Yesterday morning, Universal Coal (UNV.ASX) announced receipt of an indicative, non-binding acquisition proposal at $0.35 per share from Ata Resources Pty Ltd. Given the conditional non-binding nature of the bid, it is not quite yet the asymmetric arbitrage opportunity that we would normally trade with conviction. Somewhat fortunately for us (and a very rare exception indeed), UNV was already an existing position within the portfolio as this is the second time the junior coal minor has been subject to M&A activity in recent years.
Back in 2015, Universal had successfully brought the Kangala Colliery online and was in process of bringing the New Clydesdale Colliery (NCC) into production when a takeover approach by current major holder Ichor Coal was announced at an offer price of $0.16 per share. This was quickly followed by further proposals from counterbidders at $0.20 before a $0.25 per share bid from fellow South African junior Coal of Africa (CZA) got the nod of approval from the board of directors. The $0.25 per share bid valued the company at A$126.4m, or a 5.5 x Attributable EV/EBITDA (FY15) based on a Kangala operation at steady state. This is before the second operation, NCC, came online.
Under the CZA proposal, a loan note was offered to certain eligible investors that pushed out payment terms 18 months but grossed up the value of the consideration to roughly 30c (unadjusted for the time delay). This loan note recognised the additional value that bringing NCC online would have on the company – the projected operating cashflow could justify offering loan notes at 12.86% for the first twelve months, and 15% thereafter for the remaining six.
The CZA offer eventually failed to reach a financial close due to reported delays in securing sales agreements for the NCC product with domestic power utility Eskom. Having been subject to a contest between three separate bidders, the stock fell back to pre-bid levels (as low as $0.125 - half of what Coal of Africa had been willing to pay!). Corporate interest not-withstanding, deep-dive analysis led to our decision to retain exposure to the stock under the perception that the assets were being severely discounted by the market and were likely to see further interest from acquisitive parties.
Fast forward two years after the CZA offer fell over, and the shares are subject to an initial approach at $0.35 per share, valuing the company at $183m. Kangala is producing more coal that it ever has (with reserves set to be replenished from the contiguous Eloff tenement acquisition, and plans to double production) and NCC is producing at steady state supplying almost 40% of its output to a red hot export market, of which both factors contributed to Universal’s record $72.3m group EBITDA ($45m attributable). The shares enjoy a 7.4% dividend yield on an undisturbed share price of $0.27, an even more impressive number when taking into account a payout ratio of only 45% of attributable 2018 NPAT. With domestic coal being supplied to Eskom on a cost-plus contract, thermal export markets remaining strong, and highly advanced growth initiatives in the Brakfontein and North Block Complex projects set to increase sales from 4.7Mt to 7Mt by December 2019, the future looks bright for UNV and a management team with a strong track record of execution.
Disregarding future growth, the Ata Resources proposal values UNV at only 3.2x FY18 EV/EBITDA on an attributable basis. Previous bidder Ichor Coal retains 29% of the register, and 27.5% holder Coal Development Holdings has already flagged their intention to vote in favour of the Scheme, so these two are key to deciding the fate of the company. We remain of the view that the shares are cheap even at the offer price (and potentially ripe for a competitive bidding process reminiscent of 2015/16). It does, however, remain to be seen if Ichor and Coal Development share that view.