M&A Deals of the Year
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Some 70 deals, worth more than A$13 billion ($12.75 billion), transformed Australia's coal mining sector over 2011. Among that record crop, none were bigger, more complex or daring than Peabody Energy Corp.'s A$4.8 billion acquisition of Macarthur Coal Ltd.

The deal marks a huge, highly leveraged bet on the future prosperity of Chinese and Indian smelters by the world's largest independent coal mining company. St. Louis­-based Peabody lurched toward Asia with the acquisition of Macarthur, a deal financed almost exclusively by debt, and worth about half as much as the buyer's own capitalization. It also provided evidence that cunning could triumph over Chinese financial muscle in the battle to secure coal reserves and a future in the Asian coal export market.

Peabody, which was being advised by UBS, Bank of America Merrill Lynch, Morgan Stanley and Australian law firm Freehills, had learned lessons from an earlier failed run at Macarthur. In May 2010, it withdrew a hostile A$3.8 billion offer when Macarthur's key shareholder, Citic Resources Holdings Ltd. of China, set itself against the sale. Citic had patiently built a 24% stake in Macarthur over the course of six years and viewed its holding as a means to ensure Macarthur's independence and thus competition amongst Australian sellers of metallurgical coal.

Peabody knew that Citic was not a seller, and, worse, would likely emerge as a rival if Macarthur's independence were threatened. Thus, when it returned in July with a new A$4.7 billion, or A$16 per share, offer, it came equipped with a Trojan horse in the form of ArcelorMittal.

The world's largest steelmaker owned a 16% stake in Macarthur, giving the bid consortium a running start at its minimum target of a majority holding. It was widely assumed that ArcelorMittal, which was advised by RBC Capital Markets LLC and Australian law firm Mallesons Stephen Jaques, had lined up a 40% stake in bid vehicle PeamCoal to secure coal supplies for its Indian and European smelters. Few noticed a clause in the PeamCoal agreement that allowed ArcelorMittal to pull out of the consortium, which it did the moment the bid crested the 50% mark in October.

"Peabody was forced to foot the entire bill after bidding partner ArcelorMittal got cold feet," Morningstar Inc. analyst Michael Tian wrote in late November. "This deal adds $5 billion of net debt and exposes [Peabody] much more to macroeconomic forces for better or ill."

By the time ArcelorMittal bailed out, PeamCoal had secured 60% of Macarthur and was on track to secure all of the target. Citic had, as expected, tried to mount a rival bid with the support of Anglo American plc. The plan was dropped after Anglo balked and, in October, Citic opted to sell its stake rather than face the prospect of becoming a large minority investor in a coal company over which it had no control. Citic's decision was eased by the unusual offer of an extra A$0.25 per share payment that would be triggered if Peabody secured more than 90% of Macarthur. The payment was written into the bid in return for the support of Macarthur's board, which, advised by J.P. Morgan Australia Group Pty. Ltd. and law firm Corrs Chambers Westgarth, initially rejected a deal. Peabody duly breached the 90% mark, squeezed out the remaining shareholders and declared the deal complete on Dec. 20.

While the execution was an undoubted success, it remains to be seen if the deal is ultimately a good one for Peabody. Macarthur's valuation is "pricey" on an earnings basis, according to Tudor, Pickering, Holt & Co. analyst Brandon Blossman. Peabody valued its offer at about 10.5 times forecast 2012 Ebitda, less than the 12.5 times Ebitda it claimed was typical for comparable Australian deals.

But Peabody will be taking the long view. The real prize for the U.S. mining group is Macarthur's roughly 1 billion tons of potential resource, which the deal values at about A$2.44 per ton, higher than the average A$2.40 per ton for comparable Australian deals. The profitability of getting that coal to market, and thus the merit of the takeover, will rest on the continued health of Chinese and Indian construction and subsequent demand for steel.

Growth in the world's two most populous countries has driven prices for Macarthur's metallurgical coal, which is used to transform iron ore into steel, to historical highs in recent years. But values have been choppy. The average export price of Australian metallurgical coal topped A$300 per ton in 2008-'09, a record obtained before the global financial crisis bit and sent prices tumbling to A$156 over 2009-'10, according to "Energy in Australia 2011," a publication of the Australian government's Department of Resources, Energy and Tourism.

Prices remained in that region for 2011 but are expected to rebound next year. Seaborne metallurgical coal prices could climb to $291 per ton over the coming year, J.P. Morgan Chase & Co. noted in a report on Nov. 23.

Other analysts are also predicting a sharp rise. The newly enlarged Peabody is counting on it.