Alpha, Massey to hook up

The proposed merger of Alpha Natural Resources (ANR-N) and Massey Energy (MEE-N) announced Jan. 29 will create a top-three global metallurgical coal producer in a transaction that will be cash flow accretive in the first full year of operation and accretive to earnings per share in 2012.

The new entity will be North America’s largest supplier of metallurgical coal for the world’s steel industry and a diversified supplier of thermal coal to electric utilities in the U.S. and overseas. The deal is expected to bring synergies north of US$150 million annually by mid-2012. 

The combination will allow Alpha and Massey to take advantage of geographical and asset diversification, including operations and reserves in Central and Northern Appalachia, the Illinois basin and the Powder River basin in Wyoming. The assets of both companies include more than 110 mines and combined coal reserves of about 5 billion tons, including one of the world’s largest and highest-quality metallurgical coal reserve bases.

“No other conceivable combination could create as much in the way of synergies due to the close proximity of our mines, our prep plants, reserve blocks, and the two companies’ deep experience and managerial bench strength in Central Appalachia, none.” Kevin Crutchfield, Alpha’s chief executive officer, told analysts and investors on a recent conference call.  

Many analysts agree with the logic behind the deal. “The addition of Massey’s reserve base of 2.9 billion tons to Alpha’s 2.3 billion tons should provide ANR with substantial growth potential at a time when such opportunities in the Central Appalachian region are scarce and global coal markets are tightening,” Mark Liinamaa of Morgan Stanley Research wrote in a research note to clients. 

Michael Dudas and Satyadeep Jain of Jefferies & Co. concur: “Given all the pressures surrounding Central Appalachian operations throughout the industry, consolidating manpower, ideas, mining and transport infrastructure, permits and geology required to effectively compete makes strategic sense in our view… This much speculated combination apparently withstood competing bids and Massey’s board leaning toward remaining independent.”

If the transaction goes ahead, the combined company will have the highest free cash flow generation of any pure-play, U.S.-based coal company, with a combined enterprise value of about US$15 billion and estimated pro forma 2010 revenues of about US$6.9 billion, Crutchfield outlined on the conference call. It will have pro-forma liquidity of US$1.3 billion and debt of US$2.9 billion.

The combined entity is forecast to ship 24-26 million tonnes of metallurgical coal in its first full year of operations and in excess of 27 million tonnes beginning in 2013. “We have something on the order of 25 million tonnes of export capacity so we feel pretty good about our position and ability to tap into the world export market,” Crutchfield commented.

Under the terms of the agreement, Massey stockholders will receive 1.025 Alpha shares and US$10 in cash for each Massey share. The proposed deal represents a 21% premium to Massey’s share price based on Alpha’s closing share price on Jan. 28. Alpha and Massey shareholders will own 54% and 46%, respectively, of the combined company.

Both boards support the deal, which values Massey Energy at US$69.33 per share.

In terms of integration, Crutchfield pointed out that since Alpha’s inception in 2002 it has had a proven history of success with its 2009 merger with Foundation Coal. In that case annual net synergies of US$60 million exceeded the company’s initial estimates of US$45 million by more than 30%.

“Integration has become one of Alpha’s core competencies,” he said, noting that in this deal the two companies aim to complete all integration planning before the close of the transaction. 

“Our cultures are extremely compatible with one another, which will allow for a relatively seamless transaction,” added Massey’s chief executive and president, Baxter Phillips.

When asked whether the proposed merger was a vote of confidence in the mining business in the eastern U.S., even with higher costs and regulatory issues there, Crutchfield said the risk was manageable and were offset by the deal’s global metallurgical coal potential.

“We wanted to create additional diversity but we’ve never lost confidence in Central Appalachia,” he explained. “At the end of the day, we have a deep, deep history in Central Appalachia, as do our peers at Massey Energy. We don’t discount the regulatory risk but we believe it’s constantly manageable.”

The two executives also cited statistics on steel production and demand as further evidence that the transaction makes both strategic and financial sense. World steel production is expected to increase by 42% to 1.7 billion tonnes by 2015, and global metallurgical coal imports are expected to increase 61% from 222 million tonnes in 2009 to 357 million tonnes by 2015, they said.

“There are fairly few metallurgical coal production regions around the globe and strong demand growth appears likely to continue for several years resulting in a continued structural undersupply,” Crutchfield said. 

The deal is expected to close in mid-2011. A break-up fee has been set at US$250 million.