Wilbur Ross Believes M&A Activity in Coal Will be Unprecedented in Next 12 Months

First, thanks for a reader for highlighting this story.

Second, I always like when smart people who have made a lot of money agree with my thesis that aside from being great secular growth stories, that any day one can wake up and find your coal stock a target of acquisition.

Third, the stock prices in the short run have very little to do with the long run. I continue to stand by these names as the hedge funds tell us the world is slowing (gosh I was on that beat 9 months ago, glad they finally caught on) and its time to buy Citigroup (C). Oh and by the way, the world was not slowing 4 weeks ago when these stocks were the apple of everyone's eye. It just slowed about 2 weeks ago. Sure.

• Cleveland-Cliffs Inc.'s $10 billion takeover of Alpha Natural Resources Inc., the biggest in the coal industry, may unleash a wave of acquisitions in a business where it's proving cheaper to buy than to build.
• Coal company shares typically trade at a discount to the value of their reserves to reflect mining and transportation costs as well as the life of the mines.
• Peabody Energy Corp.'s deposits of 9.3 billion tons, the world's largest, are worth at least $146 billion at today's market prices, while the St. Louis-based company's stock is valued at $19.6 billion on the New York Stock Exchange.
• Massey Energy Co.'s reserves total about $240 billion, compared with the $6.25 billion valuation of its shares.
• Arch shares rose 33 percent this year. The company's reserves are worth at least $47 billion, compared with its stock value of $8.6 billion.
• The top eight U.S. coal producers, worth more than $50 billion, are still up for grabs. (to put in perspective, this is a fraction of the Exxon's or Chevron's of the world - in fact it's less than either of the major potash producers we own)
• ``In the next 12 months there will be an unprecedented amount of both domestic and cross-border mergers and acquisitions,'' said Wilbur Ross, chairman of International Coal Group Inc. in Scott Depot, West Virginia, and a board member at ArcelorMittal, the world's biggest steel company. ``U.S. reserves are undervalued relative to those in the rest of the world.'' (this guy is genius, much like Buffet - whose playing the same trends in railroads. Ross got into coal when it was not sexy and look what board he sits on - the largest steel maker in the world - makes you wonder if ICO will be bought up by MT)
• Coal prices more than doubled this year to $119.50 a ton on the U.S. East Coast. Demand soared 33 percent worldwide in the past five years because coal is combined with iron to make steel and is used to produce 29 percent of the world's power, according to data compiled by BP Plc.
  
• Cleveland-Cliffs, North America's biggest producer of iron ore, is buying Abingdon, Virginia-based Alpha for its 57 mines and 617 million tons to provide more raw materials to the steel industry. The purchase values Alpha's reserves at $16.19 a ton, 35 percent more than on July 15.
• The increasing need for power in emerging markets also puts a premium on coal. China, the world's fastest-growing economy, gets 80 percent of its electricity from the mineral. India uses coal to generate about half its energy. (but as China drops from 11% GDP growth to 10% - current - heck 6% in the future if things get really bad - they won't need coal; even though they are building a plant a week - so says hedge funds this week)
• The 11 percent decline in the dollar index, which measures the U.S. currency against six of its biggest trading partners, also makes U.S. coal cheaper to foreign buyers. (another key - our assets are cheap, we're on sale! 11% is just this year - go look at it the past half decade)
• ``The likelihood of overseas investors is growing stronger because of the weak dollar,'' Steven Leer, the chief executive officer of St. Louis-based Arch Coal Inc., said in an interview last month.
• Massey canceled plans to sell itself in June 2007 because of a lack of buyers. Its shares rose 182 percent since then and it's now looking to make acquisitions. (how quickly the worm turns, a lot of uninterested bidders must be kicking themselves) ``Our stock price will allow us to do some transactions that we haven't been able to do in the past,'' Mike Bauersachs, Massey's vice president of planning, said on June 27. The company plans to buy mines or reserves near its existing operations in West Virginia and Virginia to spread costs and maintain growth, he said.
• ``Not all coal companies are getting windfall profits from higher prices,'' said Jeff Watkins, an industry analyst at Hill & Associates. ``Their costs have increased dramatically.''
• ``It's clear that steel companies are willing to pay a premium to secure supplies of met coal,'' Jeremy Sussman, an analyst Natixis Bleichroeder in New York, said today in an interview.
• Foundation Coal Holdings Inc., based in Linthicum Heights, Maryland, James River Coal Co. of Richmond, Virginia, and Walter Industries Inc. of Tampa, Florida, are likely targets of steelmakers and larger mining rivals, Sussman said. Each is valued at less than $6 billion. (we own 2 of those 3)
• Ross, the billionaire investor who helped consolidate the U.S. coal and steel industries, says this is the start of a round of mergers that will prove Cleveland-Cliffs prescient in its Alpha bid. ``People will look back on this as the first major U.S. event, not as overpriced,'' Ross said yesterday in an e-mail. (well everyone other than Harbinger Partners that is)

So here's the scoop. Some of these stocks are breaking down on their charts as the "commodities are dead" trade is on in the hedge funds. We could sell, limit our exposure, and try to get back later at lower prices. Or one day we can wake up and one of our companies are bought out for a 30-40% premium. Hopefully not by a company with an activist hedge fund trying to kabosh the deal. So I'd rather take "unrealized" losses even if it causes short term performance drag because frankly these are all cheap if you are looking out past 2008. If you look backwards they look expensive but so have fertilizer stocks for the past 300%. And you would never of owned them.

We own 4 coal companies now - I would not be surprised if all 4 are bought out within 24-36 months. Unless steel prices drop 50% and the Middle East, China and India decide to punt the middle class back to their farms or in the Middle East case wherever they lived before. But that doesn't mean the stocks won't correct (perhaps sharply) in the next day, week or few weeks. They've had tremendous runs. Thesis doesn't change at any price especially with all these stocks now at about 10x 2009 estimates (which I believe will prove to be too low) If/when they reach 20x by December 31, 2009 that is a double (or more) in each name in under 18 months. And 2010 estimates will be even better. The action between now and then is white noise.

Long Massey Energy, James River Coal, Alpha Natural Resources, Cleveland Cliffs, Walter Industries in fund; long Alpha Natural Resources in personal account (just sold Cleveland Cliffs in personal account due to Harbinger and potential for weeks/months of blah - or not)