Noble Group will book close to US$200m gain on disposal

Noble Group - TP S$1.65

Noble's ASX-listed 64.5% subsidiary Gloucester Coal has proposed merging itself with the HK-listed Yanzhou Coal's Australian assets to form a new, ASX-listed Yancoal Australia. While the earnings impact is unclear, Gloucester Coal shareholders will unlock its value via cash dividend.


THE DEAL
- ASX-listed Gloucester Coal and HK-listed Yanzhou Coal have proposed to merge their Australian assets into a new company, Yancoal Australia, to be listed at ASX.

- Yanzhou Coal will own a 77% stake in Yancoal Australia, whilst the current shareholders of Gloucester Coal will own 23% of this new company.



- As a consideration for the transaction, the Gloucester Coal current shareholders will receive
(a) cash payment of A$3.20 per Gloucester share (consisting of A$0.56 special dividends and A$2.64 capital returns), and
(b) a choice of receiving
(b1) one Yancoal share for every one Gloucester share (called the "All Scrip Option"), or
(b2) one Yancoal share and one CVR share for every one Gloucester share.

- The CVR (contingent value right) share is a guarantee by Yancoal Australia to compensate the CVR share holder should the market value of the Yancoal Australia share price fall below A$6.96 per equivalent Gloucester share (calculated as 3-month volume-weighted average price) 18 months after the merger completion, subject to a cap of A$3.00 per share.

- Taking consideration (a) and (b) above combined, the transaction values Gloucester Coal at A$10.16 per Gloucester share, compared to its closing price of A$7.03 on 19 Dec 2011 (prior to trading suspension and announcement of the deal on 23 Dec 2011).

- A$10.16 per share would value Gloucester Coal at A$2.06bn or A$7.49 per tonne of reserves (proven and probable reserves combined). This is in line with the recent transaction between Whitehaven and Aston Resources which was valued at A$7.40 per tonne of reserves.

- Noble Group will book close to US$200m gain on disposal if this transaction proceeds. The deal is subject to due diligence and approval by shareholders of Gloucester Coal and Yanzhou Coal, by the Australian and People's Republic of China's regulators, and by the Australian Stock Exchange (for the listing of the newly merged company).

- Cash-wise Noble Group expects to receive A$420m (in addition to the Yancoal Australia shares) in cash distribution from the special dividends and capital returns.

IMPACT on Noble Group and our comments

- On the surface, this transaction should be good news to shareholders of Gloucester Coal, including Noble Group which owns a 64.5% stake in the company. The A$10.16 valuation attached to Gloucester Coal is almost 45% higher than its last traded market price and, best of all in our view, the uplift in value will be distributed as cash to the Gloucester shareholders (in the form of a special dividend and a capital returns payment).

- However there are several provisos to this assessment. Most importantly in our opinion, what matters to the shareholder is not only the upfront cash payment but also the holding left afterwards. In other words, is the 77-23 split (in the newly merged entity share ownership) fair? Looking at the coal reserves alone (and combining the proven and probable reserves together), Yancoal Australia's assets will contribute just under 430m tonnes or 61% of the merged total reserves of 704.6m tonnes. Gloucester will contribute 275m tonnes of 39% of that merged total.

- There are several possible explanation to this difference between the 77-23 share ownership split and the 61-29 coal reserves split - it could be the quality of the coal, the operating costs (and hence profitability) of the different coal mines, the premium of "proven reserves" valuation over the "probable reserves" valuation, the value of the infrastructure assets included in the merger and so on. Until more information is furnished to clarify these issues, however, we are unable to make a definitive assessment of this transaction.

- Secondly, we believe it is also unclear at this stage what earnings (or cash-flow) streams will emanate to Noble Group out of its 14.8% holding in the newly merged company (64.5% stake in a 23% holding in the merged entity). The point is that there is little information about Yancoal Australia's profitability today. In Yanzhou Coal's annual reports, only the revenue and gross profits of Yancoal Australia are disclosed. Therefore, beyond the US$200m asset disposal gain (which at any rate will be classified as extraordinary gain and therefore excluded from our core earnings estimate), the transaction's impact on Noble's future earnings remains unclear in our view.

- Lastly, Noble Group has made clear that it will elect for the "All Scrip Option" (i.e. the consideration option without the CVR share). Therefore, at least theoretically, Noble Group does not enjoy the protection of a minimum value of A$6.96 per Gloucester share equivalent that the minority holders in Gloucester Coal can enjoy.

- Our analyst Jeannette Sim who covers Yanzhou Coal Mining has assessed this transaction as positive for the shareholders of Yanzhou Coal Mining. Please see her report "Value Unlocked in Australian Deal" (dated 23 Dec 2011). Ms Sim has a Hold rating on Yanzhou Coal Mining with target price of HK18.00.

- Our analyst Tom Sartor, who covers Gloucester Coal, opines that "To us, the (77-23) ratio looks too heavily weighted in favour of Yancoal. It looks like it is pricing in a lot of growth in the Yancoal assets, which they are yet to educate us about." Mr Sartor has a Buy rating on Gloucester Coal with target price of A$9.47.

- Subject to further information on the profitability of Yancoal Australia, we view this transaction as a positive development to Noble Group and reiterate our Buy recommendation with target price of S$1.65 per share.