Walter Energy CEO Resigning Signals 60% Takeover Gain: Real M&A

Walter Energy CEO Resigning Signals 60% Takeover Gain
The Walter Energy Inc. mining offices stand in Brookwood, Alabama, U.S.. Photographer: Gary Tramontina/Bloomberg

Walter Energy Inc.’s shareholders, who lost almost $2 billion in three months on management turmoil and disappointing earnings, may still be rewarded with a $4 billion windfall if the coal producer is acquired.

Investor Audley Capital Advisors LLP said this week the southern Appalachia producer of steelmaking coal should explore a sale following Chief Executive Officer Keith Calder’s resignation after three months on the job. Walter Energy would fetch as much as $192 a share, or a 60 percent premium to yesterday’s close, based on the median earnings multiple paid in coal deals since 1998, according to data compiled by Bloomberg.

While the $12 billion price would mark the biggest takeover of a coal producer, Walter Energy makes twice as much profit per dollar of sales as the U.S. industry average, data compiled by Bloomberg show. With metallurgical coal trading near a record and the Birmingham, Alabama-based company’s shares down 15 percent from an all-time high in April, Walter Energy may lure buyers from Alpha Natural Resources Inc. to Consol Energy Inc., according to Raymond James Financial Inc. It may also attract steelmaker Cia. Siderurgica Nacional SA, Davenport & Co. said.

“It’s really an obvious takeout candidate, especially after their CEO resigned,” said Eric Green, a Philadelphia-based fund manager at Penn Capital Management, which oversees $6.5 billion and about 60,000 Walter Energy shares. “It would be extremely attractive for an international steel or materials company. There’s huge demand for met coal, and Walter’s is very high quality.”

‘Constructive Dialogue’

Michael Monahan, a spokesman for Walter Energy, declined to comment beyond the company’s July 19 response to Audley Capital. The coal producer said it welcomes “constructive dialogue” with all investors, is focused on creating long-term shareholder value and will still be led by “an experienced senior management team,” according to the statement.

Armel Leslie, a spokesman for London-based Audley Capital, declined to comment.

Walter Energy, which has operations in Alabama’s Blue Creek seam, gained mines in Canada when it purchased Vancouver-based Western Coal Corp. in April for C$5.3 billion ($5.6 billion).

Metallurgical coal, also referred to as coking coal, is used to forge steel, while the thermal form is used by utilities to generate electricity. Walter Energy’s coking coal is considered better quality because it’s purer and has a higher heat rate, making it desirable for steelmakers, said Timothy Parker, who oversees $8.5 billion in natural-resource stocks at T. Rowe Price Group Inc., part of the firm’s $509.9 billion under management globally.

‘Bee’s Knees’

“It’s excellent coal,” said Baltimore-based Parker, whose firm owned about 2.3 million shares of Walter Energy at the end of March. “It’s really essential for steelmaking, so it prices at a premium, especially because it’s very hard to find. It’s the bee’s knees.”

Walter Energy was also one of more than 40 companies that Bloomberg identified in March that met the acquisition criteria Warren Buffett listed in his annual letter to shareholders. Buffett typically prefers “simple” businesses with pretax profit exceeding $75 million, “consistent” earning power, and “good” returns on equity while employing little or no debt, according to his report to Berkshire Hathaway Inc. shareholders.

While Walter Energy has been a takeover candidate for “several years,” the company became more vulnerable to a sale after its CEO said he was stepping down just three months after he took the position, according to Penn Capital’s Green.

Management Conflict

Calder, whose resignation is effective at the end of this month, told the board of directors in a letter that he was leaving due to differing opinions on management philosophy, according to a June 30 statement from the company. Joseph B. Leonard, the interim chief from March 2010 to March 2011, will be the interim CEO again.

The company missed analysts’ earnings estimates three quarters in a row and has faced operational problems at deeper mines in Alabama. Since reaching a record April 8, the shares fell 21 percent before Audley Capital’s letter was made public, wiping out about $1.9 billion in market value, data compiled by Bloomberg show. The stock had gained 7.8 percent since the investor’s letter was disclosed through yesterday.

Walter Energy rose $5.51, or 4.6 percent, to $125.15 today in New York, the highest closing price since May 10.

The company should sell because it “now lacks the strong leadership needed,” which is “weighing on the share price,” Audley Capital, which owns 900,000 shares, or about 1.5 percent of the company, said in a July 17 letter to the board.

‘Headless Horseman’

Walter Energy could fetch $240 a share in a takeover, based on the 2012 earnings multiple that Peabody Energy Corp. and ArcelorMittal are offering for Macarthur Coal Ltd., the letter said. That would be double Walter Energy’s closing price of $119.64 yesterday.

“Walter has been the headless horseman before, and it’s about to be the headless horseman again,” T. Rowe’s Parker said. “It’s not totally shocking that some activists wanted to shake the tree.”

Coal producers have sold for a median of 7.25 times earnings before interest, taxes, depreciation and amortization since 1998, according to data compiled by Bloomberg. Applying that multiple to analysts’ estimated 2011 Ebitda of $1.66 billion, Walter Energy may draw a bid for its equity of $11.9 billion, or almost $192 a share, Bloomberg data show.

That’s $4.4 billion more than the company’s market value of $7.5 billion as of yesterday. Such a deal would also top Teck Resources Ltd.’s almost $8.7 billion acquisition of Fording Canadian Coal Trust in 2008 as the biggest in the industry.

Record Coal Prices

While J. Christopher Haberlin, an analyst at Davenport, estimates the company may fetch between $185 and $215 a share, David Beard, an analyst at Iberia Capital Partners LLC, pegs a takeover at about $160 a share.

The coal producer’s profit margin of 25 percent in the last 12 months tops 10 of 11 U.S. industry peers with market values greater than $500 million, according to data compiled by Bloomberg. The group’s average margin was almost 13 percent.

Benchmark prices for steelmaking coal settled at $315 a ton for the quarterly contract, according to UBS AG, the second-highest level on record. They slipped 4.5 percent from the all time high of $330 for the three-month contract that started April 1.

Prices have surged amid global production disruptions, including record flooding in Queensland, Australia, and labor strikes in the face of robust demand from China and India.

‘Time to Sell’

“Now is a good time to sell the company because of the near-record prices for met coal, strong global demand and constricted global supply,” said Davenport’s Haberlin, who’s based in Richmond, Virginia. “The assets have more value now than ever.”

Walter has projected that coking coal production will increase to 20 million metric tons in 2012 from sales of 7.2 million tons in 2010, prior to the Western Coal deal closing.

The company’s production growth, high-quality coal and rising international demand may attract buyers in the coal industry, including Consol Energy, a coal and natural-gas company, and Alpha, the world’s third-largest producer of steelmaking coal, said Jim Rollyson, an analyst at Raymond James in Houston.

Consol Energy has a market value of $12.3 billion, while Alpha of Abingdon, Virginia, is valued at $10.2 billion. Lynn Seay, a spokeswoman for Consol Energy, and Ted Pile, a spokesman for Alpha, said the companies don’t comment on speculation.

Rare Coal Quality

The quality of Walter Energy’s coal makes it attractive to producers of steel, which is used in buildings and cars, said T. Rowe’s Parker. Brazilian iron and steel manufacturer CSN, as Siderurgica Nacional is known, is also a potential buyer, according to Haberlin at Davenport. The company has a market value of 25 billion real ($16 billion).

Fabio Rocha, a spokesman for CSN, didn’t respond to an e-mail requesting comment.

While Walter Energy may appeal to a variety of companies, many firms in the mining industry are already in the midst of acquisitions or recently completed deals.

Alpha completed the $7.5 billion acquisition last month of Massey Energy Co., the owner of the mine in West Virginia where 29 workers died in an April 2010 explosion. That may make Alpha less likely to pursue another deal right now, said Iberia Capital’s Beard, who’s based in New Orleans, Louisiana.

Steel manufacturer ArcelorMittal of Luxembourg and St. Louis, Missouri-based coal miner Peabody announced on July 11 a proposed acquisition of Macarthur that values the Brisbane, Australia-based coal producer at A$4.7 billion ($5.1 billion).

Walter Energy Bidders

Although the bidders are still trying to persuade Macarthur, ArcelorMittal, with a $50 billion market capitalization, or Peabody, at $16.5 billion, may potentially bid for Walter Energy, said Davenport’s Haberlin, Raymond James’s Rollyson and Penn Capital’s Green.

Giles Read, a spokesman for ArcelorMittal, declined to comment. Representatives for Peabody didn’t respond to phone calls and e-mails requesting comment.

“Clearly the market has worked in their favor in terms of the strength in pricing of their commodity,” Raymond James’ Rollyson said. “Given the right circumstance, there will probably be some interest in Walter.”

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