Cleveland-Cliffs bids for coal miner Alpha Natural

If the takeover by Cleveland-Cliffs (CLF-N) of Alpha Natural Resources (ANR-N) goes ahead, the new entity will own nine iron-ore facilities and more than 60 coal mines across North America, South America and Australia.

The US$10-billion cash-and-stock deal brings together North America’s largest producer of iron ore pellets and an Appalachian coal miner producing metallurgical coal, used to make coke (a key ingredient in steel production), and steam coal, used as fuel to generate electricity.

To be called Cliffs Natural Resources, the new company will be one of the world’s largest suppliers to the global steel industry with a reserve base of about 1 billion short tons of iron ore and about 1 billion tons of metallurgical and thermal coal.

Management anticipates annual sales volumes to exceed 30 million tons of iron ore, nearly 18 million tons of metallurgical coal, and 17 million tons of thermal coal.

Under the agreement, Alpha stockholders would receive 0.95 of a Cleveland-Cliffs share, plus US$22.32 in cash. Based on Cleveland- Cliffs’ July 15 closing price of US$111.46 per share, the offer is worth US$128.12, a 35% premium to Alpha’s stock price.

Cleveland-Cliffs shareholders would own about 60% of the new company, with Alpha shareholders holding the remaining 40%.

JPMorgan Chase Bank is providing an underwriting commitment for up to US$1.9 billion to finance the transaction.

“The combined company is expected to generate significant cash flow, which will be used to reduce debt and take advantage of addi- tional consolidation opportunities,” Laurie Brlas, Cleveland- Cliffs’ executive vice-president and chief financial officer, said on a July 16 conference call.

The two companies note that their combined revenues for this year are expected to fall in the range of US$6.5 billion, generating earnings before interest, taxes, depreciation and amortization, or EBITDA, of US$1.9 billion.

Next year, Cliffs Natural Resources anticipates revenues of roughly US$10 billion and EBITDA of US$4.7 billion — a lot of cash that can be used to buy other assets should the right deals come along.

Tony Robson, an analyst covering Cleveland-Cliffs at BMO Capital Markets in Toronto, notes there are pros and cons to the deal.

“At almost US$20 billion, it would create America’s largest diversified bulk commodity producer and with a bit of a P/E multiple expansion, it might end up as the third-largest mining company in the United States after Freeport- McMoRan Copper & Gold and Alcoa,” he says. some diversity against the vagaries of commodity prices and a steadier cash-flow stream,” Robson adds. “But there are no other sizable iron ore plays, so it takes away from the exposure Cleveland-Cliffs previously had.”

‘The negative is that the existing shareholder base was mostly in Cleveland-Cliffs because it wanted iron ore exposure and that exposure is (now) very much diluted by coal going forward.’

“The negative is that the existing shareholder base was mostly in Cleveland-Cliffs because it wanted iron ore exposure and that exposure is (now) very much diluted by coal going forward.”

Robson says that about 60% of next year’s revenue would be from coal and rest from iron ore, so the new entity would be a predominantly coal company.

“It’s good from management’s point of view because it brings Management anticipates synergies of at least US$200 million starting in 2010 –largely through efficiencies in coal processing and blending as Cleveland-Cliffs combines its high-quality coal with the deep operating experience of the Alpha team, according to Cleveland- Cliffs’ Brlas.

Cleveland-Cliffs acquired its coal mines last year through a merger with PinnOak Resources, a premium-quality metallurgical coal producer that operated two mines in West Virginia and one in Alabama and had reserves of about 140 million tons.

Mark Liinamaa, a mining and metals analyst at Morgan Stanley in New York says the deal gives Cleveland-Cliffs valuable coal mining expertise.

“I have a lot of respect for the folks that run Alpha and as Cliffs gets into the coal business, I think having some top-quality coal mining expertise is going to be a plus.”

Liinamaa also notes that the price Cleveland-Cliffs offered was “very reasonable based on what we think Alpha can earn. It’s not particularly expensive at all, so I think they’re getting a pretty good deal if the deal goes through.”

While Liinamaa acknowledges some investors may be worried about the price of coal going forward, his view on the sector is bullish.

“We think the supply-demand picture for coking coal is very tight and we’re going to see very high prices relative to historical prices.”

Cleveland-Cliffs currently runs six iron ore mines in Michigan, Minnesota and Eastern Canada, and three coking coal mines in West Virginia and Alabama. It also owns 85% of Portman, a large iron-ore mining company in Australia, serving the Asian iron ore markets with direct-shipping fines and lump ore. In addition, the company has a 30% interest in the Amapa iron ore project in Brazil, and a 45% economic interest in the Sonoma coking and thermal coal project in Australia.

Alpha is a leading supplier of high-quality Appalachian coal to the steel industry, electric utilities and other industries. Created in 2002, it has coal reserves of 617 million tons. About 89% of its reserve base is high-BTU coal and 82% is low in sulphur, qualities that are in high demand among electric utilities that use steam coal. Alpha is also one of the country’s largest suppliers and exporters of metallurgical coal. It has 57 mines in four states supplying 11 coal preparation and blending plants.

Alpha’s Quillen estimated that next year, Alpha would post sales of about 30 million tons of steam and metallurgical coal.

After the reorganization, Quillen will serve as non-executive vice-chairman of the new company and hold a seat on its board, while Joseph Carrabba, chairman, president and chief executive of Cleveland- Cliffs, will serve as chairman and chief executive.

As for the future of coal prices, management is optimistic.

“We have a hard time convincing ourselves we’re going to see a large-scale magnitude of global slowdown,” Carrabba said during the conference call. “There might be some blips, but. . . we’re bullish on the cycle long-term, and once we got through those risk parameters, we were quite comfortable with the deal.”

The merger announcement created quite a stir in the markets, with Alpha’s stock rising and Cleveland-Cliffs’ falling.

On July 16, Alpha shares closed at US$104.93, up 10.5% from the previous day’s close of US$94.92, on a trading volume of 17.54 million shares.

Cleveland-Cliffs shares fell to US$104.02 apiece, down 7.4% from their previous close of US$111.46 per share, on a trading volume of 15.78 million shares.

Some analysts attribute the drop in Cleveland Cliffs’ share price to arbitrage and the fact that the deal is opposed by its largest shareholder, New York hedge fund Harbinger Capital Partners.

Harbinger, which controls roughly 16% of Cleveland-Cliffs’ stock (16.6 million of 105-107 million common shares), stated in a Securities and Exchange Commission filing last week that it believes the purchase of Alpha “is not in the best interest of shareholders.

It did not elaborate on the reasons behind its opposition to the deal. Harbinger said that it may approach the board, shareholders and others with proposals for alternative strategies.

Jorge Beristain, an analyst at Deutsche Bank in New York describes the merger in a research note to clients as “a bold move” that should create a North American industry leader. Beristain has a buy on the stock and has set a 52-week target price of US$150 per share.

The deal is “well structured, enhances Cleveland-Cliffs’ position to supply integrated steel companies, fortifies
its energy-related coals business and builds a solid foundation for further organic growth and M&A,” Beristain wrote. “We note current elevated spot prices for met coal and tight supply- demand balance bode well for the sharp increase in coal exposure (at more than 50% of estimated 2009 revenues).”