Bloomberg News

Cloud Peak Value Means Even Record Premium Is Cheap: Real M&A

October 12, 2011

Oct. 12 (Bloomberg) -- Cloud Peak Energy Inc. is so cheap that a potential acquirer could pay a record premium for a coal producer and still secure the Powder River Basin mining company at the industry’s lowest valuation.

Even matching the coal industry’s highest takeover premium of 56 percent, a buyer would get Cloud Peak for 11.5 times this year’s estimated net income, according to data compiled by Bloomberg. At that premium, a $1.8 billion purchase of the Gillette, Wyoming-based company’s equity would be the least expensive relative to earnings of any coal acquisition greater than $1 billion, the data show.

With Rio Tinto Group’s sale of the stake in its former coal unit in December removing an obstacle, Cloud Peak may now lure takeover interest from BHP Billiton Ltd., Xstrata Plc or Glencore International Plc, according to Morningstar Inc. An acquirer could export Cloud Peak’s thermal coal to China and India as the world’s fastest-growing major economies ramp up electricity production, Morningstar said. Cloud Peak also produces cleaner coal that will be more coveted as power plants reduce emissions to comply with new pollution regulations, said Tudor Pickering Holt & Co.

“The valuation does look really attractive,” Todd Williams, a Dallas-based coal analyst and fund manager at Westwood Holdings Group Inc., said in a telephone interview. “A longer-term option is exporting Powder River Basin coal into Asia. So if you’re a global coal company and you’re looking at that situation, it’s a nice long-term option for some cheap coal.”

Westwood oversees $13.8 billion including 1.85 million Cloud Peak shares.

Today’s Trading

Molly Nichelson, a spokeswoman for Cloud Peak, Samantha Stevens, a spokeswoman for Melbourne-based BHP, and Alison Flynn, a spokeswoman for Zug, Switzerland-based Xstrata, and Simon Buerk, a spokesman for Baar, Switzerland-based Glencore, declined to comment on market speculation.

Cloud Peak shares climbed as much as 4.9 percent today before closing up 2.8 percent at $19.57 in New York trading. That was almost triple the 1 percent gain in the Standard & Poor’s 500 Index.

Rio, now the world’s second-biggest mining company, took its Cloud Peak coal unit public in November 2009 and retained a 48 percent stake. After London-based Rio sold off the rest of its holdings in December 2010, Cloud Peak Chief Executive Officer Colin Marshall said on a May conference call that the company isn’t structured in a way that “would stop someone making an offer if they wanted to.” He was responding to a question about whether the company had so-called golden parachutes or a poison pill that may deter hostile bids.

‘Anybody’s Game’

“Rio got rid of its shares,” Michael Tian, a Chicago- based analyst at Morningstar, said in a phone interview. “It’s really anybody’s game now.”

A buyer willing to pay 56 percent more than Cloud Peak’s closing stock price yesterday -- matching the highest premium in a coal deal greater than $1 billion -- would value the company at about $29.69 a share, according to data compiled by Bloomberg. The industry’s record for a premium was set in November when Walter Energy Inc. agreed to pay 56 percent more than Western Coal Corp.’s 20-day stock trading average in a $3.9 billion takeover, the data show.

A price tag of about $1.8 billion for Cloud Peak, not including $604 million in net debt, would equate to 11.5 times analysts’ estimated net income of $157.3 million this year. That would be the cheapest multiple in the industry for any deal greater than $1 billion, data compiled by Bloomberg show.

‘Nothing Else’

“It’s undervalued in the market,” Brandon Blossman, an analyst at Tudor Pickering, the Houston-based investment bank specializing in energy companies, said in a phone interview. “We like the basin and we like Cloud Peak because it’s leveraged to that basin and nothing else.”

The Powder River Basin in Montana and Wyoming, where Arch Coal Inc., Peabody Energy Corp. and Alpha Natural Resources Inc. also operate, contains the largest and least-expensive U.S. coal reserves.

“You only have a limited number of players as it is, so anyone wanting to take over Cloud Peak would have to come from the outside,” Lucas Pipes, a New York-based analyst at Brean Murray Carret & Co., said in a phone interview. “The Federal Trade Commission would probably not allow a Peabody or an Alpha or an Arch to take out the fourth player in the area.”

‘The Long Run’

Cloud Peak’s assets may instead appeal to BHP, the world’s largest mining company, Xstrata, the biggest exporter of coal burned in power plants, or commodities trader Glencore, said Morningstar’s Tian. The companies could help build the rail and port capacity on the U.S. West Coast needed to export more coal to Asia because they already have established trading routes and customer relationships in the region, Tian said.

“In recent years, Asia coal demand has spiked,” Tian said. “The Powder River Basin, located on the other side of the world, in the long run could become the bridge.”

While Cloud Peak declined 18 percent this year through yesterday amid concern the global economy may fall back into a recession, it fared better than the 29 percent retreat for the Stowe Global Coal Index of 35 companies primarily focused on coal mining and production. Cloud Peak closed at $19.03 yesterday, giving it a market value of about $1.16 billion. It traded at 1.76 times the value of its net assets, near its record low price-to-book ratio of 1.46 times, according to data compiled by Bloomberg.

Coal Prices

Cloud Peak may deserve to trade at a discount because its mines have a lower reserve life relative to competitors and won’t benefit if prices rebound for metallurgical coal used in steelmaking, Pipes at Brean Murray wrote in an August report.

Still, while economic slowdowns in the U.S. and Europe have pushed down prices for steelmaking coal from a record, thermal coal may rise as high as $138 a metric ton by 2013, helped by increasing demand for electricity in China and India, Credit Suisse Group AG said in a report on Oct. 4. China’s economy expanded 9.5 percent in the second quarter compared with the year-earlier period, while India grew 7.7 percent, the biggest increases among the world’s 10 largest economies, according to data compiled by Bloomberg.

The benchmark Asian price for thermal coal was $120.55 a metric ton in the week ended Oct. 7, according to IHS McCloskey, a Petersfield, England-based data provider. That’s 1.4 percent lower than the previous week. Prices reached a peak of $130.85 a ton in March, the data show.

‘A Little Hotter’

“It makes sense to take the stuff from Wyoming, train it over to Washington or Oregon and ship it because it’s low- sulfur, it burns a little hotter and you can deliver it cheaper,” David Beard, an analyst at Iberia Capital Partners LLC, said in a telephone interview from New Orleans. “It’s cleaner coal for the U.S. market, and it’s cleaner coal for the international market.”

The Powder River Basin’s coal for use in power plants contains 15 times less sulfur and leads to fewer emissions of greenhouse gases than coal from the eastern U.S., according to the U.S. Department of the Interior.

The Environmental Protection Agency in July issued a final regulation, the Cross-State Air Pollution Rule, requiring 27 states from New York to Texas to improve air quality by reducing power-plant emissions. By 2014, combined with other EPA actions, the rule will require the reduction of sulfur dioxide emissions by 73 percent from 2005 levels.

“More aggressive air regulation in general and sulfur specifically are going to benefit PRB and make Cloud Peak more attractive,” said Tudor Pickering’s Blossman. “It is an excellent value here for somebody.”

--With assistance from Simon Casey in New York and Elisabeth Behrmann in Sydney. Editors: Sarah Rabil, Daniel Hauck.

To contact the reporters on this story: Devin Banerjee in New York at; Tara Lachapelle in New York at

To contact the editors responsible for this story: Daniel Hauck at; Katherine Snyder at

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