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When Aurizon confirmed it was considering buying the debt-laden Wiggins Island Coal Export Terminal this week, the initial reaction from the investment community was mostly positive.
One of Aurizon's largest investors, London-based TCI Fund Management, is cautiously optimistic the rail group can create value out of a potential deal, while analysts have described the proposal as making strategic sense.
Analysts at Ord Minnett say Aurizon has "a vested interest" in owning WICET, because the rail group previously spent about $900 million building rail links to the terminal but has not yet generated acceptable returns.
Aurizon, which built a balloon rail loop for WICET and upgraded other rail lines, has been in dispute with miners of payments it claims it is owed for building the rail links.
But any transaction still faces some serious hurdles, including how Aurizon will pay for WICET without damaging its creditworthiness.
Investors are hopeful Aurizon will not need to raise equity if a deal, which would include the Macquarie Group and Canada's Brookfield buying some of the mines that export through WICET, comes together. Any deal needs to be done by September, when WICET must repay $3.5 billion in debt.
Macquarie analyst Ian Myles says Aurizon could use its balance sheet without having to raise new capital, providing it can buy WICET for between $1.2 billion and $1.5 billion.
Reduce charges, increase exports
But Myles cautions the rail group would only create value out of an acquisition if it can reduce the terminal's port charges to around $7 per tonne from more than $20 per tonne currently, and increase export volumes to 27 million tonnes annually from 17 million tonnes.
Other analysts have suggested Aurizon may need to raise equity as well as debt to pay for WICET. First NZ Capital has forecast Aurizon could raise as much as $750 million in equity and still keep its ratio of funds from operations to debt at around 32 per cent.
Aurizon has told investors its current ratings of Baa+ from Standard & Poor's and Baa1 from Moody's Investors Service – both with stable outlooks – are "appropriate" for the company.
Both S&P and Moodys are happy for Aurizon to keep its financial leverage just above 30 per cent and keep its current credit ratings. But S&P warned this week that if Aurizon's business risk increased as a result of buying WICET, it may subsequently need to reduce its leverage.
S&P plans to scrutinise the terms and conditions of any transaction, including the pricing and duration of miners' take-or-pay contracts, which would be revised if Aurizon succeeds in acquiring the terminal. The current contracts require miners to subsidise one another if they default on their export obligations.
The ratings agency will also examine what kinds of risk Aurizon would take on and what kind of protection it would have against mines closing or defaulting on their obligations. "We view unregulated, single commodity port operations as somewhat weaker than Aurizon's currently dominant regulated below-rail operations," S&P said.
Three of WICET's initial owners – Bandanna Energy, Cockatoo Coal and Caledon Coal – have gone into administration since the terminal opened, forcing the remaining five owners to bear the financial cost of soaking up the spare capacity.
Aurizon is hopeful that more mines in Queensland's Bowen Basin would export coal through WICET if its port charges were more competitive with other nearby coal terminals like RG Tanna.
The other hurdle faced by Aurizon is how closely the Australian Competition and Consumer Commission (ACCC) would scrutinise the deal, which would vertically integrate the company's coal haulage and rail networks businesses with its port assets.
The ACCC has previously taken a tough line on the vertical integration of assets, knocking back the so-called "behavioural undertakings" provided by Brookfield to try address the concerns over a mooted combination of the group's Dalrymple Bay coal terminal with Aurizon rival Pacific National in late 2015.
But the ACCC said Brookfield could not guarantee there would be no abuse of market power, forcing the group to abandon its plans to buy Pacific National.
Aurizon is expected to argue that its situation is very different to Brookfield's, because there is already a regulatory regime in place ensuring open access to the rail networks that lead into the WICET terminal.
The company also believes it would create more competition among ports by lowering WICET's charges because miners who do not have any financial stake in WICET have no incentive to use the terminal due to its high prices.
Glencore, the miner that has the biggest stake in WICET, is trying to sell its Rolleston thermal coal mine, which exports through the terminal.
If a sale is successful, either to a Macquarie/Brookfield consortium or another party such as a private equity group or hedge fund, Glencore would no longer have any financial exposure to WICET.
This article first appeared on www.afr.com
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