Decades from now, when future generations of MBA students study the year 2005, one of the things they’re likely to read about is how energy prices skyrocketed throughout the year, spurring scores exits and acquisitions in their wake. And those students majoring in private equity just might get a chance to read about successful case studies like First Reserve Corp.’s investment in coal producer Alpha Natural Resources, which culminated in an exit that transformed the firm’s $85 million equity investment into more than $670 million in proceeds.
Not only does the Alpha investment represent First Reserve’s largest coal-generated return multiple, it was also the Greenwich, Conn.-based firm’s first-ever coal investment. The deal was initiated in Dec. 2002 with the acquisition of the distressed Virginia coal operations of Pittston Coal Co., a subsidiary of The Brink’s Co. First Reserve put up the cash-from First Reserve Fund IX LP-for the buy, while the firm’s strategic partner, American Metals and Coal International (AMCI), contributed its U.S. coal operations, thus forming Alpha Natural Resources. Ownership was split 55%/45%, with First Reserve the majority holder.
“We figured that down the road, coal would continue to be the lowest cost hydrocarbon fuel source for electricity generation, and we believed that as natural gas prices continued to rise, coal would experience robust demand,” says First Reserve Managing Director Alex Krueger.
Indeed it did. When First Reserve built Alpha, the average coal price was approximately $27 per ton. Today that figure hovers around $56 per ton.
Further pushing First Reserve into the coal sector was the fact that “a material portion of the coal producers in the eastern U.S were under financial distress,” which meant that First Reserve would be able to find attractively priced consolidation opportunities, Krueger says. On that front, too, First Reserve was proven correct. The average acquisition multiple for the first three Alpha transactions (including Pittston) was 3.8x EBITDA.
A buy-and-build operation in the truest sense of the words, in a period of about two years, First Reserve made six add-ons to the Alpha platform, all the while handpicking seasoned senior management players from the acquired assets to run the overall platform. The growth of the company is evidenced in the numbers-Alpha’s annual sales increased from 4.3 million tons to 30 million tons per annum.
First Reserve’s investment thesis for Alpha proved to be dead on, and just one year after its initial investment, Alpha underwent a leveraged recapitalization resulting in a $110 million dividend to the owners and a return of 70% of its investors’ capital.
“Coal prices improved materially throughout 2003 and definitely in 2004,” Krueger says. “As that happened, there were a couple of things that we structured in our [add-on] deals that were really important to success. One was not acquiring legacy liabilities and the drag in expense that comes with them. Second was acquiring very few coal supply contracts, so we had the opportunity to position the coal supply and coal sales however we wanted. This provided us with an opportunity to take advantage of the market.”
Two years and three months after First Reserve created Alpha, the company was taken public on the New York Stock Exchange. On Feb. 15, 2005, 29.5 million shares under the ticker symbol ANR began trading at $19 a piece, above the planned $16 to $18 offering range. By the end of the first trading day, Alpha shares closed at $22.69-an increase of $3.69, or 19.4 percent.
“[The IPO] was about 10x oversubscribed,” Krueger says, adding, “We decided to not increase the size of the offering, and instead moved the price range up.” As a result of the $644 million IPO, a special dividend was paid to existing shareholders, resulting in a realized 4.6x multiple on investment and a 113% realized rate of return. What’s more, after the offering, First Reserve and AMCI still retained a 42.5% ownership stake in Alpha.
On Jan. 24, the two investment partners reaped even more when, through a secondary offering, they sold their remaining 12.3 million shares for $21.03, generating net proceeds to Fund IX of $282 million. All said, First Reserve’s investment in Alpha resulted in a solid 7.9x investment multiple and a 140.1% IRR.
But just because First Reserve makes it look easy, that does not make it so. While the firm was in its most acquisitive stages of the Alpha investment, the coal industry was in the throes of some significant financial difficulties, which made M&A in the sector both more difficult and more risky to pull off.
“At the time we put this deal together, it was incredibly hard to get debt capacity for coal businesses,” Krueger says. “This was especially due to the fact that the companies that produced about 20% of Central Appalachia’s coal were in bankruptcy.”
Krueger says First Reserve and the management of AMCI were able to secure some debt capacity from financial institutions by leveraging their familiarity with the coal space, but not enough to facilitate all that they had in mind. On Apr. 1, 2003, the search for additional financing led First Reserve to commence a sale/leaseback transaction of substantially all of Pittston Coal Co.’s fee-owned Virginia mineral properties to Natural Resource Partners (NRP)-a move that afforded First Reserve an opportunity to continue with its acquisition strategy.
The exclusive nature of the coal industry only adds to First Reserve’s status when one considers that Alpha’s most substantial acquisitions were proprietary. These include the buyouts of Mears Enterprises Inc. (Nov. 2003); Moravian Run Reclamation Co. Inc. (April 2004); and the $315 million acquisition of Nicewonder Coal Group (Oct. 2005), Alpha’s largest add-on.
“It was solely the personal relationships that senior management had with the individuals and families that owned these assets that facilitated getting some very attractive deals done,” Krueger says.