Teck to buy Fording for US$14.1 billion

Teck Cominco (TCK.A-T, TCK.B-T, TCK-N) will benefit from more than rising metallurgical coal prices in its US$14.1-billion takeover of Fording Canadian Coal Trust (FDG.UN-T, FDG-N) by using about US$3.2 billion in tax savings to cut the price.

Teck has offered US$82 in cash plus 0.245 of a Teck Class B subordinate voting share per Fording unit, which works out to about US$12.4 billion in cash and 36.9 million shares.

In return Teck will boost its interest in the Elk Valley Coal Partnership, which includes six operating mines in British Columbia and Alberta, to 100%. The mines produced 23.4 million tonnes of metallurgical coal in 2007.

Teck is already a managing partner of Elk Valley Coal, and has a 52% interest through a 40% direct interest in the partnership and a 19.9% interest in Fording units. The company also produces copper, zinc and specialty metals, and has a stake in several oil sands developments.

“This acquisition nearly doubles our exposure to metallurgical coal in a time of strong industry fundamentals,” Teck CEO, Don Lindsay, said during a conference call on July 29.

Bullish on continued demand from emerging economies like China and India, Lindsay said the company is still prepared for some volatility in the coal market.

“But the long-term trend of economic development will continue to require steel and metallurgical coal,” Lindsay said.

Lindsay cited a report by Thomson One Analytics that projected metallurgical coal to average US$278.50 per tonne in 2009 and US$244.15 for 2010.

A June report by Deutche Bank analyst Robert Clifford projects that metallurgical coal prices will fall from about US$300 per tonne this year to about US$255 in 2009 and US$204 in 2010, dropping below US$200 in the following years.

Teck plans to fund the cash portion of the deal with a US$9.8 billion bridge and term loan facility that has been fully underwritten by a syndicate of banks.

Because Teck is buying a royalty, the transaction will be treated as a Canadian Development Expense for tax purposes, which is fully deductible against Teck’s taxable Canadian income using the 30% declining balance method.

Scotia Capital analyst, Lawrence Smith, asked whether the tax benefit would be a deterrent to another potential bidder as it’s only available to someone who has a significant mining income within Canada.

“In some ways, Teck is in a unique position to take advantage of the tax shield is that a fair comment?” Smith asked.

Lindsay responded that it was fair. “But I wouldn’t overstate it,” he said. “It is an advantage that we do have.”

Earlier in the call, Lindsay said the total tax savings of the transaction are expected to be US$3.9 billion and that US$2.2 billion of that would be accrue within 14 months of closing the deal; the net of that tax savings is US$3.2 billion.

The tax savings results in a net after tax purchase price for the transaction of US$69.91 per unit compared to the US$92 offer price.

According to analyst consensus estimates in a Bloomberg Capital Markets report, Teck’s earnings before interest, taxes, depreciation and amortization (EBITDA) would be 50% higher at US$6.87 billion in 2009 with the Fording acquisition compared to Teck on a stand alone basis. At the same time, Teck will only increase its number of shares by 8%.

Teck also agreed to pay Ontario Teachers Pension Plan Board a “top-up” fee of US$105 million in connection to obligations from Teck’s acquisition of 11.25% of the Fording units from the Teachers last September.

The transaction is expected to close at the end of this coming October. Before closing, Fording unitholders will have 20 trading days to sell their units into the market as capital property.

The transaction is being structured as a sale of assets by Fording Canadian unitholders will be given income from Fording, which will be taxed as ordinary income instead of capital gain.

Teck believes many investors will do this because the Canadian tax consequences will be more attractive than holding the units through to closing and receiving the final distribution of cash and Teck B shares as income.

“We believe that large financial institutions will be keen to participate in the recirculation and buy as much of our block as they can get their hands on because they’ll end up earning a good return for their capital,” Lindsay said.

The deal is subject to a break fee of US$400 million should Fording accept another offer.

Fording has already looked long and hard for a buyer though. It set up a committee and conducted a global search to take advantage of strong coal prices and as a way to deal with its structure as an income trust before 2011 when there will no longer be tax benefits for income trusts. The committee unanimously approved the deal with Teck.

“Teck is the logical and best buyer for Fording Canadian Coal Trust,” said Fording’s committee chair, Michael Grandin during the conference call.Teck shares rose 6% on the news, up $2.44 per share to $42.85 on a trading volume of 7.7 million shares.

Fording shares were up nearly 8%, or $6.55, to $90.35 apiece on a volume of 8.4 million shares.

This is a second major coal-related acquisition in a short time. In July, Cleveland-Cliffs (CLF-N) merged with Alpha Natural Resources (ANR-N); a US$10-billion deal creating an entity consisting of nine iron-ore facilities and more than 60 coal mines across North America, South America and Australia. The merged company will be known as Cliffs Natural Resources.