructuring Agreement)

- Non DRA debts

- Electricity price and conditions for the contract on electricity

- Environmental protection norms

- Social issues and employment level

- Anotech contract status

- Downstream capacities

- Ownership in the Bauxite mines

For each of the key issuesTender Comission has established Work Groups consisting of representatives of various bodies. The initial aim of the Work Group was to find a solution which would facilitate the privatisation of KAP and address the major concerns of the potential investors.

Based on the work groups analysis and advisor’s recommendations, proposals for each key issue have been formed. Working groups and advisor have had different attitudes regarding the issues of electricity price and Bauxite.


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Debt toward the Major Creditors


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Debt toward the Major Creditors

The Debt Restructuring Agreement of KAP was signed on April 27, 2001 and was classified in three classes. In the Class “A” debt are Glencore (5.660.120 USD), Rudnici boksita (Bauxite Mines) and EPCG (3.780.560 USD) and Standard Bank/Gerald (1.000.000 USD). The total debt from this Class – 10.441.680 USD with related interest of 12% (for Standard Bank/Gerald the interest amounted 6,5% or LIBOR +2,5%) was paid on March 31, 2004.

Class “B” consists of debts in the amount of 111.127.000 USD and they belong to Vektra (53.100.000 USD), to Standard Bank/Gerald (28.498.000 USD) and to Glencore (a) 5.729.000 USD and (b) 23.800.000 USD), with interest of 6,5% or LIBOR +2,5% (the smaller amount is taken).

In the Class “C” are: Vektra (8.056.527 USD), Glencore (1.200.000 USD) and Domestic Creditors (25.000.000 USD) with interest of 6,5% or LIBOR +2,5% (the smaller amount is taken).

The Class “C” calculates interest from 2006, and the interest is going to be repaid from 2013.

The Dabt toward Main Creditors as at March 31.2004 (according to data of Standard Bank London – Agent Bank) amounts 138.288.205 USD: toward Vektra 69.252.292 USD toward Glencore 34.757.626 USD and toward Standard Bank/Gerald 34.278.287 USD. The company Sinochem of London has law suit with KAP due to 3.340.000 USD. Several times the Standard Bank has been informed about this because they undertook the claims of the Sinochem.

Until privatization the KAP debts will be reduced significantly (the reduction of aprox. EUR 15 millions is expected) because the market price of aluminium is rather high, therefore this should be taken into consideration during talks with Creditors and investors.


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Debt toward Major Creditors (Continuation)

Proposal

Given that potential bidder is in better position to negotiate KAP’s debt and to reach solution with the Major Creditors, then sellers or advisor, it has been proposed to enable direct negotiations among pre-qualifed bidders and the Major Creditors with reference to conditions and terms of compensation of debt.

Organized process with reduced number of candidates, limited period for negotiations and scope of negotiations previously agreed with Major Creditors and candidates will maximize chances for success of negotiations.


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KAP’s debt toward the Government of Montenegro, the State funds domestic state companies and pre-sanctiones debts


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KAP’s debts toward the Government of Montenegro, the State funds, the domestic state sompanies and pre-sanctiones debts

By Debt Restructuring Agreement US$ 25 millions was anticipated for restructuring of KAP’s debt toward the Government of Montenegro but only US$ 20 millions was restructured toward it. Domestic state companies could not “fit into” in the rest of US$ 5 millions, therefore the indivudual contracts on debt restructuring with EPCG, Bauxite Mines, Jugopetrol and the Port of Bar were signed. The base for these contracts was the solutions from the Debt Restructuring Agreement of KAP. We mention that the Railroad of Montenegro refused to sign the contract.

According to delivered table of the status of domestic debts (KAP owes on behalf of pre-sanctions debts (mostly the Paris club) around EUR 32.5 millions (unofficial data of CBCG), then to the Government, domestic state companies, funds and banks on the basis of restructured and non-restructured debt of cca EUR 79.5 millions on behalf of obligations arose up to October 7, 1998. At current exchange rate, and EUR 4.5 millions the obligations arose in 1999, 2000, (the law suits with EPCG), and 2003. (the restructured debt). KAP has obligations toward so colled “other creditors” (“25. maj” Macedonia and “Vitol” Switzerland) of cca 1.8 millions, as obligations undertaken from the Government in the period up to October 07.1998.

Obligations of KAP for these three groups of Creditors, amount in total EUR 116.58 millions (USD 78.476.588,00 EUR 50.584.873,00, SHF 647.532,00) according to exchange rate of CBCG dated May 24, 2004.


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KAP’s debts toward the Government of Montenegro, the State funds, the domestic state Companies and pre-sanctions debts (continuation)

Proposal:

The debt toward the Government, State funds, domestic state companies as well as pre- sanctions debts to be separated from the balance of KAP and assigned to the competence of the Government in order to be used as additional quarantee which will be progressively paid off as the new investor fulfills its obligations. In the meantime, it is necessary the Ministry of finance and Central Bank of Montenegro to bring into accordance data on the amount of pre-sanction debts.

KAP’s debt to Jugopetrol Kotor will be solved separately according to the agreement that KAP and BNP Paribas will reach with Jugopetrol Kotor regarding regulating the debt toward this company (it is possible debt to be paid off persuant to the signed Debt Restructuring Agreement which has been signed by KAP and Jugopetrol).

The Government of Montenegro is obliged to help in bringing into accordance the KAP’s debt to Railway of Montenegro, having in mind provisions of the Debt Restructuring Agreement.

KAP’s restructured debt to the Bauxite mines will be “salved” separately, with possible additional financing of the Bauxite Mines by KAP’s investor.


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Electricity price


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Electricity price

It is important to provide KAP’s Buyer with electricity supply under competative prices for longer period of time. Potential investors usually make comperisons of electricity tariffs in world’s smelters as well as structure of costs of the world aluminium industry. These costs are main indicators of metal price on long term.

Potential investors see an adequate addressing of electricity issue for KAP through building of new power plant or through provision of electricity supply through long term contract. In case of construction of new source of electricity, the Buyer will need to provide a interim electricity supply.

Proposel of price relations of EPCG and KAP

Alternative 1:

1. Price relations of EPCG and KAP in 2005.

Electricity price which EPCG will deliver to the KAP in 2005. is formed according to the following:

a) for year 2005 EPCG is obliged to provide annual delivery up to level of 1.204.762 MWh in equal monthy instalments i.e. 2/3 of necessary electricity for production;

b) Electricity price from item a) is

24,39 USD for MWh, converted into EUR according to middle exchange rate from echange rate list of ECB on day of invoice issuing. If the result of conversion is less then EUR 20.44 the price of EUR 20.44 for MWh will be applied.

c) Costs of electricity transamission independently purchased by KAP from abroad, will be paid EUR 2.21 for MWh.


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Electricity price (continued) 2. Price relation EPCG-KAP for the period 2006-2008

a) In the period 2006 - 2008 EPCG is obligated to provide annual supply up to the level of 1.204.762 MW/h in equal monthly tranches, i.e. 2/3 of the energy needed for production;

b) Electricity price (CE) from the item a) shall be established under the formula:

CE = PC + BK , where:

· PC – initial price established in the item 1. b) is 24,39 USD for MW/h converted in EUR under the ECB’s average exchange rate on the date of invoice issuance. If conversion result is lower than 20,44 EUR, price of 20,44 EUR for MW/h shall be applied.)

· BK – energy price correction in case of positive deviation of primary aluminium price from the reference value of 1.550 USD/t .

BK should be calculated according to the following:

BK = ((LME - 1.550) x 0,024) x (srk(USD)) where:

- LME – is average primary aluminium price at London Metal Exchange in the month for which invoicing of the energy deleivered is carried out;

- srk(USD) - average USD exchange rate according to ECB’s exchange rate list on the date of invoicing

- BK higher or equal to 0,00 EUR

Obtained BK represents amount in EUR.

c) Electricity price above 2/3 of the energy needed for production, i.e. above the quantity established in the item 1. a) in equal monthly amounts, KAP shall import or this price shall be formed by free agreement between KAP and EPCG

d) Transmission of the electricity purchased by KAP independently from import, shall be paid at the price of 2,21 EUR per MWh.


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Electricity price (continued) 3. KAP-EPCG price relations in the period 2009 - 2010

a) In the period 2009 - 2010 EPCG is obligated to provide annual supply up to the level of 903.570 MW/h in equal monthly tranches, i.e. up to 1/2 of the energy needed for production;

b) Electricity price (CE) from the item a) shall be established under the formula: CE = PC + BK, where:

· PC – initial price established under the item 1b) (24,39 USD for MW/h converted in EUR under the average ECB’s exchange rate on the date of invoice issuance. If conversion result is lower than 20,44 EUR, price of 20,44 EUR for MW/h shall be applied.) increased (decreased) by increasing (decreasing) index of the energy price on the Exchange in Leipzig for the period 01.01.2006 – 01.01.2009 ( i.e. 01.01.2006-01.01.2010, for the year 2010).

· BK - energy price correction in case of positive deviation of primary aluminium price from the reference value of 1.550 USD/t .

BK should be calculated according to the following: BK = ((LME - 1.550) x 0,024) x (srk(USD)) where:

- LME – is average primary aluminium price at London Metal Exchange in the month for which invoicing of the energy deleivered is carried out;

- srk(USD) - average USD exchange rate according to ECB’s exchange rate list on the date of invoicing

- BK higher or equal to 0,00 EUR

Obtained BK represents amount in EUR.

c) Electricity price above the quantity from the item 6. a) (903.570 MW/h) KAP shall import or this price shall be formed by free agreement between KAP and EPCG.

d) Transmission of the electricity purchased by KAP independently from import, shall be paid at the price established by Energy Agency.


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Environmental issues


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Environmental issues

Impacts of operation of Kombinat aluminijuma Podgorica on environment and health of people are noted in Diagnostic report. Based on that report, Report of the State Commission from 1993, two M.A. theses and other available expert reports and studies, it has been concluded that technology installed at KAP is 30-35 years old, and in that period there was no essential changes except at the very beginning of operation when red mud filtration system was improved. During the period of UN sanctions KAP operated in irregular conditions with “stop-go” system. This unavoidably caused equipment damages (scrubbing system of the Smelter Potline B etc.) and increse of scrap. Cosequences in deterioration of environmental quality reflect in deterioration of the basic environmental segments of: undrground and ground waters, air, soil. Solving of the problems stated understands activities in two directions: rehabilitation of the consequences of the previous pollutions and prevention of further pollution.

Proposal:

Government should undertake the activities for rehabilitation of the consequences of previous pollutions arised as the consequence of Kombinat’s operation.

Future investor should prevent further pollution and to propose investments intended for improval of the quality of all environmental and working segments at the site of KAP.

“Section line” should be established as the result of current revision of environment in order to define the line between the current status and new obligations of the investor that should be adjusted to the requirements of European and world standards.

Precised exploring of the environmental status shall be possible to do only as the result of environmental due dilligence that is in the course.


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Labor


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Labor

2.746 emoloyees are employed in the primary production which is the subject of privatization. There are 389 invalids totally. 838 employees are employed in KAP’s Downstream capacities, out of which 62 of them are professional invalids. Amount for salaries of invalids in the primary production paid by KAP in 2003 is EUR 2.994.971,28 (excluding salary amount for invalids in Downstream capacities). This salary amount represents 9,73% of the total KAP’s salary amount.

According to information from Bauxite Mine their total number of emloyees is 1.400 out which 145 of them are professional invalids that should be treated in the same manner as KAP’s professional invalids (in case decision of value increse of Bauxite Mines is reached).

There is a significant number of redundant labor as well as in other similar companies. Taking into account the level of employment, company does not have benefits from the diference in average salary costs in Montenegro and Western countries. Average salary in KAP is significantly higher than national level. Issue of employment level has been repeated by the potential investors we talked to. Part of redundant employees relate to invalids that are on the payroll of the compyny


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Labor (continued)

Proposal:

Issue of invalids should be displaced from KAP and Bauxite Mine (if decision on value increase is reached) i.e. Government should take over the obligation after: KAP/and Bauxite Mines/ make complete revision of the certificates on degree of disability with coordination of the Ministry of Labor and Social Welfare,

Ministry of Labor and Social Welfare should urgently propose amendments to existing law regulations.

According to existing law regulations, it is necessary to carry out optimization of existing labor nad invalids,

For payment of costs arised by taking over of obligations toward invalids, it is necessary part of privatization revenue to be allocated to social Funds.


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Contract with Anotech


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Contract with Anotech

In 2000, seven year contract was signed with Anotech company which includes the obligation of USD 15 mio investment. Anotech company has addressed to KAP’s Board of Directors with a demand to extend a contract on management and reconstruction for the following 30 months.

KAP’s Board of Directors has rejected a request, evaluating that it is not in accordance with the signed contract.

On the ocassion of its request explanation, Anotech has stated that total value of investments spent amounts USD 19,287.950,78 ant that it exceeds the investment plan by cca 4,287.950 USD. Anotech claims that feasibility study has been used only as a base for the investment, and that it has been made on the basis of physical examination of the equipment at the Anode plant, and that equipment and spare parts have been bought mainly at the european market including credit indebtedness at very unfavourable credit conditions. They have also stated some other reasons because of which they ask for the extention of the term for 30 months. Based on the Work group attitude and a proposal of the advisor it has been proposed:

Proposal:

A new owner/owners of KAP, pursuant to valid agreement, has the right to terminate the contract between KAP and Anotech unilaterally, after the privatization.


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Downstream capacities


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Downstream capacities

Since 1999, downstream capacities have, for the purposes of privatisation, been divided into three plants: Processing plant (strip casting, strip rolling, foil rolling, packaging, pressing, bicycle rims); Casting plant (billet casting, billet forging); Wire and rope plant, FAK (wire extrusion, wires for ground ducts). In the previous period, an international tender for sale of certain parts of downistream capacities was launched 4 times. Interest has been shown only for the plant of Al processing – Prerada and for the Casting plant.

Proposal:

GOM prefers privatisation of the primary production and downstream capacities.

The potential buyers should be given an option regarding buying downstream capacities,

In the process of potential investors selection, investors which offer the business plan and investment program for dowrstream capacities will be given additional points according criteria for evaluation of the offers,

As an option, downstream capacities should be provided, through a commercial contract during privatisation, with supply of required quantity of Al (up to the installed capacities) if they are not taken by KAP’s buyer. The price will be commercial – within range to be proposed by the Advisor.


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The Bauxite mine


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The Bauxite mine

The Bauxite mine is the independent company with different structure of ownership (state ownes 31,38% of shares) which has signed a longterm agreement with KAP (30 years) regarding bauxite delivery However, there has not been a contract on price relations between those two companies for two years now.

The bauxite mines in Nikšić have been working for more than 50 years. In the past it has delivered bauxite to other parts of ex Jugoslavia, independent States union and Romania, since 1971 the only client of this company is KAP. From KAP’s standpoint, Bauxite mine is its only bauxite supplier, thus, both subjects completely depend on each other.

We consider that is it not good for KAP to try to satisfy its needs for bauxite by purchasing it outside Montenegro :

Bauxite is the good of great volume but small value; thus, international transport and manipulative expenses can increase expenses of bauxite devilery largerly, especially at current high transport prices.

Storage capacity of the Port of Bar limits the possibility of bauhite import from the international markets like markets of India, Australia, Venezuela or Guinea.

Beside that, it is debatable that Bauxite mines will not survive if faced with international competition, and bauxite reserves should be considred a resource which can not be used again.

Hence, KAP has to continue relining on the local bauxite inventories, both from economic and social standpoint, thus resolving a question of those two companies mutual relation. Considering a specific structure of shareholders at the Bauxite mines, inclusion of this company into the range of a transaction should be predicted by a combination, on of capital increase in the company and purchasing of the existing shares owned by the state. On the contrary, investor should not be prevented from buying the existing shares of private shareholders. By presenting close economic connection and mutual dependency between two companies, we have proposed the Bauxite mine to be included into the range of the transaction.


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The Bauxite mine

Proposal:

Alternative 1

Sale of minority block of shares (31,38% owned by the Funds) with additional financing. Realization of this model understands making a decision on additional financing at the Bauxite mine general assembly, to the amount of EUR 8 mio, including the following conditions set by majority shareholders:

1) The Bauxite mine and KAP to enter the privatisation process as two separate companies .

2) to define bauxite price LME formula depended, or the bauxite price to be fixed, that is, EUR 26; ;

3) the average salary amount to stay at the same level at least .

4) the same social program and environmental protection conditions as for KAP .

5) Investment and business plan for the period of 5 years to be proposed by the investor ;

Alternative 2

Sale of minority block of shares (31,38 % owned by Funds)

Possibility of KAP’s buyer to continue buying shares at free stock market.

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Section 4

Target investors’ group


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Target investor group

Several types of investors could be potentially interested in investing in KAP: aluminium producers, trading groups, different financial investitors. .

The process should be designed in order to promote the candidacy of the preferred target investor type, but should also take into account the market reality .

In order to maximise the number of candidates, we propose to open the process to both strategic investors, financial investors and consortiums.

The main reason behind the unusual extension to the financial investors is related to the risk of expected low competition among strategic players, while the potential presence of the financial investor will create the risk for industrial players of unexpected competiotion.

Nevertheless, we propose to ectablish a “quality control” of potential investors through appropriate definition of the eligibility criteria, in order to eliminate non suitable parties, unable to fulfil Government of Montenegro’s expectations related to the transaction or to effectively close the transaction.

On following pages we briefly present main characteristics of those categories of investors.


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Target investor group – Strategic investors

The investors of this type are from the aluminium sector, (i.e.the same business as KAP) are hands-on, active managers, able to handle business and strategic issues with speed.

Compared to other types of investors, strategic investors have a longer term investment horizon and are ready to pay a higher price, provided they are given the operational and management control of the target company.

The main advantages of involving strategic investors are the following:

Managerial, commercial, financial and administrative support and discipline;

Introduction of new technologies and technical expertiese, as well as the experience to respond to increasing competition;

Providing financing to support the future growth;

Securing the strategic investor for KAP shall increase the profile of the privatisation programme internationally, which will be useful for the future trade sales.

In theory strategic investors may be mindful of future exit routes, but follow the market far less frequently than financial investors and are less senstive to market volatility or liquidity issues.


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Target investor group – Financial investors

Portfolio investors are in the business of managing large funds, which invest in a predetermined risk class of assets. Investment decisions are made on a risk-return basis, taking into account the economic and political risk of the country in question as well as the other risks, growth prospects, liquidity and volatility of the target asset.

Typically, this type of investors exercise passive management control through the voting process and are rarely hands-on managers. The ultimate purpose of such investors is to divest in the short or medium term to realise their profits. Some portfolio investors are specialised in managing distress situations, such as KAP, and those will be our main target.

Private equity investors are a specific group of medium-term portfolio investors. These are typically investment funds providing medium-term, committed share capital, to help unquoted companies grow and succeed. Private equity is money invested in exchange for a stake in the company and, as shareholders, the investors’ returns depend on the growth and profitability of the company.

Given the complex situation of KAP and the fact that it is beneficial to increase interest in its privatisation, it is recommended that portfolio investors and private equity groups are allowed to participate in the sale process, either alone or in consortium with a third party. They will be required to demonstrate their capacity to bring relevant technical experience and know-how in the production and sale of aluminium in collaboration with third parties.


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Target investor group – Financial investors (cont’d)

International institutions such as the EBRD and the IFC (International Finance Company, World Bank Group) could be invited to participate in the privatisation alongside the strategic investors. Typically, these institutions invest in privatised companies in consortium with strategic investors and on the same price-per-share terms.

The involvement of an international institution in the privatisation may be beneficial for both the Montenegrin authorities and potential strategic investors. The presence of an international institution would upgrade the status of the privatisation tender and increase the visibility of the transaction.

From the investors’ point of view, the participation of an international institution may be perceived as a protection against the risk of political interference and as a guarantee that the vendor would meet all contractual obligations. Such a participation may even result in a higher credit rating of KAP and in an easier access to local and international debt financing. On the other side, the Government should be aware that some strategic investors may turn down the proposal to team up with international institutions for various reasons.

We recommend that international institutions should be invited to participate in the privatisation process, but the investors should be free to decide and/or approach on their own the international institutions that will express interest in KAP.


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Target investor group – Consortia and SPV (Organization for special purposes) In order to offer prospective strategic and financial investors a larger degree of flexibility and, in

particiular, to encourage the participation of those candidates who are not in a position or prefer not to bid on a stand-alone basis, offers submitted by consortia or special-purpose vehicles (SPVs ) should be accepted.

In addition, it is possible that the pre-qualified bidders on the basis of their stand-alone participation in the tender will create consortia of SPV before the submission of binding offers.

Consortia, consisting of different Industrial and/or financial investors, will be allowed to participate in the tender only under the condition that at least one member of the consortium 1) fulfils all the relevant criteria. or 2) has proven experience in production and sale of Al and proven financial ability to realize investment program.

All consortium partners will have to be jointly and severally liable.

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Section 5

Eligibility and selection criteria


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Eligibility criteria

Based on our experience in similar tenders world-wide and specifically in the region of Central and Eastern Europe, taking into account the specifics of the privatisation of KAP, we recommend the eligibility criteria listed further.

Their main purpose of the eligibility criteria is to limit the number of bidders to those being serious in their participation in the tender, such with relevant experience and capacity to pay the purchase price.

Experience and financial ability

In order to secure the sound development of KAP, we believe that the potential strategic investors should be present in the aluminium industry as producer. Potential financial investor should have sufficient experience of investment fund management and should demonstrate the ability to provide adequate technical and managerial capacities. Bidders will be requested to provide details related to their involvement in the aluminium business and of any existing relationships, if any, they might have with the companies. Strategic investors will be required to have a minimum of 3 years’ experience in the

production of aluminium. Financial investors should be in operation of at least 3 years and should prove appropriate

technical experience and know-how in the production and sale of aluminium in collaboration with third parties.


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Eligibility criteria (cont’inved)

The incoming investor of KAP will be undertaking several substantial financial obligations, not only to pay the purchase price but also to settle restructured debt and to undertake an investment program. In addition, since the Government is concerned to ensure the survival and long term development of KAP and associated businesses, the financial capacity of bidders or their shareholders is of primary concern. Strategic investors’ total annual production should be no less than 120,000 tonnes of

aluminum

Financial investors will need to demonstrate a minimum funds under management of at least EUR 500 milion and to prove experience in Al Business in a way acceptable by Commission.

If a producer is a consortium, at least one member of a consortium should have Al production of at least 50.000 t annually. Consortium should provide acceptable bank guarantee (Intention letter of A bank) proving the ability of a Consortium to realize the investment program to the amount of at least EUR 120.000 mio, including solidary responsibility of all consortium members.

The incoming investor is obliged to comply with all ecological, health, protectional standards of the Republic of Montenegro and Curopean Union and to Implement Ecological action plan.

Ownership structure

The investors will be asked to provide a statement with respect to their ultimate shareholding structure and all necessary documentation demonstrating those statements.


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Evaluation criteria

Unlike eligibility criteria, where potential bidders are judged on their own merits, not on transaction-related elements, the evaluation criteria applied to the submitted bids were designed in order to judge the bidder on transaction related elements, in the most objective and indisputable manner.

After the validity of all the submitted Bid Packages is assessed, valid bids shall be evaluated according to the following proposed Bid Scoring System (BSS).

Purchase price

5 year investment program

Option of purchasing of Dowstream assets

Participation in purchasing of Bauxite Mine shares

Social aspect

Proposed model for electricity supply

Changes in purchase agreement

Purchasing of shares of minority shareholders


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Evaluation criteria (continued)

The selection criteria described above were designed to ensure simple, fair and transparent evaluation of the bids while corresponding to the objectives of the Government as well as the approach to key issues.

Other, non scored obligations will be defined by Tender Rules.


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Section 6

_______________________________________________________________________________

Tender process principles


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Tender process principles

Transparency The Government will be judged by a domestic and international audience on their capacity

to run a transparent sale process. Selection criteria should therefore be meaningful and easily measurable, ensuring that final

bids can be objectively compared. At the same time through the eligibility criteria the Government cans ensure that only the parties fulfilling its objectives can participate in the tender.

A highly transparent process should also assist in securing the highest quality of potential bidders.

Efficiency A speedy and efficient selection process is a pre-condition for a successful sale As the bidding process is expensive for bidders and can, if significantly drawn out, have a

negative impact on operations at the companies, it is vital to conclude as rapidly as possible with as little disruption as possible.

Fairness All potential bidders should be guaranteed equal access and equal information in the

process as the starting point is not necessarily the same for all parties. Some of them already have a well developed knowledge of the company.

The process must ensure full access to information and provide the time necessarily for all parties to assimilate it.

The fairness of the process will also have an impact on the quality of bidders and in this light we would stress that process should not only be fair but should be seen to be fair by participants and observers.


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Request of Expression of Interest and pre-qualification phase

The launch of the tender will be officially announced by the Agency through an invitation to express interest published in the national and/or international press and on the web site of the Privatisation Agency.

The purpose of this phase is to guarantee the seriousness, the technical capability and the financial strength of the competitors. This stage aims at pre-qualifying potential investors which comply with specific criteria. Such criteria are designed to ensure:

The integrity and transparency of the sale process, and The seriousness of undertakings given by the investors in terms of investment and

development commitments, the bidders’ management capabilities as well as payment of the purchase price and capacity to close the deal with Major Creditors.

Bidders will have three weeks to express their interest from the launch of the tender.

Bidders which will have expressed their interest for the acquisition of the Shares and have been found as satisfying the prequalification criteria on the basis of demonstrated evidence, will be invited to purchase the Tender Documentation and thus participate in the next stages of the tender.


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Circulation of the Tender Documents

A Notice of Eligibility, Confidentiality Agreement and Tender Documents Fee Invoice will be sent to Pre-qualified participants who fulfil Eligibility Criteria

The confidentiality agreement will set out a number of obligations concerning respect of the confidentiality of information to be received and restricting the right of use or otherwise damaging the value of the assets.

Upon payment of the amount for purchasing of Tender Documents and signing of the confidentiality agreement, the Tender Documentation will be made available to the pre-qualified bidders.

The Tender Documentation consists of (a) the Information Memorandum, (b) the Tender Rules, (c) the draft Sale and Purchase Agreement, and (d) other information and documentation as may be needed. The pre-qualified bidders should be given 14 days in order to analyse the Transaction Documentation before the commencement of the data room phase.

Qualified Tender Participants will be encouraged to submit drafts of the SPA with any amendments they propose to the Advisors prior to the Bid Submission Deadline for clarifications and consultation. If the Tender Commission agrees that a proposed amendment is acceptable, a new draft SPA shall be circulated to all Qualified Tender Participants including the amendment agreed.


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Due diligence

As data room contains sensitive information to add to candidates’ understanding of the business but which was not included in the Information Memorandum, their availability to candidates will be governed by rules which are fixed in advance in the instructions to bidders document. In parallel with site visits, data room will be made available to candidates and their advisers

All bidders will bid on the same set of Transaction Documents and terms and conditions. This will ensure comparability of offers; transparency of process; and crucially maximise the Government of Montenegro’s bargaining power in negotiations with the selected bidder. The final stage will consist of the submission of final the Bid package.

The due diligence phase shall be governed by the Tender rules. Participants are to submit an Access application, upon which within 7 days, participants shall be notified on the precise dates of investors’ access to the data room, site visits and management meetings.


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Negotiations with the Major creditors

The DRA imposes significant requirements in the event of any sale of the shares of KAP:

According to the DRA, KAP must notify and request the approval of the Major Creditors reasonably in advance of a proposed sale (whether by privatisation or otherwise) of a material portion of the stock or shares or assets of KAP, and of the likely terms of the proposed sale.

The completion of the sale shall be subject to the prior approval of two of the three Major Creditors.

KAP may proceed with a sale without the approval of the Major Creditors if the Restructured Debt and interest is paid off in full as a condition to the completion of the sale.

KAP may also proceed without prior approval if the sale does not result in loss of control by the present shareholders of KAP, provided that if two out of three of the Major Creditors has reasonably objected to the sale and the Major Creditors so require, the fraction of the Restructured Debt which corresponds to the proportion of the shares or assets sold is paid off.

KAP may also proceed without prior approval and no repayment if the two of the three Major Creditors object unreasonably.

Qualified Tender Participants shall be given the opportunity to negotiate the terms of the DRA directly with the Major Creditors and to seek the approval of the Major Creditors to the proposed Bid. It will be requested to state, as the part of his final bid, that bidder arrived at an agreement with the Major Creditors, allowing the conclusion of the transaction.


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Bid package and submission of bids

The precondition to submitting a bid by qualified tender participant is the procurement and submission of a bid bond. The Bid Bond may be cashed in by the Agency provided the bidder does not fulfil certain obligations arising from submitting the bid, i.e. does not sign the SPA, does not pay the purchase price, etc. The amount of the Bid Bond is set at EUR1,000,000.

The bid package will be submitted in both English and Serbian languages (except for certain supporting documents) and for some of the documents, in order to speed up the following stages of the process, will also be required in electronic form.

Bid package should consist of (Bid form shall be explained in detail in Tender Rules): Identification/Qualification Documents with all elements of financial reports, Bid Bond, proof

on sufficient finacial resources, identification details and contacts etc., Bid of purchase price with proposal for debt addressing, Investment and business plan for the 5-year period including Downstream assets and

possibly Bauxite Mine, Environmental and occupational protection program Social program Electricity supply program

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Section 7

Timetable


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Tender process overview

Launching of a public invitation for the submission of expression of interest

Pre-qualification of potential investors

Sale of tender documents to the pre-qualified potential investors

Development of due diligence by pre-qualified investors

Submission of final binding offers

Selection of the preferred bidder(s)

Negotiations and signing of the transaction documentation

Transaction closing process


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Privatisation timetable

W1 W2 W3 W4 W5 W6 W7 W8 W9 W10 W11 W12 W13 W14 W15 W16 W17 W18

Tender Announcement Expressions of InterestCirculation of Tender DocumentsAssessment of Tender Documents by investorsDue diligencePreparation of Bid packageDeadline for Bid SubmissionNegotiations with preferred bidder/s

Tender process timetable