Alpha Natural Resources Diversifies with Foundation Coal Purchase

Yesterday, Alpha Natural Resources, Inc. (ANR) announced that it would purchase, in an all stock deal, Foundation Coal Holdings, Inc. (FCL) whereby FCL shareholders would receive 1.084 shares of ANR for every share of FCL. Based off of its 5-day moving average of $32.73 per share, this represents a 37% premium over FCL’s 5-day moving average.

Alpha will also assume the +$500 MM of Foundation’s net debt. The merged company will trade and operate under the Alpha name. The merger effectively gives the new company diversification -- the old ANR was exclusively focused in Central and Northern Appalachia (W. Virginia, Virginia, Kentucky, Pennsylvania), while the majority of Foundation Coal reserves and production come from the Powder River Basin (Wyoming). The reserve diversity will help the new ANR because the old ANR brings a higher margin product -- metallurgical coal -- whereas Foundation Coal produces almost all steam coal, which is used in the electric generation process, and does not experience as much market volatility as metallurgical coal.

Because Central Appalachia faces ongoing operational and environmental issues, acquiring a foothold in a major western U.S. coal basin will reduce the merged company’s risk profile. Alpha will use its large cash position to repay the term loan portion of its secured credit facility, and the $500 MM of FCL net debt will remain outstanding.

Current market conditions favor acquisitions. Valuations are still depressed, and many coal companies have substantial amounts of liquidity. The weak economic environment has created high coal stockpiles and customer deferrals. Many producers have idled or shut down operations.

In an effort to survive and bolster margins with economies of scale, companies will likely join up or be acquired by bigger, better capitalized names. One issue brought into the spotlight with this deal is the future of Central Appalachian production (CAPP). With increased scrutiny on mountain removal mining and the issuance of 404 permits, the long-term viability of CAPP is uncertain to some extent. With tough regulatory jurisprudence, mining in Central Appalachia would be more costly, and new mines would take longer to come online, if at all.

While this impact wouldn’t be felt in the next year or two, this could have a long-term dampening effect on production out of this region. The move to purchase FCL exemplifies how reserve diversity is crucial to a coal producer as a going concern.