An agreement to sell Rio Tinto’s (NYSE: RIO; LSE: RIO) Hunter Valley thermal coal assets in Australia to Yancoal Australia (ASX: YAL; US-OTC: YACAF) may come as no surprise to coal watchers — but the high sticker price might.
The US$2.4-billion price tag — US$1.95 billion in cash and US$500 million in deferred payments of US$100 million a year for five years — implies a 17–22% premium, according to Macquarie Research. The Australian bank’s research analysts value the coal assets at US$2 billion.
In addition to the cash payment, Rio Tinto is entitled to a US$2-per-tonne production royalty over 10 years, starting three years after the sale closes. However, the royalty is payable only when benchmark prices for Newcastle thermal coal surpass US$75 per tonne.
Edward Sterck and David Gagliano of BMO Capital Markets note that the additional annual income from the royalty, “assuming production stays at current levels … could provide more annual income to Rio Tinto of up to US$35 million.” (Their long-term forecast for the Newcastle benchmark is US$65 per tonne.)
In addition, the BMO analysts say that the transaction appears to be net present value (NPV) accretive, noting the price “implies 2017, 2018, and 2019 enterprise value/earnings before interest, taxes, depreciation and amortization [EV/EBITDA] multiples of 3.4 times, 5.3 times and 10.1 times (three-year average: 6.3 times) — a premium to Rio’s 2017 EV/EBITDA of 4.4 times.”
The assets are held in Rio Tinto’s wholly owned Australian subsidiary, Coal & Allied Industries Ltd., and consist of its thermal coal business in the Hunter Valley region of New South Wales. Coal & Allied owns and operates a number of multi-seam open-pit mines, with a 67.6% interest in the Hunter Valley operations, an 80% interest in the Mount Thorley mine and a 55.6% interest in Port Waratah Coal Services, which owns a coal export terminal at the Port of Newcastle, in addition to other undeveloped coal assets, including various landholdings.
The Hunter Valley operations and Mount Thorley Warkworth mines produced 25.9 million tonnes of saleable thermal and semi-soft coking coal in 2016, of which Rio Tinto’s share was 17.1 million tonnes.
After the transaction closes, Rio Tinto will have just two coal mines left in its global portfolio: the Hail Creek and Kestrel mines in Queensland, Australia. Last year Hail Creek produced 4.9 million tonnes of hard coking coal and 3.1 million tonnes of thermal coal, while Kestrel churned out 3.3 million tonnes of hard coking coal and 0.7 million tonnes of thermal coal.
Yancoal Australia is 78% owned by China’s Yanzhou Coal Mining (NYSE: YZC), which is listed on the Hong Kong, Shanghai and New York stock exchanges. China’s state-owned Yankuang Group Co. owns a 56% stake in Yanzhou Coal.
Under the listing rules for the Sydney and London stock exchanges, Chinalco’s 10.1% shareholder interest in Rio Tinto makes Yancoal Australia a related party, so approval is needed from a majority of independent Rio Tinto shareholders (i.e., not including Chinalco and any other entities considered associates of Chinalco under listing rules in the United Kingdom).
In a press release announcing the sale, Rio Tinto said it had undertaken a “comprehensive market testing and price discovery process” and “held extensive discussions with several potential acquirers,” but that Yancoal Australia “provided the only offer that represented compelling value for the assets.”
The sale brings Rio Tinto’s divestments since 2013 up to at least US$7.7 billion.
Macquarie notes that incorporating the transaction “should see Rio’s gearing fall to 10% by the end of 2017, compared to 16% previously, and well below the company’s target range of 20–30%.”
BMO notes that Rio’s balance sheet “remains amongst the strongest of its peers, with a projected year-end 2016 net debt position of less than US$11 billion, and a net debt/EBITDA of 0.8 times.”