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Categorized | Financial

Davis ready to make contrarian coal bet

Posted on June 30, 2015

Mick Davis©Charlie Bibby/FT

Former Xstrata CEO Mick Davis

Mick Davis, former chief executive of Xstrata, knows coal.

By the time Xstrata was sold to Glencore in 2013, Mr Davis had turned the miner into the world’s largest exporter of thermal coal, the type used in power stations. Coal lay behind Xstrata’s decade-long record as a corporate success story, riding the commodities boom.

    So it is no surprise that Mr Davis could make coal his first deal for X2, the private company he has established with the aim of creating a mid-tier mining group. Having secured equity commitments of up to $5.6bn from investors, X2 is talking to Rio Tinto, the miner with listings in London and Sydney, about acquiring its Australian coal assets in New South Wales.

    No deal has been finalised and X2 and Rio both declined to comment, but Mr Davis appears ready to take a contrarian bet on coal.

    The commodity has been suffering from a supply glut for years. The price of thermal coal has halved since 2011, and opposition to fossil fuels’ role in contributing to climate-changing carbon dioxide emissions is growing.

    But Mr Davis is probably focused on the opportunity to buy coal assets at a low point in the commodities cycle. “It would make sense for this to be the first foray for X2, especially given that a private equity fund should be able to take a long-term view on a commodity that is out of favour,” said analysts at Investec.

    Analysts at several firms value Rio’s Australian thermal coal assets at between $900m and $2bn, and there is a plausible long-term rationale for buying them.

    Although Japan is no longer the largest importer of thermal coal, its utilities are prepared to pay a premium to the market price to lock in reliable, high quality supplies. Many Japanese power stations are configured to burn only high-grade Australian coal.

    If Mr Davis is successful in concluding a deal with Rio, marketing rights for the Australian coal would be handed to Noble Group, Asia’s biggest commodity trader by sales. Noble was an anchor investor in X2, pledging $500m alongside private equity group TPG.

    It is almost two years since X2 announced its ambitions, and Mr Davis has been proved right in not rushing into a deal, given commodity prices have continued to decline.

    The problem for X2 remains finding an appropriate seller. Miners have generally been disposing of assets that Mr Davis would not want, or asking too high a price for those he may be interested in.

    Rio is no different. Sam Walsh, Rio’s chief executive, is wary of being excoriated by investors in years to come for having sold assets on the cheap.

    Mr Davis is not ruling out deals involving commodities beyond coal. Along with “bulks”, such as coal, he is expected to try to acquire mines producing industrial metals such as copper, manganese, nickel and zinc. Demand for these metals is more predictable than for precious ones such as gold.

    Given that a portfolio of businesses is X2’s aim, Mr Davis talked to BHP Billiton about a deal for its many unwanted assets.

    But BHP instead chose to offload its non-core businesses through the creation of a new public company, South32. It has had a difficult start, with its shares down 13 per cent since the stock started trading in May.

    Mr Davis could target a takeover of South32, which has some coal assets, or another listed company, although that would probably mean paying a premium to its share price. He has also been in talks with Anglo American, another miner selling a portfolio of unwanted coal, copper and platinum assets.

    The main competition for Rio’s thermal coal assets could come from Glencore.

    Peter Freyberg, Glencore’s head of coal, said this month it was ready to buy “bolt-on” coal assets.

    Now the world’s biggest exporter of thermal coal, Glencore’s Australian operations are next door to Rio’s. Privately, some Glencore executives see themselves as natural owners of Rio’s thermal coal assets.

    Cost savings are rare in mining deals but most likely when assets are close to each other, and analysts at Credit Suisse last year estimated potential for annual synergies of $500m from combining the Rio and Glencore operations in New South Wales.

    Paul Gait, analyst at Bernstein, says: “Glencore would get marketing and operational synergies, the price tag is not prohibitive and they already acquired Clermont [another Australian coal mine] from Rio. Against this X2 has the cash, a better balance sheet and no antitrust concerns to worry about.”