Consol Energy Seen Rising 32% on Coal-Gas Split: Real M&A

Consol Energy Inc., the coal producer that’s also trying to get in on North America’s shale-gas boom, may be one step closer to a breakup that could hand its shareholders a 32 percent gain.

The Canonsburg, Pennsylvania-based company, which has mined coal since the U.S. Civil War, said last week that it’s evaluating its corporate structure and ways to boost the stock price. Management sees some investors favoring Consol’s growing natural gas business with acreage in the Marcellus shale deposit, and others assigning more value to the cash-flow generating coal assets, leaving it to decide whether it’s time to separate the two, Nomura Holdings Inc. said.

While Consol shares rose in the past year even as most coal stocks were battered, it’s underperforming the broader Standard & Poor’s 500 Energy Index, which has been led by gains in oil and gas producers, data compiled by Bloomberg show. Deutsche Bank AG and Raymond James Financial Inc. estimate that Consol would be valued at up to $50 a share, 32 percent more than yesterday, if it were to break up. At that price, Consol’s market value would climb about $2.8 billion to $11.4 billion.

“Investors have been voicing some concerns about this conglomerate structure,” Lucas Pipes, a New York-based analyst at Brean Capital LLC, said in a phone interview. “The gas guys don’t really understand the coal business, and the coal guys don’t really understand the gas business, so ultimately this ought to be two separate companies.”

Exploring Options

Consol shares closed at a 21-month high on Oct. 11 after saying that it’s considering “all options” because investors aren’t recognizing the full value of the assets. The company was echoing a July statement that it is evaluating its corporate structure.

Consol is exploring ways to significantly reduce its coal holdings and focus more on gas, the Wall Street Journal reported last week. One idea being considered is to make the coal and gas businesses two separate publicly traded entities, the Journal said, citing unnamed people familiar with the matter.

Lynn Seay, a spokeswoman at Consol, declined to comment on specific alternatives the company is exploring and whether they include a breakup. “If and when there is something to announce,” it will be communicated to shareholders, she said in an e-mail yesterday, reiterating the company’s Oct. 11 statement.

Latent Value

Sum-of-the-parts models from Deutsche Bank, Raymond James, Nomura and Goldman Sachs Group Inc. reveal a gap between Consol’s current price and the value of its businesses. The estimates range from $39 a share to $50, versus yesterday’s price of $37.77.

Today, Consol shares rose 0.6 percent to $38.

Consol’s coal assets are in “cash flow harvest mode,” while the gas business is in the “early innings of a very material growth mode,” Curt Woodworth, a New York-based analyst at Nomura, wrote in an Oct. 3 report. While management sees operational synergies between the two, “these would have to be weighed against the value gap created from a hybrid company structure.”

The company already has been looking to sell assets to help finance the growing gas business. In April, it said it was stepping up the divestitures to include “core” assets such as its coal- and gas-transportation infrastructure.

Antero Resources Corp., a shale-gas producer with similar acreage and reserve quality to Consol, made its trading debut last week after pricing higher than expected. The stock, which has since surged 25 percent, indicates there may be unrealized value in Consol, Pipes of Brean Capital wrote in an Oct. 11 note.

Coal Disconnect

At that time, Antero’s valuation implied that Consol’s gas business may be worth about $7.4 billion, leaving the coal business -- which contributes the bulk of the company’s revenue and profit -- valued at less than $4 billion, Pipes wrote.

That means the coal unit is undervalued at just 4.5 times his estimate for 2014 earnings before interest, taxes, depreciation and amortization. North American coal companies larger than $1 billion, excluding Consol, trade for a median of 7.1 times next year’s Ebitda, data compiled by Bloomberg show.

“When you look at Consol’s coal assets, they’re very high quality, and it’s a difficult time for coal,” Pipes said.

Coal stocks have been languishing amid a supply glut that reduced prices for coking coal, used to make steel, and a drop in thermal-coal demand as some electricity plants switched to gas. The Bloomberg Industries U.S. Coal Operations Index lost 24 percent in the past year. Consol, buoyed by its energy operations, climbed 5.4 percent in that span.

Fracking Boom

Shares of North American oil and gas producers have risen amid a surge in hydraulic fracturing, or fracking, to extract gas trapped in shale formations, a market in which Consol has been increasing its presence. After years of developing coal-bed methane, natural gas found in seams of underground coal, Consol acquired Dominion Resources Inc.’s gas exploration and production business for $3.48 billion in 2010.

“Consol holds tremendous long-term value, a substantial amount of which is locked up within” the gas business, James Rollyson, a Houston-based analyst at Raymond James, wrote in an Oct. 3 report. “Consol may be able to unlock considerable value” in a breakup.

One option is to wait for production volumes and commodity prices to improve until each business is “self-reliant,” which may be as soon as 2015, Rollyson wrote. Another option is to immediately spin off the gas piece, leaving the debt with the coal company, which generates enough cash flow to support it, he wrote.

Group Discount

Consol’s gas business would benefit from being a standalone company so that it can trade alongside other producers that operate in the Marcellus and Utica shale deposits, such as Cabot Oil & Gas Corp., EQT Corp. and Range Resources Corp., according to Shawn Driscoll, manager of natural resources strategy at T. Rowe Price Group Inc. in Baltimore. Cabot shares jumped 59 percent in the past 12 months, while EQT is up 47 percent and Range Resources gained 11 percent.

T. Rowe Price, which has $614 billion of assets under management, was Consol’s second-largest shareholder with an 8.2 percent stake as of June 30, data compiled by Bloomberg show.

Consol has “a healthy conglomerate discount,” Driscoll said in an e-mail. “I absolutely think it should split the company in two.”

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