Financial Evaluation Of A Coal Mine Acquisition A Case Study

INTRODUCTION In the second quarter of 1979, Rapid Mining Co., Inc. ("Rapid") inquired whether Crocker National Bank ("CNB") would provide $4 million in term loan financing to help ("Dry Creek") acquire the outstanding shares of the Dry Creek Coal Company ("Dry Creek") in West Virginia. Prior to approaching CNB, Rapid had sought financing with the assistance of a financial advisor from a number of commercial banks without success. A summary of the initial terms requested by Rapid is shown in Table 1 compared with the actual terms on which the transaction closed. It is not difficult to note that the two sets of terms differ significantly. This is often the case when financing requests based on the expectations and vision of a mine developer are juxtaposed with more pragmatic requirements of a commercial bank. The "art" and fund of structuring financing plans for mining ventures (highly leveraged acquisitions or grass roots) comes in working with mine developers to arrive at a final financial structure that meets their objectives and constraints as well as those of the bank or other financial institutions providing much of the financing. Beginning with the terms requested by Rapid and ending with the terms that closed the transaction, this article briefly describes the process we went through with Rapid Mining. The Seller and Buyer The Dry Creek Coal Company was established in 1961, after its owner acquired the coal leases from Republic Steel. Republic has mined the primary coal seam from 1948-1961. Dry Creek was owned as a subchapter S corporation (i.e., for federal income tax purposes, income is taxed at the shareholder level) and had been run on a low key basis. Since the company had virtually no debt and limited cash needs, the owner produced primarily when rail cars were available and income was required. Output was therefore erratic as is shown in the top of Table II, but the result was a profitable little company with an attractive free cash position. Because the owner wished to retire and enjoy his wealth in a more readily spendable form, he had put the mine, with stated recoverable reserves of approximately 13 million tons, up for sale. In contrast, Rapid Coal's investors consisted of a number of investors of disparate financial situations. They had agreed upon a primary objective of income maximization and planned an annual production rate of 120,000 TPA which they and the current owner believed realizable. The Formulation of a Financing Structure Figure 1 presents a simplified overview of the sequence of steps taken in the financing process which lasted approximately three months from start to finish. Since banks see many requests for funding and considerble time is required to follow up on each, an important step was determining, after a brief review of the materials provided to us, whether the basic "eonomic entity" was viable. In this case, the size and quality of the reserves, the inherent operating cost characteristics, the sales arrangements, the management/labor situation and Rapid's principles all appeared to be sound enough to warrant investing the time necessary to do a thorough analysis of the project. Once this decision was made, the evaluation and analytic process shown in Figure 2 was initiated. The first and most fundamental concern of any banker is whether the loan will be paid back as scheduled from the cash flow generated by the project. The amount of debt relative to the owner's equity is of course crucial in such a determination. Before the debt/equity issue was addressed, however, a number of more qualitative factors had to be studied and if