Severstal Resources reaches agreement to acquire PBS Coals and expands gold business

Steel producers thirst for coal mines continues with news of the latest acquisition. Through its mining division Severstal Resources, Severstal intends to acquire the business of PBS Coals by way of an acquisition of Penfold Capital Acquisition Corp following a business combination of PBS and Penfold for an all cash purchase price of C$8.30 per share, implying an enterprise value of $1.3 billion. PBS is engaged in the mining, processing and sale of metallurgical and thermal coal in Somerset County, Pennsylvania, USA. PBS’s operations are located in the Northern Appalachian coalfields, situated between Severstal’s North American production centres, and have the capacity to produce over 4 Mt of metallurgical coal.

PBS’s portfolio includes six underground and six surface mining operations. In the fiscal year ended March 31, 2008, PBS produced approximately 2.4 Mt (clean) of coal, including 1.5 Mt of coking coal. PBS has 133.5 Mt of in-situ coal reserves and 228.3 Mt tonnes of in-situ coal resources. In addition to its significant reserves, PBS has an experienced management team and a competitive cost position among international coal producers, Severstal reports.

Severstal expects benefits from the vertical integration of its upstream operations; the increase in self-sufficiency with regard to the supply of primary raw materials available to its North American operations and that this will allow Severstal to control its operating costs. PBS’s central location will also mitigate transportation costs between Severstal’s facilities.

Roman Deniskin, CEO of Severstal Resources, commented: “Severstal Resources believes that the high demand for primary raw materials for steel production, including coking coal and iron ore, will continue due to the strong industrial fundamentals in global metals and mining. To keep pace with the global growth of the steel industry, our mining business is capitalising on the opportunity to expand into a new geographic market, gain access to export markets and diversify its mining technologies. Our significant experience with coal mining in Russia leaves us well positioned to make the most of our acquisition of PBS, ensuring its continued growth by providing additional management and operational expertise. ”

Gregory Mason, CEO of Severstal International and COO of OAO Severstal, added: “Securing the supply of raw materials is a critical piece to maximizing the full potential of our US business. The acquisition of PBS will help ensure that Severstal controls its operating costs by providing a guaranteed supply of metallurgical coal for our coke making operations in the US. The integration of our upstream production, from coal and coke making to steel making, will allow us to sustain profitability.”

Severstal Resources expects to fund its proposed offer for PBS through cash on hand. The transaction is subject to a number of conditions including obtaining all necessary regulatory approvals. The transaction is expected to close by mid-October. Upon completion of the acquisition, PBS will operate as a business unit of Severstal Resources.

Severstal’s takeover bid is conditional upon Penfold consummating a business combination with PBS, whereby Penfold will acquire PBS and the resulting public company will be known as PBS Coals Ltd. The transaction has been unanimously approved by the board of directors of both PBS (and the independent committee of the board of PBS) and Penfold and they have determined that the transaction is in the best interest of their respective shareholders.

Penfold and PBS have entered into a support agreement whereby they have agreed to support Severstal’s bid. The support agreement includes a commitment by PBS and Penfold not to solicit or initiate discussions concerning alternative transactions. PBS has agreed to pay a break fee of C$41.9 million to Severstal in certain circumstances and has granted Severstal the right to match competing offers.

Holders of approximately 66.8% of the outstanding shares of PBS, including all directors and officers of PBS, have executed irrevocable lock-up agreements whereby they have agreed to tender their shares to Severstal. Such holders together with the holders who have executed soft lock-up agreements to tender shares to Severstal represent approximately 71.5% of the outstanding shares of PBS.

Severstal Resources is a leading feedstock supplier in Russia to the iron-and-steel industry which manages the mining assets of Severstal. Severstal Resources incorporates the Karelsky Okatysh and Olcon iron ore complexes and Vorkutaugol, a coal mining complex. Stalmag, a niobium production facility is also part of Severstal Resources. In 2007, these operations produced 7.6 Mt of coking-coal, 1.8 Mt of steam coal, 10 Mt of iron-ore pellets and 4.7 Mt of iron-ore concentrate. In 2007, Severstal Resources established a gold business segment, which totalled 5.3 t of gold output over the past year.

Its latest move in gold was also in August, taking control of Balazhal, a gold mine in East Kazakhstan, 260 km south of Semipalatinsk. The purchase of 100% of the asset was made through one of Severstal’s subsidiaries. Recoverable reserves at Balazhal are estimated at up to 20 t of gold, and the mine has a resource potential of up to 30-40 t. The mine and heap leaching plants were built on the deposit in 2004. Mining operations were suspended due to financial difficulties in 2006.

Severstal Resources plans to resume production by 2009 and to raise output to 1.5-2 t of gold a year within two to three years. Both potential heap leaching and gold concentrate production are being considered. In the latter case the concentrate will be processed using the BIOX technology at the Suzdal site, another Severstal Resources operation in Kazakhstan.

Commenting on the transaction, Nikolay Zelensky, head of the Severstal Resources gold business segment said, “Balazhal is an attractive asset which allows us to quickly restore the existing production facilities. Buying this asset is a further step to strengthening Severstal’s gold mining business in Kazakhstan, which we consider to be a strategic region.”

Severstal entered the gold mining business in August 2007, first acquiring a stake in Celtic Resources Holdings, Ireland, and later the entire company. In addition, Neryungri Metallic, Sakha Yakutia, and the Aprelkovo mine, in the Transbaikal region, were purchased. While developing production at Celtic’s operating assets in Kazakhstan and at the companies acquired in Russia, the Severstal Resources gold business unit purchased exploration and follow-on gold production licenses in the Transbaikal region, Irkutsk Region and Bouryat Republic. Its resource base totals approximately 445 t, including the recently acquired Balazhal mine.