* Peabody spinoff had aimed to dominate Appalachia coal
* Five years later, Patriot files for Ch. 11 protection
* Recession, crippling $2 bln legacy liabilities cited
By Steve James
July 13 When Patriot Coal was spun
off by Peabody Energy Corp five years ago, it aimed to
become the dominant producer in the Appalachian coalfields,
buying up small, struggling mining companies and increasing
production to cater to growing demand from power companies and
For a while, Patriot was a darling of Wall Street, its stock
rising from $15 at its IPO on Oct. 31, 2007, to an all-time high
of $80.70 on June 18, 2008.
During the same period, the shares of Peabody, which had
shifted its focus to lower-cost mines in Wyoming and lucrative,
export-oriented mines in Australia, nearly doubled from $44.65
Then the recession hit.
Patriot had only one profitable quarter since the spinoff,
and on Monday it filed for Chapter 11 bankruptcy protection. It
is continuing to operate, but has cut 1,000 of its 4,700
workforce, idled some of its 19 underground mines and lowered
Patriot, like most of its peers, was rocked a year after its
spinoff when the economy went into a slide, sending coal prices
tumbling, along with demand from utilities and steelmakers.
But the downturn also prevented Patriot from achieving its
stated goal of acquiring other assets and becoming the premier
coal company in Appalachia.
As a smaller producer with lower revenue, Patriot had
trouble obtaining adequate financing. In addition, it was
saddled with legacy pension and health cost liabilities of
around $2 billion -- almost twice that of Peabody, a company
that produces 10 times as much coal.
"The coal industry is undergoing a major transformation and
Patriot's existing capital structure prevents it from making the
necessary adjustments to achieve long-term success," Chairman
and CEO Irl Engelhardt said in a statement on the day of the
Chapter 11 filing.
Peabody declined comment on Patriot's Chapter 11 filing.
Despite Patriot's bankruptcy, analysts do not expect a wave
of similar action by publicly traded coal companies, although
many smaller, independent mining companies are vulnerable, they
"Others hope to weather the storm, but for Patriot the storm
hit hard," said Lucas Pipes, an analyst with Brean Murray,
Carret & Co.
It was not supposed to turn out this way.
Peabody had such confidence in Patriot's prospects in 2007
that several high-level Peabody veterans joined the young
company's management team, including Engelhardt, a former
Peabody CEO with a sterling reputation in the industry.
Engelhardt was Patriot's chairman, and in May this year
added the CEO post when he replaced Richard Whiting.
Patriot's growth strategy looked appealing at a time when
the long-term outlook for coal was bright, according to the IPO
filing. "With its strong presence in Appalachia, Patriot will be
positioned to be a consolidator in that highly fragmented
region," Peabody said in a letter to shareholders.
"It was a good idea at the time," said analyst Bill Burns,
of Johnson Rice & Co in New Orleans, referring to the spinoff.
Patriot shareholders were given a rosy outlook by Peabody.
"We believe strong coal markets will continue worldwide, as long
as growth continues in the U.S., Asia and other industrialized
economies that are increasing coal demand for electricity
generation and steelmaking," it said in the filing.
But Peabody also warned that Patriot was assuming
"significant" legacy liabilities with the assets it took over.
In its first year, strong coal prices and demand offset the
higher costs of mining in the older coalfields of eastern
Kentucky, West Virginia and Virginia. But the recession hit and
coal demand fell, sending down prices along with Patriot's
Patriot was able to acquire only one other asset -- a
subsidiary of Arch Coal called Magnum.
Then this year, demand sharply dropped when the mild winter
depressed electricity use and some power companies switched from
coal as natural gas prices made it a more economical fuel.
Patriot responded by cutting its workforce and production,
lowering its 2012 sales target to 25 million to 27 million tons
-- down from the 31 million it sold last year. Revenue in the
first quarter of this year declined 13 percent to $502 million.
With less revenue, the company struggled to pay pensions and
healthcare to workers and retirees, while debt repayments on
$200 million in convertible notes due next year loomed.
On May 8, Patriot posted a wider-than-expected quarterly
loss, but at the same time announced it had signed a $625
million revolving credit facility and term loan.
Just a week later, Patriot warned that a major customer
might default on a contract, setting off a stock drop that ended
with the Chapter 11 filing and Patriot shares at just 61 cents.
The company did not reveal which customer defaulted, but in
the Chapter 11 filing, Chief Financial Officer Mark Schroeder
identified two -- Bridgehouse Commodities Trading Ltd and
Keystone Industries -- and Patriot has sued both for breach of
Florida-based Keystone did not respond to a Reuters request
for comment. Bridgehouse, which is registered in the Isle of
Man, could not immediately be reached.
Patriot suggested in its May 14 statement that the deals
amounted to a total of about 1 million tons of steelmaking
coal, or 20 percent of its 2012 sales target for that coal type.
In its Chapter 11 filing, St Louis-based Patriot said it has
$3.57 billion in assets and $3.07 billion of liabilities. It has
arranged for $802 million of financing to help it continue
operating through reorganization.
"This outcome was not fully unexpected given the inability
for Patriot to refinance debt immediately following the contract
default," said analyst Curt Woodworth of Nomura.
He forecast Patriot's negative free cash flow will worsen,
growing to $172 million in 2013 compared with $157 million this
Pipes said Peabody and Arch could be financially affected by
Patriot's filing. A Peabody filing with the SEC lists potential
liabilities of less than $150 million due to federal and state
black lung occupational disease liabilities, which had been
assumed by Patriot.
Arch listed potential obligations due to contracts acquired
by Magnum as about $64 million.