Stephen Duck, CRU.
Between 2007 and 2011, there was a wave of metallurgical coal M&A activity. Large, publicly traded producers spent billions of dollars acquiring assets at the peak of the cycle, many of which were sold off at huge losses once prices crashed. In 2014, the slump in metallurgical coal prices triggered a second surge in M&A activity in North America, as cash flows from mining operations evaporated. In recent months, more companies have publicly declared that coal mines are up for sale and this raises the question of whether, as prices remain low, this is a good time to buy struggling assets.
Recent metallurgical coal transactions indicate positive NPVs
The US has seen the most M&A activity in recent months, as major miners in Appalachia have spun-off assets to smaller, family-owned businesses, often backed by private equity firms. The following table provides a list of recent M&A activity where there is a high-level of transparency in the details of transactions.
To assess whether there are M&A opportunities in the industry, we use a simplified discounted cash flow (DCF) model, incorporating our long-term coal price forecasts and our understanding of mines' business costs using CRU's Metallurgical Coal and Thermal Coal Cost Models. Incorporating the reported acquisition prices and our view of the business costs of each mine into our DCF model, we have assessed whether each of the deals are NPV positive under our long-term price forecast and we found the following results.
- Severstal sold its PBS assets to Corsa Coal in July 2014 for US$60 million. Corsa Coal operates a metallurgical coal complex nearby PBS mines, which we believe provides a strategic rationale for the purchase, and our analysis indicates that the acquisition is NPV positive. Under our price forecasts and cost estimates for the asset, margins per tonne are forecast to be relatively slim between 2015 to 2020, but the low acquisition price (i.e. US$23/t of capacity) ensures these are sufficient to keep the NPV of the transaction positive.
- Blackhawk Mining acquired bankrupt James River assets for US$55 million in August 2014. The Hamden mining complex in West Virginia was included in the sale, which involved Blackhawk paying US$20 million in cash and assuming US$32 million in liabilities. Taking into account these liabilities, we estimate the acquisition price at US$16.7/t of capacity. We believe that the Hamden transaction is NPV negative under our price forecast, given the mine's relatively high business costs.
- Omega Holding, a privately held firm located in Cedar Bluff, Virginia, acquired the Harold Keene coal assets from SunCoke Energy in December 2014 for approximately US$9.5 million. CRU believes that this transaction is NPV positive given the low transaction cost (i.e. US$15/t of capacity).
Each of these transactions involve mines that are some of the lowest cost in the US industry. The acquisition price of each transaction is also low enough to ensure positive NPVs under our price forecast. The analysis serves to demonstrate that coal assets can be acquired that are value creating, but the transaction price required is low (i.e. of the order US$ 15 – 25/t of capacity). This compares with almost US$300 – 700/t paid by the majors at the top of the cycle between 2007 and 2011, often leveraging on extremely low interest rates to finance their acquisitions through debt.
Mines in Australia and North America are up for sale
To assess the future M&A opportunities in the metallurgical coal sector, we have selected 15 mines for our analysis, many of which are owned by companies that are looking to divest assets. These mines are primarily located in Australia and the US, although their characteristics (i.e. mine type, mining costs, product mixes, capacities and reserves) vary considerably.
Most mines in our sample are currently operating, but we have also assessed mines that are under care and maintenance and that would require capital expenditure to commence operations. Using our DCF model, the following table assesses whether the NPV of future cash flows of each mine is positive or negative under our long-term price forecast from CRU's Metallurgical Coal Long Term Outlook and our assessment of each mine's business costs.
A number of mines in our sample in Australia, the US and Russia are NPV positive based on our long-term price forecasts. These operations are typically low-cost mines, although a number of third quartile mines, all based in the US, are also shown to be NPV positive. Unsurprisingly, the lowest cost mines provide the highest NPVs in the sample. Mines that indicate a negative NPV over the forecast period are typically high-cost mines that are producing a larger proportion of semi-soft coking coal, PCI and thermal coal.
It is interesting to calculate a maximum price for a potential acquisition by estimating the NPV of the future cash flows of each asset. The acquisition price is typically higher for the Australian mines, which are also typically the largest mines and lowest cost in the sample. US mines typically indicate lower maximum acquisition prices, reflecting their higher business costs and smaller scale of production.
The following chart indicates the maximum acquisition prices per tonne of capacity of each mine. With the exception of Mine A, a low-cost Australian mine, the maximum acquisition prices typically lie within a range of around US$25 – 200/t of capacity. This range is significantly higher than our analysis of recent transactions in the US industry in the range of US$15 – 25/t of capacity.
Metallurgical coal M&A is risky, but there are opportunities
Our analysis shows that there are metallurfical coal assets for sale that offer decent acquisition opportunities, although the success of each individual deal will depend on a number of factors, including the competitive positive of mines, as well as the long-term outlook for prices. Companies that are betting on a recovery in metallurgical coal prices may be able to buy assets that offer a return, given the low acquisition prices involved. An interesting finding from our analysis is that some higher cost mines offer value in acquisition; the maximum acquisition price required for a positive NPV for a third quartile mine is typically low, at less than US$50/t of mine capacity.
Acquiring coal assets today is fairly risky, but those with deep enough pockets to ride out low prices for a few years may be able to acquire high-quality assets cheaply. Low-cost Australian mines may offer the largest NPV, but they are riskier because of the considerable capital required to purchase the assets. Larger mines may be difficult for companies to sell, given the higher acquisition prices involved and companies may look to acquire mines with partners to reduce their exposure to this risk. US mines may be more attractive despite their smaller margins, given the reduced risk of a lower acquisition price. However, there are a number of high-cost mines that are available for sale, particularly in the US, that will continue to lose cash during a sustained period of low prices. These mines will struggle to find a buyer and will be forced to close as a result.
Written by Stephen Duck. Edited by Jonathan Rowland.
About the author: Stephen Duck is a Senior Consultant in CRU's steel raw materials team and is Editor of the Metallurgical Coal Market Outlook. He has over 5 yr experience in commodities research and strategy consulting.
Read the article online at: https://www.worldcoal.com/special-reports/09062015/to-buy-or-not-to-buy-mergers-and-acquisitions-in-metallurgical-coal-market-cru-coal/