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 Yeeman Chin, an analyst with Macquarie in Hong Kong, who has an underperform rating on the stock and a target price of HK$8.20 (US$1.06). “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. These issues have driven the company to seek overseas acquisitions.
Yanzhou Coal’s present target is Australia’s Felix Resources (FLX.ASX), which haa an annual capacity of 4.8 million metric tons. Yanzhou Coal has offered US$2.95 billion for the company, which would make it the largest takeover of Australian company by a Chinese firm to date. The company 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 Coal is paying US$2.8 billion or A$16.95 per share (US$13.96) with US$150 million or A$1 (US$0.82) per share as a dividend from Felix Resources to its shareholders.
The main hurdle facing the deal is it still needs to get 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, but Yanzhou Coal’s acquisition is not seen as politically motivated. “If it were a politically driven transaction it would be driven by Shenhua Energy or China Coal, not a smaller provincial SOE like Yanzhou Coal,” 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.
“I think you could argue that such a takeover of this magnitude needs to be carefully considered by the Australian government and this takeover in its current form will probably need more work,” said Jonathan Barratt, managing director of Commodity Broking Services in Sydney.