Merrill Lynch arranges buyout of Indonesia's fourth largest coal miner

The $279 million deal is financed through a privately- placed two-tranche loan structure which gives investors a right to 30% of any future equity upside.
Merrill Lynch has completed another privately placed off-market investment banking transaction in the form of a $279 million buyout of IndonesiaÆs fourth largest coal miner, Berau Coal. The acquisition is financed through a two-tranche high-yielding loan that was said to have attracted just under 10 investors.

The highly complex transaction, which is believed to be the first private sector unlisted buyout involving multiple investors in Southeast Asia, centres on the clean-up of a messy ownership structure. The aim is to make the company more efficient with regard to its operations. Berau, which is currently stretched to the limit with regard to capacity, plans to expand production to meet the growing demand for coal from power producers and to improve its marketing.

What Merrill has done is essentially to raise the money needed for one of the existing shareholders - Indonesian individual Rizal Risjat
- to increase his stake in the company to 90% from 9.3% and to ensure the smooth exit of the other owners. Ten percent of the company will remain in the hands of Sojitz, a listed Japanese trading and investment company.

To ensure sufficient interest from investors, who do foot the entire bill for this buyout, the mezzanine tranche is structured to give them 30% of the potential future capital gain when the new owner sells out. As an additional protection, and to ensure a reasonable investment horizon for the participating investors, they will get a guaranteed internal rate of return of 20% if there is no qualifying exiting event (an IPO, a trade sale, a high-yield refinancing etcetera) within two years.

Depending on what exit route is ultimately used, investors can likely expect between 10% and 25% returns on this investment, people involved in the transaction says.

ôParticularly with regard to the mezzanine tranche, the deal is structured to align RizalÆs interest with that of investorsÆ from the perspective that he is motivated to sell at the highest price and they get a share of that,ö one person says. ôThey get a good fixed- income return, but itÆs the additional equity upside that will get them over the line (in terms of the potential for above market returns).ö

From an investor point of view, the transaction comes at the right time given the present bullish view on coal and the commodity boom.

There is also a strong preference among investors for US dollar- denominated and export-oriented companies in the commodity space in Indonesia û a category which Berau fits into after being founded by US oil major Mobil Oil in the 1980s.

Since then the company has changed owners several times before ending up being controlled by a group of five or six different parties, including four Indonesian parties, one US investor and a Tokyo-listed company. The entire ownership structure before this deal, however, included three layers of direct and indirect owners, some of whom could lay claim to the company only through their holdings of call options, which explains why no fewer than 15 legal firms were involved in various parts of this buyout transaction.

Making the transaction even more complex, it also had to deal with outstanding options that had to be unwound, share pledges, default warrants and competing buyers for the assets, not to mention the sharp correction in global equity and emerging debt markets while negotiations were ongoing. Merrill is said to have been working on the deal for more than four months.

The complex ownership is likely to have contributed to the companyÆs inefficient operations and a cost structure that in some areas is well above the industry average. For one, BerauÆs extraction costs are approximately $19 per tonne, which compares with between $12 and $17 for most of its competitors.

ôThis means there is significant upside under the new management to cut costs,ö says one observer, who notes that investors also bought the story based on the companyÆs bluechip client list, which includes names like Korea Midland Power, Malaysian power producer Tenaga, Guangdong Power and Hong KongÆs CLP Power.

With the production expansion now forecast, there should also be significant upside to the companyÆs earnings once its house is in order, he adds. This year, Barau is expected to generate EBITDA of $70 million from the production of 11 million tonnes of coal.

The new owner wonÆt be involved in the day-to-day operations himself, but has brought in a new Indonesian CEO with experience in the countryÆs coal and commodities industries. The company is also looking to identify foreign talent to come in and run the mining and coal production operations as well as the marketing efforts.

According to people involved in the deal, the price tag on the acquisition corresponded to 3.6 times the projected 2006 EBITDA, which compares with an EBITDA multiple between five and eight times for most publicly traded coal assets globally. In the US, coal companies tend to trade at even higher forward PEs of eight to 10 times.

Aside from the acquisition cost, the $297 million that Merrill raised for the new owner also covered one year of pre-funded interest for the debt facility now put in place, as well as some other expenses.

The funds raised were split into two parts. The smaller tranche is a
$39.5 million three-year senior loan, which will pay 400bp above Libor and which will primarily be used to retire an existing US dollar loan and bring down the companyÆs existing cost of debt. The second tranche consists of $239.5 million of two-year mezzanine debt in the form of a so-called ôcellsö (a collateralized equity-leveraged loan security). This portion will pay Libor plus 800bp and will carry the rights for investors to get part of the equity upside in case of a future sale or listing of the company.

Most of the participating investors bought into both tranches. The type of investors represented was said to have included ôhighly sophisticatedö players who have been involved in Indonesia both during and after the financial crisis and who understand the risks û for which, read hedge funds. However, according to the people involved, the group comprised a mixture of equity and credit accounts, as well as investors specialising in coal assets.

Merrill Lynch has been quite active with regard to privately placed transactions over the past 12 months, including a $150 million pre- IPO convertible bond that it arranged for Golden State Environment Group Corp, a mainland water supplier and waste treatment company, in July. In December 2005 it completed a $151 million pre-IPO CB for Indonesian specialty chemicals group PT Sulfindo and in early May it wrapped up a privately placed highly structured deal that raised $500 million for a leveraged buyout of Hong Kong-listed Asia Aluminum by its chairman.

Representatives for the US investment bank say these type of transactions, which tend to pay higher fees, are doing wonders for its P&L account. And on the equity side, its simultaneous slip in the league tables, which some rivals suggest may be the reason for this new focus rather than the result, should be cleared up later in the year as Merrill will act as one of the bookrunners for ICBCÆs upcoming IPO, they argue.

ICBC looks set to become one to the worldÆs three largest listings ever, and if it goes ahead with a dual A-share and H-share it could even be the largest.
According to a banker not involved in this deal, hedge funds in particular are extremely keen on private deals like this one because of the potential for higher returns and have to a large extent already taken over from private equity funds as a primary source of funding for unlisted companies.
¬ Haymarket Media Limited. All rights reserved.
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