Is Coal Miner Massey Buyout Bait?

It's been a tough year for Massey Energy (MEE), but today the stock got a boost. The coal mining company announced it is "exploring strategic alternatives," which is finance-speak for a possible buyout.

Investors are taking the news seriously -- shares of Massey were up almost 10% at one point in today's trading, though they have since settled around 6%. While a deal is a real possibility, it will likely take a few months to put together. In the meantime, Massey's stock will probably be volatile.

Disaster at the Upper Big Branch Mine

Founded in 1920, Massey is now one of the largest coal producers in the U.S., with its main operations in Central Appalachia. Over the years, the company has been savvy with its acquisitions -- finding new low-cost sources of reserves. For example, in the latest quarter, Massey sold 9.8 million tons of coal, up from 9.4 tons in the same period a year ago.

The company focuses primarily on metallurgical coal, which is in high demand because of its use in steel -- a key import for countries like China.

Despite all this, Massey still posted a net loss of $88.7 million in the second quarter of 2010. The main reason, of course, was the estimated expenses related to the tragedy at its Upper Big Branch mine in West Virginia. In early April, a massive explosion there killed 29 miners. It was the worst U.S. mining disaster in over 40 years.

Is the Timing Right?

From time to time, Massey has been the subject of buyout rumors. But now, the timing seems right. First of all, government officials are likely to increase scrutiny of other Massey mines. Besides the explosion at the Upper Branch mine, there have been other safety violations.

Next, it looks like investors have also factored in the growth in coal prices, at least in the short run. In fact, the recent interest rate hike in China may actually moderate things.

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Yet, the fact remains that Massey has substantial reserves of coal. And based on the current valuation of the company's stock, a buyer could pick up these assets for a cheap valuation. True, there will be uncertainty regarding the litigation and regulatory liabilities. But then again, a buyer can structure a transaction to fire-wall these problems.

And what about a going-private transaction? It's possible, but it will probably be difficult to pull off. Massey's debt load is large because of its aggressive acquisitions. Also, the litigation costs will eat into cash flows.

So a buyout from another coal operator appears to be the most logical alternative for Massey. And it would certainly be a good way to capitalize on the long-haul trends in industry, especially as urbanization and electrification continue to grow in emerging countries.