Massey Energy: Where There's Sale Smoke, There May Not Be Fire

About: Alpha Appalachia Holdings, Inc. (MEE), Includes: ANRZQ, ARCH, BTU, CNX
by: Mike Mustafoglu

On October 20, 2010, The Wall Street Journal broke the story that Massey (NYSE:MEE) may be considering strategic options (read, "sale of the company") in the wake of the April mine explosion that killed 29 miners. In the ensuing days, the media was full of rumors as to who might be looking to buy MEE including the rival Alpha Natural Resources (ANR) and an Indian company. An analyst report claimed MEE may be worth $60 per share in a buyout; there was talk of ANR having already submitted a bid.

I went long in MEE stock and options after the news and I am sporting a nice profit, but I am beginning to wonder if the expectations of a sale are realistic. For one thing, recently, the company's CEO stated that MEE might be looking to acquire other coal companies. Despite all the takeover smoke, I have not seen any fire yet. The basis for my lingering doubts about MEE's attractiveness are as follows:

  1. The board of Massey is operating from a position of weakness, not strength, because of uncertainty with the pending investigation of the Upper Big Branch mine disaster where 29 miners died. It does not appear that safety concerns are over at Massey. The company announced it would close its underground mines to conduct safety training.

  2. Central Appalachia (CAPP) is a very challenging environment in which to operate, with much stricter environmental regulations, safety oversight, rapidly worsening geology, and limited pricing power because of low natural gas prices. The major U.S. coal producers all fully recognize the challenges facing CAPP producers and have been strategically underweighting CAPP for a decade. Peabody Energy (NYSE:BTU) spun off Patriot Coal several years ago for the above reasons. Arch Coal (NYSE:ACI) gave away its high-cost CAPP mines in exchange for giving away the legacy liabilities of those mines. CONSOL Energy (NYSE:CNX) has resisted the temptation to acquire CAPP reserves and, instead, made a major purchase of shale gas reserves earlier this year. Given all these considerations, are these companies now going to switch course simply because Massey's board is now reportedly a more willing seller?

  3. Alpha Natural Resources (ANR) is the only company that is likely to bid for MEE since it has a preference for growth through acquisitions. However, ANR has diluted its exposure to Central Appalachia with the purchase of Foundation Coal. Since about 75% of MEE's shipments are thermal coal, ANR is unlikely to acquire MEE at much of a premium based on ANR's view that the CAPP thermal coal market is in a long-term structural decline.

  4. Major global mining companies, which also have been mentioned as potential buyers, may not be attracted to MEE. These companies are usually interested in world-class deposits producing global seaborne commodities. Massey has over 60 mines serving dozens of local customers. This would be difficult to manage from overseas and the operating synergies would be lacking to justify a takeover premium. And even further, these companies would need strong operating skills to take over MEE's mines. Since 2004, MEE has never hit its production and cost targets! These metrics are very important for a mining company since pricing is usually out of its control.

  5. Finally, given the aforementioned risks and uncertainties facing CAPP producers, could long-term debt financing be obtained on acceptable terms to get potential private equity buyers interested in Massey?

Massey's CEO, Mr. Blankenship, may be onto something though: All this takeover talk has stoked the MEE shares to almost $50 from the mid-30s, giving him a more valuable currency in his stock. Then again, the price of all small cap producers have recently jumped in the wake of Walter Energy's bid for Canada's Western Coal, eroding some of Mr. Blankenship's purchasing power. Watch your positions carefully.

Disclosure: Long MEE