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Analysis: Peabody/ArcelorMittal bet on steel growth

Handout photograph of man walking next to handling and processing equipment at Macarthur Coal's Coppabella mine
Handout photograph of man walking next to handling and processing equipment at Macarthur Coal's Coppabella mine

By Steve James

NEW YORK (Reuters) - The world's biggest steelmaker and America's largest coal producer could pay top dollar for Australia's Macarthur Coal , but they are likely to reap a benefit if the surging Asian steel business keeps growing, according to analysts.

"It's a bet on the future of (steelmaking) met (metallurgical) coal," analyst Brett Levy, of Jefferies & Co, said of the sweetened bid by U.S. miner Peabody Energy and Europe-based steelmaker ArcelorMittal .

"It's a belief that met coal is a scarce resource."

Macarthur is the world's biggest producer of pulverized, cleaner-burning coal (PCI) and was a takeover target as Asia's rapid industrialization created an insatiable appetite for the commodity used to fire blast furnaces.

However, metallurgical coal prices have dropped recently while the steel industry in Europe and North America is recovering from the recession at a much slower pace than Asia.

The bid of A$4.9 billion ($5.2 billion) on Tuesday appears set to seal the deal after a rival bidder failed to emerge for the Australian miner. [nL4E7JU00V]

The total offer of A$16.16 per share was 3 percent higher than the previous bid and is 44 percent above Macarthur's last trade on July 11, when the approach was announced.

Levy calculated the price was about 11.1 times the forward EBITDA (earnings before interest, taxes, depreciation and amortization). "That's a very full multiple, so it may or may not be immediately accretive (to earnings). I suspect not."

Analyst Jeremy Sussman, of Brean Murray Carret & Co, also said the offer was expensive on a basis of equity value to EBITDA. He also noted the price spread between top quality metallurgical, or coking coal, and PCI has been widening.

"Overall, while the deal is slightly on the expensive side...this likely transaction makes a lot of strategic sense for Peabody.

"It will give Peabody access to precious terminal space in Australia and will make it a more met-heavy coal producer," Sussman wrote in a research note.

He said Peabody was currently working on three major strategic projects: The acquisition of Macarthur, development of the huge Tavan Tolgoi met coal deposit in Mongolia and a 50 million ton-per-year mine in China's Xinjiang province.

"The bottom line with these three major potential projects is that they are all medium to long-term game-changers and should certainly help Peabody further cement its status as the bellwether of the coal space," Sussman wrote.

Charles Bradford, a steel analyst with Bradford Research noted that although metallurgical coal prices have fallen from a high of around $330 per tonne to a recent benchmark of $225, they are still higher than around $200 last year.

"When I do the numbers on all raw materials (for steel), coking coal looks the best," he said. "The crunch could be if China expands (steel production), there may not be enough coking coal, so the market is likely to remain the tightest."

Bradford said steelmaking in China, India and South Korea was booming, although none of those countries had enough of their own coal.

"If you look at the profitability in the steel business, the raw material suppliers have always done better than the producers (of steel)," said Bradford.

Jefferies' Levy noted ArcelorMittal makes most of its steel in blast furnaces. "And their CEO Lakshmi Mittal has made it very clear he wants the company to control its iron ore and met (coal) inputs -- 75 percent of all raw materials.

"I suspect half of the production from Macarthur will go straight into ArecelorMittal blast furnaces. The other half will be part of Peabody's bet on the strength and growth of Asian steelmakers.

"They are both doing the same thing for different reasons -- one is buying for itself, the other is buying to sell to others," said Levy.

Macarthur stock ended the day 6 cents higher at A$15.86 on the Australian Stock Exchange. On the New York Stock Exchange, ArcelorMittal was 16 cents higher at $21.28 but Peabody was down 12 cents at $48.47 in afternoon trading.

(Reporting by Steve James; editing by Gunna Dickson)

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