Wall Street's “Escape Hatch”
Was it just another blundering mining deal? Or did Morgan Stanley devise the most cynical piece of corporate manoeuvring the industry’s ever seen. “They had an escape hatch and they used it.”
In October 2007, after a strategic review led by Morgan Stanley, the board of American coal giant Peabody Energy agreed to split the company into two.
Coal prices were rising, Peabody's share price was at an all-time high, it had been buying-up assets in Australia and was generating $5bn per annum, producing two per cent of the world's electricity. Its mines in Montana and Wyoming in the east of the US, which sold coking coal for steel, were profitable and thriving. But in Kentucky and Virginia in the west, where it sold thermal coal for power stations, Peabody's assets were rickety and high-cost.
They were also unionised, and came with high healthcare payments: 8,400 workers were owed over $600m. A young Senator from Peabody's state of Illinois, Barack Obama, was meanwhile running to become America's president on a platform that was avowedly anti-coal.
Peabody hived-off the mines and their obligations and the new company began trading on the New York Stock Exchange. Many of its former workers were veterans from Vietnam and it was given a bold American name: Patriot Coal.
In a call with Wall Street, Peabody's CFO talked-up the deal. “Our retiree, healthcare liability and related expense will be reduced by about 40 percent. Workers' compensation liability will be cut nearly 90 percent,” he told analysts from UBS and Goldman Sachs. “In total, our legacy liabilities, expenses and cash flows will be nearly cut in half.”
Less than a year after it was created, Patriot announced a second deal, paying $709m for Magnum Coal, its biggest neighbouring producer. The deal nearly doubled Patriot's tonnage and added 600 million tonnes of coal in the ground. But Magnum, like Patriot, was newly created and had been stacked with obligations.
The new group was being setup to fail, unions argued. Patriot had been given 13 per cent of Peabody's coal reserves and 40 per cent of its healthcare costs. The Magnum transaction piled-on another 2,300 workers, lifting total obligations to $1.1bn.
Workers who had spent their whole lives
working for Peabody, some suffering from black lung disease, found it hard to believe that their pensions had been dumped into a “made-up” company. “They’re gonna take our insurance away from us,” one retiree said. “I never worked for Patriot in my life. I worked for Peabody.”
Initially, Patriot did well. It produced 22 million tonnes in 2007 and the shares quadrupled in its first year. But healthcare payments, plus debt from the Magnum deal and a water cleanup bill that unexpectedly landed on its doorstep, swallowed an ever-bigger chunk of the revenue and when coal prices wobbled, Patriot went under. In July 2012, five years after it was founded, the company entered Chapter 11.
Unions were outraged, marching on Peabody’s headquarters. Retirees in their 80s were bundled into prisoner trucks. “They dump in all the legacy costs from years and mines all over the country onto this little company, knowing full well that company can't survive,” one union boss yelled.
Peabody remained defiant. Patriot was entirely viable, it claimed, and Peabody had “lived up to its obligations... this is a matter solely between the union and Patriot Coal.”
In Peabody's defence, America's fracking boom had flooded the country with natural gas, depressing energy prices. Its board may have made an astute decision that was too well timed. “Was debtor Patriot Coal Corporation created to fail?” one judge wrote in a ruling. “Maybe not. Maybe.”
But the raw facts looked incriminating: Peabody had stuffed its liabilities into a company that almost immediately filed for bankruptcy. Its American branding was also a slap in the face, workers said. After years of court proceedings, Patriot wrote to 12,500 workers in 2016 saying healthcare payments would be stopped.
Morgan Stanley and Peabody had created a model that allowed companies to bundle their smallest assets and their biggest liabilities out the backdoor. “Bankruptcy is a legal mechanism that these companies use to avoid accountability,” one lawyer noted at the time. “Patriot's a perfect example of how that works. They had an escape hatch and they used it.”
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