If you were to take two of the fastest-growing names in one of the world's most acutely undersupplied raw materials, and squeeze them together with all the fundamental strength of a long-term "global supercycle" of expanding demand, you would create a diamond.
Already a veritable gem before the transaction, Alpha Natural Resources (NYSE: ANR ) has fashioned itself into a many-faceted diamond masterpiece with $7.1 billion acquisition of rival Massey Energy (NYSE: MEE ) announced Monday morning. The new-and-improved Alpha will control more than 5 billion tons of coal in reserves, and command an enterprise value of some $15 billion.
At an implied valuation of $69.33 per share for Massey, this friendly offer tacks a 21% premium onto the pre-announcement share price, and stands some 86% above where the shares traded when Fools first mulled this Massey sale back in October. Massey shareholders will take home $10 in cash per share, plus 1.025 shares of Alpha, in a transaction that I consider a meaningful victory for holders of either stock.
The Massey name, tarnished as it was by that deadly mine explosion and a questionable environmental record, will now be fittingly retired. Alpha, which emerged after its compelling 2009 purchase of Foundation Coal as the alpha miner of the U.S. met coal pack, will abruptly balloon in scale to chase global met coal production leaders BHP Billiton (NYSE: BHP ) and Teck Resources (NYSE: TCK ) .
Resurveying the strategic landscape
This deal alters the coal miners' playing field in fascinating ways. Even the king of coal -- Peabody Energy (NYSE: BTU ) -- sits suddenly less comfortably upon its throne. Peabody generated nearly $6.9 billion in revenue for 2010, which happens to mirror the precise estimate of pro forma 2010 revenue for the combined Alpha and Massey operations. The royal's market heft will exceed that of pro forma Alpha by only about 20%, leaving principally their disparate product mixes and geographical profiles as key distinguishing features between the two.
With Peabody's growth strategy clearly focused upon Australia, Arch Coal (NYSE: ACI ) and Alpha Natural Resources could prove very effective at amassing domestic market share going forward. Arch will remain substantially more heavily weighted in steam coal production than Alpha, though Arch is targeting a respectable 7 million tons of met coal production from its Central Appalachian operations in 2011.
While Alpha will become "America's largest supplier of metallurgical coal for the world's steel industry," Fools are reminded not to overlook the significance of the miner's thermal coal exposure. From its coveted high-quality Appalachian coals, to its high-volume operations in Powder River Basin, the new Alpha will be in a position benefit enormously from expanding coal-fired generation worldwide ... in parallel with the anticipated strength in long-term met coal demand.
Even for a met-heavy miner like Alpha, steam coal remains the bread-and-butter, while the higher per-ton margins available in met coal production are like pasta dinner that gives you something to dip your bread into. Through the first nine months of 2010, for example, Alpha derived fully 61.5% of its sales from coals bound for the thermal market. The Massey acquisition will tip the product-mix needle meaningfully in the direction of met coal -- particularly when we factor-in Massey's targeted doubling of met coal production capacity to 20 million tons by 2015 -- but tracking long-term trends in thermal coal pricing and supply must remain a key aspect of a Fool's due diligence even after this move toward met.
Snapshot of a fast-moving met market
Nearly one full year has passed since I urged Fools to prepare for a meaningful surge in met coal prices and the shares of companies that mine the stuff. In the interim, each of the producers discussed therein has at least doubled the impressive price performance of the S&P 500. Exacerbating the price increases that had already taken hold amid an acutely undersupplied market, recent flooding in Australia significantly hampered global output and sent Pacific seaborne spot prices soaring toward the $300 mark.
Consolidation fever has taken hold in a very major way. Steelmaker ArcelorMittal recently opted for a $593 million move into the Canadian Arctic. Walter Energy (NYSE: WLT ) walked away with Western Coal for a cool $3.24 billion. Peabody Energy was stymied in its $3.3 billion bid for Australia's Macarthur Coal last May, while Massey Energy jump-started the dealmaking in 2010 with its $960 million acquisition of Cumberland Resources. That flurry of activity follows an eventful 2009, which featured Yanzhou Coal Mining's $2.9 billion foray into Australia and Alpha's $2 billion grab for Foundation Coal.
The metaphysics of met coal supply and demand
Long after the Australian floods have receded, and that nation's critical output is restored, I maintain that the persistent drivers of a dramatic bull market for metallurgical coal will persist ... much to the benefit of Fools who approach the sector with an appropriately long-term perspective. Peabody recently reiterated its bullish five-year forecast for 30% growth in worldwide steel consumption over the next five years ... requiring an incredible 300 million tons of additional annual met coal production. Even if only a fraction of forecasted demand were to materialize, I believe this is one commodity that will remain in very short supply for many years to come. I intend to hold my position in Peabody Energy for the long haul, and soon I may just have to make some room beside it for the newest $15 billion behemoth of the coal world: Alpha Natural Resources.