Mongolian Coking Coal Producer SouthGobi Resources is a Prime Taveover Target, Teck Resources Should Acquire it Before a Competitor Does

M&A activity in the coal space has been robust; Rio Tinto acquired Riversdale in Mozambique, Alpha acquired Massey and Arch acquired Intl. Coal. Glencore is stalking South Africa’s Optimum Coal, Peabody & Mittal are close to winning Macarthur Coal and Banpu is bidding for Hunnu Coal. As a recently retained consultant for SouthGobi Resources, (SGQRF.PK, SGQ.TO, 1878.HK), I’ve carefully studied the competitive landscape. I believe that SGQ is a prime takeover target.

A company noticeably absent from the list of acquirers is Teck Resources. As all of Teck’s coal assets are in Canada, the company would benefit from diversification. Why does Teck need to diversify? Because coking coal exporters Mozambique & Mongolia are becoming incredibly important drivers of coking coal supply. While Vale and Rio Tinto own dominant positions in Mozambique, Mongolia remains up for grabs. The dominant producers there are Mongolian Mining and SouthGobi Resources.

Much has been written about the Tavan Tolgoi coking coal deposit, but Mongolia’s National Security Council just rejected a deal to mine the western portion of the concession. The world is expecting 50mm tonnes of coking coal out of Mongolia by 2015-16—that’s not going to happen. SGQ will remain a top Mongolian coking coal exporter for years to come.

From a run-rate of 5.3mm tonnes, by 2016 SouthGobi will be exporting 12-13mm tonnes of coking coal to China. As a major producer in a country that global miners and steel companies desperately want access to, SGQ is a tremendously valuable strategic asset. In 5 years, a combined Teck and SGQ would be producing more than 40mm tonnes of coking coal.

SGQ is still in the early stages of substantial organic earnings and production growth. Within 3 years the company will be exporting 10mm tonnes of coking coal and generating $500mm of EBITDA, valuing the company at just 3x 2014e EBITDA. Sooner or later, suitors will recognize not only how cheap SGQ is, but its importance as a major strategic asset sitting on China’s doorstep. In fact interested parties are already talking to SouthGobi’s 57% majority owner Ivanhoe Mines. If Teck doesn’t acquire SGQ a competitor will, leaving Teck without a presence in Mozambique or Mongolia.

Speaking to SGQ’s strategic importance, the company is an excellent hedge of global coking coal markets. When Australia's coking coal mines get shut by severe flooding or Teck experiences a major strike at its Canadian operations, SouthGobi's proximity to China makes it even more valuable. Importantly, SGQ's enterprise value of about $1.5 billion makes it easily digestible. Thus, while one could argue that getting a foothold in Mongolia is not an absolute necessity, SGQ is such a cheap option that Teck would be foolish to pass it up. Peter Epstein is a constultant and shareholder in SouthGobi. You can follow Peter on SeekingAlpha

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