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There's a reason why Walter Energy, (NYSE:WLT), Patriot Coal, (PCX), Cloud Peak, (NYSE:CLD) and Cline Mining, (OTCPK:CLNMF) are routinely mentioned as takeout candidates. I would add Alpha Natural Resources, (NYSE:ANR), Canada's Teck Resources, (NYSE:TCK), Peabody Energy, (NYSE:BTU) and SouthGobi Resources, (OTC:SGQRF) to the list of possible takeouts. I hope to write about some of these companies in the near future. Why so many prime targets in North America alone?

There are a number of trends in coal mining that make growth through acquisition the clear and increasingly prudent approach. Growth is not an option, it's a necessity. Cost inflation is running rampant. A research report by Citi last year showed that average mining costs in Australia increased 15% per year through 2010. Costs doubled from A$ 45 to A$ 90 per metric tonne over a five-year period. There's scant evidence that the rate of increase is slowing appreciably. Even if cost inflation slows to 10% per year, coking coal costs will reach A$ 145 per tonne by 2015.

Why are costs so difficult to control? Because each year the extraction of coal gets harder, the coal seams thinner and deeper, the distance to mine faces longer and the amount of time, materials and energy larger. There's no avoiding it, it's the nature of mining. But it may be getting worse. Labor scarcity and elevated worker turnover, (resulting in lower productivity) is driving up wage expense. Finally, environmental, legal, compliance and safety issues add to the burden.

The best way to combat cost inflation in mining is to make acquisitions. Well planned deals enable companies to extract valuable economic and logistic synergies. Alpha Natural Resources is in the process of wringing out upwards of $200mm from its takeover of Massey Energy. The rationalization of mines, enhanced ability to blend coals and higher utilization of equipment and key facilities, will help the company control costs.

Logistics pose another headwind to organic growth. Getting allocations at ports and on railroads is increasingly difficult. The uncertainty of obtaining access and longer construction times on the new infrastructure make decision making daunting. Even if a project secures an allocation to a new or expanding facility, the commissioning of that facility may be delayed for any number of reasons.

Financing an acquisition is quite attractive at this time, especially for the majors. Teck Resources, Rio Tinto, (NYSE:RIO) Vale, (NYSE:VALE) and BHP - these companies are issuing five, seven and 10-year debt at under well 4%. It's important to remember that the number of strategic established coal mining assets is finite. New projects on the drawing board may never see the light of day, and are likely to be delayed at the very least. With cheap capital, doesn't it make sense to acquire synergistic assets before one's competition does?

Buying producing assets has other benefits. A company can accelerate or delay the growth of acquired assets more readily than with greenfield projects. Banks will gladly loan against the cash flow generating assets. A company can get instant geological diversification with a savvy purchase. And finally, a company can prudently hedge existing operations with the right acquisition. For example, an Australian coking coal producer can hedge against severe weather in Queensland by acquiring a coking coal operation in Canada.

What I've written is a brief summary of the myriad of headwinds and uncertainties of organic growth. Each and every delay or cost over-run decreases the NPV of a project. In addition, the added uncertainty may necessitate a higher discount factor in the NPV calculation. Thus, the hurdle rate for green field projects is climbing while the desirability of growth through acquisition is increasing.

Source: Why M&A Activity In The Coal Sector Will Accelerate

Additional disclosure: I'm a consultant for SouthGobi Resources.