Given Coronado Global Resource’s progress to listing on the Australian Securities Exchange really is a barometer of investor sentiment towards the coal sector then it has to be acknowledged that the needle is pointing to change with storms ahead.
After a frugal pricing outcome from its book-build late last week, Coronado’s US private equity owner has decided to scale back the miner’s initial public offering to the minimum issuance needed to meet ASX rules that require a 20 per cent free float.
Coronado had hoped to raise up to $1.39 billion by releasing 30.1 per cent of the business into an Australian IPO.
Instead, Houston-based owner Energy and Minerals Group will pocket $774 million after deciding to keep the float to the bare minimum. This will be done by issuing $667 million worth of new, primary equity and $107 million sell-down in equity held by EMG.
This is a disappointment that will ripple far beyond EMG’s Houston boardroom.
Certainly it is hard to believe that EMG principle John Calvert is not gently regretting the decision to accept advice that Australia was the appropriate home market for his coking coal combine.
We hear that Calvert went very, very close to pulling Coronado’s IPO in the wake of a book-build whose pricing came in at the very bottom of the $4.00-$4.90 range that was flagged in the prospectus.
He decided instead to keep some level of faith with those that signed up and to raise a middle-finger salute to those that didn’t.
Those close to the situation say Calvert held that, even at the top of the price range, he had priced the IPO to clear.
It is said he has been left wholly perplexed by the market’s discomfort with a pitch whose indicative pricing implied a valuation multiple of between 3.7 to 4.4 times current year forecast earnings. The company had committed to 100 per cent flow through of 2018-19 free cash flow into dividends and to maintain a dividend band of 60-100 per cent of free cash flow beyond that.
Not only does that imply a minimum dividend yield of 10.3 per cent, but it raises the distinct possibility that about half of the issue price of $4.00 will be repaid to owners over the first two years of Coronado’s public life.
While Coronado’s planned 30 per cent issuance was fully covered, the discouraging pricing outcome announces a meaningful gap between the way the market and the coal miners value the sector’s current and future earnings.
When Coronado first fell on our radar we wondered whether it was the Last of the Mohicans. As time went on, it emerged that it might have been the first because there is a little queue of privately held coal plays who possibilities include market listing.
The question for likes of Barry Tudor at Pembroke Resources, for example, is whether Hong King or Singapore might reveal more value.
Under Coronado IPO Plan A, Australian investors were supposed to end up accounting for better than half the book. But, for reasons general and very particular, they just did not turn up in, or with, the right numbers. Early estimates suggest that domestic funds and private investors will account for less than a third of the pruned offering.
The word within is that if Calvert had his time again he would more likely have listed Coronado in the US or London, where interest in a pure coking coal play was assessed to be particularly robust. Because, in the end, Coronado’s free float will be held predominantly by global investors who, if Calvert has it right, have got themselves a real bargain.
In deciding to proceed, Calvert has raised funds enough to cover the cost of acquiring Coronado’s Australian footprint and pocketed $107 million along the way.
The mine was acquired last year in a $700 million deal with Wesfarmers. It arrived with the Gordian knot of an uncommercial thermal coal supply contract with the Stanwell power plant that also delivered the state-owner generator with a share of price upside on the coking coal that is shipped to export markets.
The Australian conglomerate was a ready seller whose motivation and capacity to secure better terms with Stanwell was limited. Wesfarmers wanted out of coal and it needed a win for the balance sheet as it contemplated the downside of its $1 billion misadventure in British hardware.
Coronado, on the other hand, was fully motivated to get a new Stanwell deal. It arrived at negotiations with a pre-IPO deadline for a better settlement. And it was able to force the pace and shape of a new agreement by warning Stanwell management that it risked losing access to Curragh thermal coal from 2028 should negotiations fail.
The end result was a more commercial thermal coal contract, a drop-dead date of 2026 on the coking coal price sharing deal and access to the northern parts of the Curragh coal deposit, which were previously locked up by – you guessed it – Stanwell.
So Coronado will generate more income from the domestic thermal coal stream, get to keep all of the coking coal revenue pie from 2026 and it has extended the mine life by at least a decade.
But evidently local investors were not quite as impressed by this hard-arsed niftiness as we were.
The equivocation in Australia is said to have had many fathers.
We hear there was a bank of cynicism, hardened by recent experience, over the potential US private equity was delivering a peak-pricing turkey to the Australian market. There was also a spreading base of funds whose preference or new investment mandates rule out coal as an investment class. There was the cohort that received Coronado’s pricing outlook somewhat less rosily than did the company. And, in the end, there was a shift in global investments markets in the days and weeks ahead of the book-build.
There are some who receive Coronado’s need to scale-back as a blow to the reputation of Australian capital markets generally and to any claim local markets might have as a destination for mining companies looking to list. I would not go as far as that. But I am pretty sure that, by the time the escrow on EMG’s remaining 80 per cent stake is lifted in 2020, there will be plenty of locals regretting their short-sightedness.
To a degree the Coronado IPO was a plebiscite on the coking coal outlook. The likes of Calvert and Coronado maintain that there has been a structural elevation in the market with the arrival of the Indian steel industry. India, which is short coking coal, is about to transform itself in to the region’s second biggest steel industry. It is about to be our biggest coking coal customer.
But, with some good reason, the equity market prefers the view that there will be a supply side response to prices that have consistently travelled at better than $US200 a tonne through this year. So, while the changed demand might put a new and higher volume floor under the market, there will be a price reversion to historical trend.
So it is that Goldman Sachs, for example, ran its valuation on a model that had prices and foreign exchange assumptions that were far more cautious than the Wood Mackenzie numbers that informed the Coronado prospectus.
For example, WoodMac had coking coal running at $US167/t through 2020-21 and long term at $US152/t. But the Goldman’s model assumes a price of $US148 in 2020-21 and a long term price of $152/t.As a result, Goldman’s forecast Coronado’s EBITDA margin.
It is worth noting that the Goldman outlook is more generous than Australia’s official forecaster, the Office of the Chief Economist. Its September Resources and Energy Quarterly carried a coking coal outlook that has prices at $US145/t by 2020 on the back of supply growth driven by a globe of new coking coal projects.
In the end, Calvert’s decision to secure EMG’s liquidity moment but to hang on to as many Coronado cards as he could tells us that he is out to show investors far and wide that they have got his business and the coking coal market wrong.