Cleveland-Cliffs to merge with Alpha Natural Resources

After Cleveland-Cliffs (CLF-N) and Alpha Natural Resources (ANR-N) wrap up their merger, 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 Alpha, 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 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 will receive 0.95 of a Cleveland-Cliffs share, plus US$22.32 in cash. Based on Cleveland-Cliff’s July 15 closing price of US$111.46 per share, the offer is worth US$128.12, or a 35% premium to Alpha’s stock.

Cleveland-Cliffs shareholders will 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.

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 billiona lot of cash that can be used to buy other assets should the right deals come along.

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

Management anticipates synergies of at least US$200 million starting in 2010largely through efficiencies in coal processing and blending as Cleveland-Cliffs combines its high-quality coal with the deep operating experience of the Alpha team, Brlas added.

“The synergies are really built as much around the operating excellence that Alpha certainly brings to the existing coal mines that we bought through the PinnOak acquisition,” Joseph Carrabba, chairman, president and chief executive of Cleveland-Cliffs said.

In July 2007, Cleveland-Cliffs acquired PinnOak Resources, a premium-quality metallurgical coal producer that operates two mines in West Virginia and one mine in Alabama. PinnOak controls reserves of about 140 million tons.

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 (FCX-N) and Alcoa (AA-N).”

“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. Approximately 60% of next year’s revenue would be coal and 40% iron ore so it would become a predominantly coal company.”

“It’s good from management’s point of view because it brings some diversity against the vagaries of commodity prices and a steadier cash-flow stream,” Robson adds, “but there are no other sizeable iron-ore plays so it takes away from the exposure Cleveland-Cliffs previously had.”

Currently Cleveland-Cliffs operates six iron ore mines in Michigan, Minnesota and Eastern Canada, and three coking coal mines in West Virginia and Alabama. Cliffs 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 Amap project, a Brazilian iron ore project, and a 45% economic interest in the Sonoma project, an Australian coking and thermal coal project.

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 sulfur, qualities that are in high demand among electric utilities that use steam coal. It 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 will 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 Cleveland-Cliff’s Carrabba will serve as chairman and chief executive.

As for the future of coal, the team is all glass half-full. “We have a hard time convincing ourselves we’re going to see a large-scale magnitude of global slowdown,” Carrabba said. “There might be some blips, but certainly not in the long-term. We’re long on the cycle. We’re bullish on the cycle long-term, and once we got through those risk parameters, we were quite comfortable with the deal.”

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

Alpha shares closed at US$104.93 on July 16, 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 its previous close of US$111.46, on a trading volume of 15.78 million shares.