Investing

I have received a few emails and comments on Felix and the chances of a counter offer. In summary, a counter is likely.

There are three criteria that determine the chances of a counter:

• Return on Investment of the deal based on the current price propose
• Contract flexibility based on the contract signed with the initial party
• Capability of alternate bidders to finance

Based on Yanzhou’s $18 offer they should see a 60% plus return in 2-3 years. This clearly support a counter offer. Furthermore there are parties that could create synergies from buying Felix, thereby creating an even greater return. At $24 there would still be a 20% return before synergies. If Xstrata were to bid then they could achieve substantially more than 20% because their Ulan mine is next door to Felix’s Moolarben mine. Examples of synergies would include shared transport infrastructure or marketing.

Next we consider the contract signed between Felix and Yanzhou. I was surprised by the small break fee of A$33M . While Felix directors are prevented from actively seeking another offer. They are allowed to negotiate and assist a potential acquirer once a superior offer is made. The contract appears quite supportive of an auction developing. 

Finally the ability of other bidders to finance a bid comes into question. This is probably the biggest impediment to an alternate deal. It isn’t easy to get substantial debt or equity finance right now (unless you’re borrowing from the Chinese government). Xstrata recently did a large rights offering to reduce debt as did Rio Tinto, it therefore seems unlikely that they would bid. BHP, Vale, China Shenhua, Noble and Peabody have been identified as potential bidders. There have also been rumours that Canadian Teck Resources were looking for an Australian mine to diversify their coal sources.

By looking at Felix as a percentage of the acquiring companies capital, looking at debt to market value of equity and analysing synergies it’s easy to establish who the most likely counter bids will come from.

• BHP: Felix would be a minor addition to their portfolio. They could offer shares as well as cash which might be attractive for those with large capital gains. BHP has a tiny amount of debt (though they could do a deal for Felix using available cash without additional debt) and could capture synergies with it’s current businesses. BHP seems like the most capable and obvious choice.
• Vale: Vale is not far behind BHP. Vale own AMCI who in turn on 19.9% of Felix! Felix would be a small but valuable addition to Vale’s portfolio. Vale is not highly levered and could easily afford to buy Felix with available cash or additional debt. Given that Vale already own nearly 20% of Felix they seem like a high likely candidate for a counter offer. (When I originally wrote this I incorrectly stated that AMCI was owned by Vale. Vale own AMCI Australia based in Brisbane not the AMCI that owns Felix. Vale still has the cash or debt capacity to buy Felix and Vale still has Australian operations that would provide synergies. However Vale is not as likely as when I thought the owned AMCI. Vale is still in the top 3. While you might expect Vale to be more interested in Metallurgical coal, in fact they already own Thermal coal operations in Australia, which is supportive of a bid.)
• China Shenhua are nearly 6 times larger than Yanzhou. They are very conservatively levered and Felix would end up as a small part of their portfolio. Shenhua have a very low amount of debt and could very easily buy Felix through debt. Given that Yanzhou are already bidding it seems unlikely that Shenhua would become involved. Even if the bid was substantially higher, Yanzhou has the debt capacity. Shenhua are prospecting for coal in Australia but do not have any mining operations here.
• Yanzhou is only the fourth most obvious candidate. At the offer price, Felix is 20% of their total capital so this is a substantial, company changing, acquisition for Yanzhou. They have effectively no debt so they can easily go to 20% debt to market value of equity. Even if Felix sells for more, Yanzhou have the debt capacity while remaining at a conservative debt to equity ratio.
• Rio and Xstrata are not likely acquirers. They both conducted substantial rights offerings to lower their debt and are unlikely to lever up so quickly. Felix would be a neat addition to either portfolio but the finance doesn’t make sense.
• Peabody is similar to Yanzhou in that Felix would become around 20% of the company. Peabody, however, already has debt at 33% of total capital. They would have some synergies but it seems unlikely that Peabody would be able to finance an offer.
• Teck Resources is rumoured to be looking for an Australian mine to diversify their operations and to offer their customers a wider variety of loading locations. Felix would be 10% of capital for Teck so it would be a nice addition. Teck’s debt is already 75% of capital and they are unlikely to be able to make such a substantial purchase.
• Noble is the smallest of the potential acquirers. Felix would be 45% of current capital. Noble has recently purchased Gloucester coal and it’s unlikely that Noble could manage to integrate two acquisition in such a short time. Given Noble’s current debt and size it’s also unlikely that they could finance a bid.

In closing, BHP and Vale are the obvious bidders if an auction develops. China Shenhua is not going to compete directly with Yanzhou. BHP and Vale could acquire a neat addition to their respective portfolios and achieve a high return on investment even at a substantially higher offer; both because of the attractiveness of Felix’s assets and because they would realize synergies with their existing businesses. Vale already owns 20% of Felix so they won’t need to do substantial due diligence to put together an offer.

A counter offer is reasonably likely from a non-Chinese company with the capacity to finance. It’s unlikely that Yanzhou has made their final offer. Given the synergies on offer, the ability to pay with shares and the break fee it seems likely that a counter will cause another Australian mineral company to spurn their Chinese fiancé or at least make her increase the dowry.

posted by Neil  # 9:01 AM