Yanzhou Coal Mining (1171.HK, 600188.SH, YZC.NYSE) is China’s fourth-largest coal producer and has a wary eye to the future. The Shandong company’s mines are mature – production output in 2008 was 35.51 million metric tons, an increase of just 2.8% over 2007 – and so survival hinges on expansion.
However, attempts to develop projects in other parts of China, notably Shaanxi province, have stalled. The problem? Yanzhou Coal is "only" a provincial-level state-owned enterprise (SOE).
"They keep getting delayed on those projects and there are disputes with local partners," said Yee Man Chin, an analyst with Macquarie in Hong Kong, who has an underperform rating on the stock. "A lot of it has to do with the fact that Yanzhou Coal is not a central government SOE so when they move out of Shandong it’s a lot tougher for them."
Its competitors, China Shenhua Energy (1088.HK, 601088.SH) and China Coal Energy (1898.HK, 601898.SH) are national-level players and don’t face the same territorial issues. Consequently, Yanzhou is looking overseas.
Its present target is Australia’s Felix Resources (FLX.ASX), which has an annual capacity of 4.8 million metric tons. Yanzhou has offered US$2.95 billion for the company, which would make it the largest Chinese takeover in Australia to date. Yanzhou has a cash-rich balance sheet so it can pay a high price, but analysts have warned that it may be overpaying – the price is 15 times Felix’s current price-to-earnings (P/E) ratio, but if Felix’s profit from the disposal of mining assets in 2008 is removed then the price is 30 times P/E.
"If you invest in a Chinese coal mine with the same annual production it will cost less than US$1 billion," said Martin Wang, an analyst with Guotai Junan Securities, who has a sell recommendation on the company’s stock.
Yanzhou is paying US$2.8 billion – A$16.95 (US$13.96) per share – in addition to A$1.00 (US$0.82) per share as a dividend from Felix Resources to its shareholders.
The main hurdle facing the deal is getting past Australia’s Foreign Investment Review Board (FIRB). Some believe this might be tricky, coming so soon after the collapse of the Aluminum Corp of China-Rio Tinto deal. Others note that Yanzhou’s acquisition is unlikely to be politically motivated. "If it were a politically driven transaction, it would be driven by Shenhua Energy or China Coal, not a provincial SOE like Yanzhou," said Chin.
Even if the FIRB does approve, it’s uncertain how much of Felix Resources it will allow Yanzhou to buy. The board has shown a preference for foreign companies taking stakes of less than 49.9%, meaning Yanzhou Coal might have to make do with less than a 100% takeover.
"A takeover of this magnitude needs to be carefully considered by the Australian government. This takeover in its current form will probably need more work," said Jonathan Barratt, managing director of Commodity Broking Services in Sydney.