Yancoal knocks on a back door deal

The Chinese approach to Gloucester Coal, proposing a merger with Yancoal Australia, is driven by an interesting mix of necessity and opportunity.

In 2009, Yancoal's parent, the Chinese state-owned enterprise Yanzhou Coal Mining, acquired Felix Resources and its coal mines in NSW and Queensland for more than $3 billion, the biggest acquisition of an Australian company by China at that time.

The problem for Yanzhou is that to obtain Foreign Investment Review Board approval it committed to offering 30 per cent of Yancoal to public investors before the end of 2012. With the clock ticking and market conditions deteriorating the prospect of a forced selldown against a deadline and into a potentially difficult market next year will have been the focus of significant attention within Yanzhou.

Earlier this year Yancoal was on the final short list of bidders for Whitehaven Resources, which is now merging with Nathan Tinkler's Aston Resources, but couldn't agree terms. It is unclear what Yancoal would have done with Whitehaven had it acquired it but the move on Gloucester suggests that strategy has been to kill two birds with one stone.

There aren't many independent coal producers of size left after an intense bout of consolidation in the sector – the $5 billion merger of Whitehaven and Aston is an attempt to fill the void between the small prospective producers and the big end of the coal sector dominated by the major resource houses.

Gloucester, with a market capitalisation around the $1.5 billion, represents an opportunity for Yancoal to bulk up and, because the two companies have projects in NSW's Hunter Valley, it's an opportunity with underlying business logic.

That logic is strengthened further by the fact that Gloucester, after buying Donaldson Coal from its own parent, Noble Group, not only owns three mines but has excess capacity at the Port of Newcastle. The major constraint on Yancoal's expansion of its NSW mines is port capacity.

So, a merger with Gloucester would help enlarge Yanzhou's Australian coal interests (it has already been expanding aggressively but has made no secret of its ambition to massively lift its coal production) and enable it to expand its existing operations more rapidly. It would also offer an opportunity to satisfy its FIRB commitment, with Yancoal effectively being back door-listed via Gloucester.

It is a doable transaction if Yanzhou is prepared to put the right price on the table. Gloucester is controlled by the Hong Kong-based Noble, which owns 65 per cent of its capital after a series of internecine deals.

Noble is a development capital provider, investor and trader, rather than a natural long-term owner of assets, and therefore could be expected to be a seller on the right terms, although it also demonstrated during the protracted skirmishing around Macarthur Coal in which it was indirectly caught up (it originally planned to sell its Gloucester interest into Macarthur before the original spate of bids for that company derailed the plan) that it has its own strong views on value.

Provided they can agree on value, therefore, Noble can deliver control of Gloucester to Yanzhou and provide both another significant increase in the scale of its coal interests and a vehicle for satisfying its FIRB obligations in the process.