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Privatization strategy
Kombinat aluminijuma Podgorica
DRAFT
KAP PROJECT
June 2004
June 2004
1
Privatization strategy of Kombinat aluminijuma Podgorica
Section
Executive Summary
KAP PROJECT
June 2004
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
2
Executive summary
3
Executive summary
KAP PROJECT
June 2004

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
KAP PROJECT
June 2004

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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Objectives of the Government of Montenegro
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 longterm 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.
KAP PROJECT
June 2004
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Objectives of the Government of Montenegro

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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June 2004
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Objectives of the Government of Montenegro

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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June 2004
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Objectives of the Government of Montenegro

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.
KAP PROJECT
June 2004
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Section 2
Investors’ rationale and concerns
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Investors’ rationale and concerns
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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Investors’ rationale and concerns

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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June 2004
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Investors’ rationale and concerns

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)
KAP PROJECT
June 2004
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Investors’ rationale and concerns

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.
KAP PROJECT
June 2004
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Section 3
Key issues
16
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)
-
KAP PROJECT
June 2004
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
KAP PROJECT
June 2004
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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
KAP PROJECT
June 2004

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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June 2004
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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 presanctions 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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June 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:
KAP PROJECT
June 2004

The debt toward the Government, State funds, domestic state companies as well as presanctions 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.
23
Electricity price
KAP PROJECT
June 2004
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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)
KAP PROJECT
June 2004
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.
a)
b)
Price relation EPCG-KAP for the period 2006-2008
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;
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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June 2004
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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. 01.01.200601.01.2010, 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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June 2004
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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:
KAP PROJECT
June 2004

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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June 2004
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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:
KAP PROJECT
June 2004

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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June 2004
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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:

KAP PROJECT
June 2004
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.
34
Downstream capacities
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June 2004
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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:
KAP PROJECT
June 2004

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.
36
The Bauxite mine
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June 2004
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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.
KAP PROJECT
June 2004
38
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
KAP PROJECT
June 2004

Sale of minority block of shares (31,38 % owned by Funds)

Possibility of KAP’s buyer to continue buying shares at free stock market.
39
Section 4
Target investors’ group
40
Target investor group
KAP PROJECT
June 2004

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.
41
Target investor group – Strategic investors
KAP PROJECT
June 2004

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.
42
Target investor group – Financial investors
KAP PROJECT
June 2004

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.
43
Target investor group – Financial investors (cont’d)
KAP PROJECT
June 2004

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.
44
Target investor group – Consortia and SPV (Organization for
special purposes)
KAP PROJECT
June 2004

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.
45
Section 5
Eligibility and selection criteria
46
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.


KAP PROJECT
June 2004
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.
47
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.
KAP PROJECT
June 2004
48
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

KAP PROJECT
June 2004

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
49
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.
KAP PROJECT
June 2004
50
Section 6
_______________________________________________________________________________
Tender process principles
KAP PROJECT
June 2004
51
Tender process principles
KAP PROJECT
June 2004

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.
52
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:


KAP PROJECT
June 2004
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.
53
Circulation of the Tender Documents
KAP PROJECT
June 2004

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.
54
Due diligence
KAP PROJECT
June 2004

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.
55
Negotiations with the Major creditors


KAP PROJECT
June 2004
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.
56
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):
KAP PROJECT
June 2004

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
57
Section 7
Timetable
58
Tender process overview
KAP PROJECT
June 2004

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
59
Privatisation timetable
Tender process timetable
W1
W2
W3
W4
W5
W6
W7
W8
W9
W10
W11
W12
W13
W14
W15
W16
W17
W18
Tender Announcement
Expressions of Interest
Circulation of Tender Documents
Assessment of Tender Documents by investors
Due diligence
Preparation of Bid package
Deadline for Bid Submission
Negotiations with preferred bidder/s
KAP PROJECT
June 2004
60