Bak King Coal

By bne IntelliNews May 7, 2007

Nicholas Watson in Prague -

Coal may still suffer from an image problem with much of the financial community, but not for Czech financier Zdenek Bakala, who will float his coal mining assets in London later this year and plans to use the proceeds to snap up other coal mines in Russia, Ukraine and Poland

The coal industry in the CEE region is one of the last major sectors left untouched by foreign investors and for a combination of factors coming together simultaneously could arguably represent enormous opportunities for those willing to take another look at this unfashionable sector.

Bakala intends to IPO what will be called New World Resources, a Netherlands-based holding company wholly owned by the Czech financier's private equity vehicle RPG Industries.

The IPO is set for the third quarter and will be lead managed by Morgan Stanley and JP Morgan. Based on the multiples of where other coal-mining enterprises around the world were trading at recently, the deal could value New World Resources at over $4.0bn. Assuming the reports of a sale of 20-30% of the holding company, that would raise $900m-$1.35bn, which is not a bad return for a reputed $500m investment Bakala made only two years ago.

That initial investment involved the acquisition of a majority stake in the Czech black coal group Karbon Invest, which owns the black coal miner Ostravsko Karvinske Doly (OKD), and represented the region's largest ever leveraged buyout. Since then, Bakala has set about restructuring the business, refinancing its debt, divesting some assets such a rolled aluminium products supplier and selling stakes in the business to other private equity houses.

Little of this would be of much interest to the wider investment community, however, had not a combination of factors come together to give the coal industry a big shot in the arm.

A happy confluence of events

"The OKD opportunity surfaced when they sought advice on financing a few years ago and once my partners and I investigated more closely, we realised that if there ever were a time to put up money for coal, then that was the time," says Bakala, puffing on a fat Cuban cigar.

Why? Bakala explains the price of coal used for coking, the type which RPG mostly mines, has benefited over the past few years from the surge in demand for steel and a consolidating steel industry, while the price of coal as an energy source has risen in tandem with oil and gas prices as consumption of energy increases. Coal for use in generating power was given a further boost by Russia's heavy-handed response at the beginning of this year to the stalled talks over raising the price of its gas to Ukraine when Moscow cut off supplies for several days.

"I do not expect a major shift from coal-fired generation to gas-fired generation in the Czech Republic and Poland in the near future," says Bakala. "Coal-fired generation remains a reliable and economical domestic source of energy for Poland and the Czech Republic, but also for other countries with significant domestic coal reserves."

"In the short-term I expect an increase in the coal-fired generation especially in the Czech Republic, which will replace a significant portion of the to-be-retired capacity of Jaslovske Bohunice, a nuclear power plant in Slovakia," he says. "In the long term, and as long as coal is available in sufficient quantities, I expect most of the electricity generation in the Czech Republic and Poland to be based on coal, with nuclear energy being the primary 'low-CO2' option."

Not such a dirty business

What made the Karbon Invest deal especially attractive to Bakala was that the mining industry was seen by a lot of the financial community as dirty, small and something to be ignored.

"One of the reasons why we have the resurgence of interest by investors in coal is simply because people are moving away from the old-fashioned view that coal is dirty," he says. "Nobody really paid enough attention to the fact you can now design and build a zero-emission coal-fired power station and, historically, coal has been used as a raw material for the production of gasoline, for example in South Africa."

"Also, if you look at the total market capitalisation of all the publicly traded coal companies in the world, it's still smaller than Shell's cap. There was simply no real need to pay attention to coal if you are a large financial investor - it has been neglected and only a small community of coal industry specialists knew what was really happening," he says.

Furthermore, the industry is extremely fragmented and ripe for consolidation. RPG intends to help drive this consolidation in the CEE region using the proceeds from next year's IPO and is looking for opportunities particularly in Poland, which shares the same coal basin with the Czech Republic, as well as Ukraine and Russia. On May 3, New World Resources said it planned to issue €300m offering in senior notes, with the proceeds to be used to repay debt and to finance its expansion.

"The region starts for us in Karlovy Vary [in western Czech Republic] and ends in the Kuzbass coal basin in Siberia," says Bakala. "There are a number of situations that my guys are processing and at some point in time there will be a deal."

Might Russia become as proprietorial over its coal reserves as it is over its oil and gas deposits? Unlikely, says Bakala; the coal industry does not hold the same geopolitical importance as the oil and gas sector and is actually regarded more as an adjunct to the steel industry, which generally owns its own mines to guarantee supplies.

Coal pit-falls

However, Bakala concedes there are some clouds on the horizon. One involves the heavily unionized nature of the industry in places like Poland, which threatens to stall the consolidation process there. "Yes, the unions are more militant in Poland, where output is 10 times that of the Czech Republic. Under the Communism, coal miners made more money and received social support that was unavailable to everyone - it was a highly privileged profession."

In the Czech Republic, OKD is the second largest private employer in country, and as a 150-year-old company, has generations of people in the same family who have worked there. "It's a lifetime employer for generations of families, it's not an easy animal to control."

Also for RPG, "whose fortunes are tied to those of the steel industry," the forecast for coal prices is for a decline, says Bakala. After rising steeply in 2005, steel prices have since fallen from their peaks and are expected to continue to decrease moderately over the medium term. As such, banks are cutting their forecasts for coking coal, with Morgan Stanley predicting prices will fall by 9% to $105 per tonne in 2007 and 2008.

All this has had an impact of how coal companies around the world are valued. Bakala said the multiples at which these firms in places like the US, Canada and Australia have traded recently were close to 8-times EBITDA (earnings before interest, tax, depreciation and amortisation), but that this was a "major, massive unsustainable peak" As an indication, OKD's EBITDA for 2005 was Kc12.8bn ($573m).

Nevertheless, the growing trend of private equity firms exiting their CEE investments by using the equity markets bodes well for the IPO of New World Resources. Bakala has been at the forefront of the developments in the region's private equity industry when in 2004 he pulled off the surprise acquisition of Karbon Invest, which had been kept out of the headlines despite being two years in the making and organized by a man the Czech media never seem to tire of writing about.

As well as being a landmark deal in itself, it announced in the most emphatic fashion the return of the U.S. university-educated Bakala, who had been largely absent from the headlines since 2002 when he left the post of CEO of Patria Finance, the Czech investment bank he founded in 1994 but sold to Belgium's KBC Group in 2000.

Analysts say the maturing of the private equity sector in the region is the natural outcome of the improving exit opportunities. The increase in M&A and development of the equity markets means private equity firms are enjoying more options for exiting their portfolio companies, either through IPOs or trade sales. Bakala lays the blame for the historical lack of IPOs in the region at the door of the governments, many of whom couldn't grasp that "at an equity market is a useful thing to have."

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