Well over a year ago, Teck Cominco Ltd.'s Don Lindsay approached management at Fording Canadian Coal Trust, seeking to take full control of the companies' shared coal assets.
At first, it looked as if the former investment banker turned mining CEO's attempt at coal consolidation had backfired.
Fording reacted to the approach by putting itself up for sale. Theannouncement generated strong interest from international steel makersand mining firms seeking a stake in the world's second-largest producerof seaborne hard coking coal.
At the same time, the price of coal was skyrocketing on unexpected production problems in Australia caused by massive flooding.
Fording's unit price soared 130 per cent in the months after theauction process was announced. Most industry observers believed thatTeck had been priced out of a deal for the 48 per cent of the ElkValley Coal Partnership it didn't already own.
Mr. Lindsay, however, wasn't ready to give up, and he had a couple of aces up his sleeve.
In September, 2007, after his first approach to Fording, he pulled thetrigger on a deal that took Teck's stake in the income trust to 19.9per cent. He did that through a $600-million deal with OntarioTeachers' Pension Plan for 11 per cent of Fording's units.
The near 20-per-cent interest would likely be enough to dissuade somemining sector bidders. It would also give Teck an option to sell thestake in the event of a knock-out bid from a steel producer looking tohedge its exposure to coking coal prices. Even if it sold, Teck couldkeep its 40-per-cent interest in the Elk Valley partnership andcontinue as the operator of the mines.
“That was a very real possibility, particularly when the coal stockswere in a bit of a frenzy, frankly, several weeks ago. If the price hadkept going, we might well have done that,” Mr. Lindsay said ininterview.
More important, what few divined before yesterday's surprise$14-billion (U.S.) deal announcement, was the massive tax savings thatTeck believes it will be able to reap from the takeover.
The company estimates it will generate tax savings of $3.9-billion fromthe transaction using established rules covering the acquisition ofCanadian resource properties. Under the deal terms, Fording is regardedas a royalty trust, similar to an oil and gas trust. That will enableTeck to use the deal price as a deduction against taxes paid on some ofits Canadian operations, such as the Trail smelter and the HighlandValley copper operation, both in British Columbia. It says it can usethe Canadian Development Expense (CDE) rules, which allow a 30-per-centannual writeoff.
While common in the oil and gas sector, it is believed to be the first time the tax benefit has been used in mining.
“We're buying assets, we're not bidding for the units,” Mr. Lindsay said, confident that the tax structure will work.
“It's a plan of arrangement and the unitholders will have to vote to dothis and to wind up the trust. That is very tax effective for us. Whileon the surface it looks like we're bidding $92, which is a premium tomarket of 18 per cent as of Friday, the reality for us is the after-taxcost to us is $69.91,” he said.
Analysts and observers were caught off-guard by the tax savings element of the bid.
“I was surprised by this transaction. Given that this now looks like atax-driven proposition, which we weren't previously privy too, it lookslike they're getting this for $70 a share on a net basis, which makessense,” said Canaccord Adams analyst Orest Wowkodaw.
Greg Barnes of TD Newcrest, in a note to clients, said there is a low probability of a competing bid.
A statement from the chairman of the Fording independent committee oftrustees overseeing the sale process suggests Teck had the advantage.
“While our sale process attracted interest from numerous companiesinvolved in the global mining and steel industries, certain issues,such as our corporate structure and non-operating 60-per-cent interestin the Elk Valley Coal Partnership, presented challenges to somepotential acquirers,” said Michael Grandin.
Teck's offer of $82 in cash and 0.245 of a Teck B share for eachFording unit, “represents the best alternative for Fordingunitholders,” Mr. Grandin added. Teck also has the right to match anycompeting offers. Fording must pay Teck a break fee of $400-million,representing about 3 per cent of the deal's value, if it accepts ahigher offer.
Teck bought the Teachers' stake in Fording for $36 (Canadian) a unit.Under that deal, Teck would have to top up Teachers to the bid price ifit bought the rest of Fording within a year.
Teck, however, was able to strike a separate deal with Teachers thatwill see it pay the pension fund $105-million (U.S.) instead. Thetop-up arrangement was set to expire at the end of this month, but Mr.Lindsay said it would have taken weeks until Teck would be clear tomake a bid for Fording.
“If we waited until, say, mid-September, we would lose six weeks ormore of cash flow, which is far more than $105-million,” he said.
Teck also wanted to act quickly to take advantage of the recent selloff in coal stocks.
“We wanted to be able to launch our bid during a time of very weakequity markets and give unitholders a chance to get out with an almostall-cash bid,” Mr. Lindsay said.