Get Your Head in the Cloud

Investors must have their head in the clouds to shun this IPO.

Global mining giant Rio Tinto (NYSE: RTP  ) continues to raise capital to reduce the daunting debt burden left over from that ill-timed Alcan acquisition, and the result is a new investment vehicle for coal that has been ruthlessly spurned by an increasingly cautious market.

Cloud Peak Energy (NYSE: CLD  ) may have spooked some would-be investors with the hasty issuance of $600 million in new debt, but the lackluster reception of the shares offered through the IPO raises this Fool's value-focused eyebrows. With shares representing a 52% stake in the company garnering less than $459 million, and roughly half the proceeds of the senior note offerings going back to Rio Tinto, the implied enterprise value for the new entity comes in at around $1.2 billion. Relating that valuation back to the underlying coal assets, I detect the scent of Foolish opportunity.

Looking to comparable sales
Like house hunters scrutinizing comparable sales, we have a telling transaction from the recent past to shed light upon the present valuation of these new Cloud Peak shares. Back in March, Rio Tinto managed to sell its Jacob's Ranch coal mine to Arch Coal (NYSE: ACI  ) for $761 million. At the time, I pointed out that the transaction valued the coal assets in the ground at about $2 per ton. Since all three of the coal mines comprising Cloud Peak Energy's assets are located in the same Powder River Basin (PRB) region of Wyoming and Montana as the mine that Arch Coal purchased, and given the comparable ore quality among all of these mines, it would seem that investors have an opportunity to outperform Arch Coal's cost basis for similar assets.

Looking to Rio Tinto's ore reserves as of December 31, 2008, we find that the three mines in the Cloud Peak portfolio boasted combined proven and probable reserves of 948 million tons. Essentially, Rio Tinto has just sold a 52% stake in producing PRB coal mines to you -- the public -- for about a third less than Arch Coal paid for similar assets earlier in the year. The results of the IPO value the assets at about $1.27 per ton. These mines produced a combined 94 million tons of coal in 2008, which represents only about 78% of total permitted capacity.

Although Peabody Energy (NYSE: BTU  ) recently noted persistent weakness in domestic demand, rival Arch Coal has noted the emergence of export demand for PRB thermal coal emanating from Asia. If this matures into a trend, it could provide a boost to railroads like Union Pacific (NYSE: UNP  ) and Berkshire Hathaway's (NYSE: BRK-A  ) Burlington Northern Santa Fe (NYSE: BNI  ) that haul the stuff, but I believe that the biggest boost for investors could come to those with their heads in the cloud.

The "Coal" tag in the Motley Fool CAPS community lists 25 companies. Find out what other investors are saying about the stocks you're watching, or share your Foolish thoughts with us. CAPS is free and fun!

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly in the CAPS community under the user name TMFSinchiruna. He tweets. He owns shares of Arch Coal and Peabody Energy. Berkshire Hathaway is a Motley Fool Stock Advisor selection, a Motley Fool Inside Value recommendation and The Fool owns shares of it. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool and its disclosure policy are firmly coupled.


Read/Post Comments (4) | Recommend This Article (31)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 23, 2009, at 8:09 PM, toothdude wrote:

    CLD will be a $28-$30 STOCK BY NEXT QUARTER or should be. JMO

  • Report this Comment On November 24, 2009, at 2:27 PM, jmsp8 wrote:

    I bought 200 - I think mostly because of CLD's size it will eventually be sold to ACI or perhaps BTU at a higher price. CLD came from a good dividend paying company so if it doesn' get sold and pays a 2% or better dividend - I might keep it. If it goes down below $13.00 I will probably buy another 200.

  • Report this Comment On November 24, 2009, at 5:09 PM, retireddelfool wrote:

    I think CLD is a bargain period.

    I bought CLD at $14.45 and will buy more once I get rid of some clunkers.

    Thank you Rio......

  • Report this Comment On December 01, 2009, at 3:54 PM, Reaktor1 wrote:

    It's getting coald and dark out, time to get in on clean coal. On sale today for $13.30, nice entry point.

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