Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

It's often said that the art of the takeover lies not in the deals you do, but the ones you pass over. There are few more telling proofs of this maxim than the 2011 acquisition of Australian miner Macarthur Coal Ltd.

The deal was conceived as a joint bid by steelmaker ArcelorMittal and U.S. coal miner Peabody Energy Corp. Lakshmi Mittal bailed midway through, attracting a degree of mockery in some quarters.

A Billion Here, a Billion There
Only bankruptcy could discharge the net debts Peabody took on to buy Macarthur Coal
Source: Bloomberg

His instincts turned out to be correct. Left solo to shoulder $4.1 billion of debt, Peabody soldiered on for five years as falling coal demand and prices whittled away the cash margins it needed to service its borrowings before finally spiraling into Chapter 11 bankruptcy last year. ArcelorMittal has hardly had an easy ride, but it at least escaped that fate.

There is an unexpected coda to this sorry tale, though. Six years on from Peabody's disastrous bet on exporting Australian coal to Asia, the wager appears to be finally paying off. Adjusted Ebitda from Australian mines came to $241 million in the September quarter, Peabody said Wednesday, oustripping the $197 million from its U.S. pits despite accounting for less than a fifth of total tonnage.

Delayed Gratification
Six years on from a takeover that nearly killed the company, adjusted Ebitda from Peabody's Australian mines is finally firing
Source: Bloomberg

After years of operating on almost invisible margins or at an outright loss, Peabody's Australian operations have taken the larger share of earnings in every one of the past four quarters barring March.

The Macarthur takeover got almost everything wrong, but that performance is an indication of one big thing that was more or less right: Peabody's U.S. operations, despite comprising some of the world's biggest and highest-quality thermal coal mines, remain under long-term threat from the growth of natural gas and renewables.

A shift toward supplying the Asian steel mills that consume the coking coal in Macarthur's deposits is the best way to make the most out of the global decline of coal. Rio Tinto Group, which has sold out of its last thermal mines, still has a couple of coking pits to supply this more resilient market.

Peabody doesn't deserve too much credit. While its Australian coking coal mines have done well out of a price spike induced by a cyclone in April and China's resurgent steel production since then, little of that can be attributed to the Macarthur takeover.

Only one of the three pits it acquired in that deal, Coppabella, was called out by Chief Executive Officer Glenn Kellow as a core operation in Peabody's earnings briefing. The other key coking coal mines, Millennium and North Goonyella, had been part of its portfolio long before 2011.

That transaction was also a bet that the rise and rise of China's steel sector would be cheap and dirty. Macarthur's main product is pulverized coal, a variant whose chief advantage for blast furnaces is that it costs less than higher-quality coking coal. In fact, as Gadfly noted last week, the movement in China's steel industry has been up rather than down the cost curve, toward higher-grade iron ores that need less coal in the blast furnace feed.

Steel Glints
The estimated profitability of Chinese steel mills has leapt through 1,000 yuan a ton
Source: Bloomberg Intelligence

At present, the sun is shining on Peabody's Australian pits. Profits at Chinese steel mills have leapt through 1,000 yuan ($150) a metric ton, giving owners plenty of scope to pay top dollar for high-quality carbon. The Macarthur takeover almost killed Peabody. As cleaner fuels supplant its core business supplying American power stations, it may yet be its salvation.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net