$1 Billion Dilemma

FOR SALE: Peabody Coal Co., the nation's No. 1 coal producer. Sold 72 million tons worth $723.4 million in 1975. Has untapped reserves of 9 billion tons in the U.S., plus holdings in Australia. Potential buyers must 1) be able to raise $1 billion, and 2) get approval of the Federal Trade Commission. If qualified, call Kennecott Copper Co. in New York City --and call collect. soon as the U.S.'s biggest copper company acquired Peabody in 1968, the FTC charged it with violation of a dubious antitrust law. That led to a formal FTC ruling in 1971 that Kennecott must get rid of Peabody. The order demanded a divestiture that ranks with the largest in American business history and expanded antitrust law to say, in effect, big mergers and acquisitions are almost by definition bad.

Kennecott fought the ruling unsuccessfully through the courts (the U.S. Supreme Court refused to hear the case) and even enlisted top politicians, labor leaders and economists to argue on its side. But nothing shook the FTC's resolve. Earlier this month, Kennecott lost what may very well be its last legal appeal when a federal court failed to reverse the order. Despite all the legal maneuvering, the copper company insists that it also has tried to find a way of giving up Peabody without inflicting financial harm upon itself, but the FTC wants it to try harder. The commission recently asked a federal court to fine the company and its officers $100,000 per day for delaying the process of divestiture.

Kennecott executives say they cannot discuss their Peabody problems because of this pending suit. Yet they previously made no secret of the fact that they have talked to "more than 200 parties" interested in buying at least part of Peabody. Of these, only five seemed able to pay the full sale price--reportedly a cool $1 billion. So far, however, Cities Service Corp., the Tennessee Valley Authority and a privately owned coal-exporting firm called ICM-Carbomin International have either formally or informally dropped out of contention. While the other two--both syndicates of electric utilities--keep on negotiating, a consortium headed by Newmont Mining Corp. has appeared a last likely bidder. But this group is said to have offered only $800 million for Peabody, and whether it can or will go to $ 1 billion is uncertain.

Alternatively, Kennecott can declare a stock dividend of its Peabody holdings and so set up the coal company as an independent entity once again. Kennecott shareholders seem to favor such a spin-off scheme and may sue if it does not come about; their expectation is that the Kennecott and Peabody shares they would have as a result of a spin-off might fare better in the stock market than Kennecott alone. Trouble is, Kennecott has acted as if the divestiture order did not exist. The company lavished management time on running Peabody and spent $532 million to buy equipment and open new coal mines --time and money that it did not put into its copper business. The result is that Kennecott's copper operations are in poor shape. Concludes John Bogert, a Wall Street mining analyst: "Kennecott did not milk Peabody; it milked itself for Peabody."

Tax Considerations. What Kennecott needs to return its copper business to health is the money it put into Peabody. Unfortunately, the only way to recoup the $532 million in a spin-off would be to have Peabody borrow the money. But that would saddle the coal company with such an onerous debt that its future growth would be imperiled.

Kennecott's final option is to sell 20% of Peabody and spin off the remaining 80% to shareholders. (These proportions would be dictated by complicated tax considerations.) Though this would provide some of the needed cash and probably please many stockholders, like all compromises it falls well short of what managers and shareholders hoped to get.

Given these gloomy alternatives, it is little wonder that Kennecott badly wants to keep Peabody. But that is prevented by a narrow reading by the FTC and the courts of a much debated section of antitrust law; this is the concept that mergers can be stopped not because they reduce competition but because they eliminate "potential" sources of competition. Back in the mid-1960s Kennecott decided that it would make a major attempt to diversify out of copper. Among other things, it bought a small coal field for the purpose, according to Kennecott, of assuring its own fuel supplies. In the FTC'S eyes, the purchase was damaging evidence that Kennecott had plans to enter the coal business. That meant that when the copper company bought Peabody, it removed itself as a "potential competitor" in the coal industry. Since competition was at least theoretically diminished, the FTC decided that Kennecott was violating antitrust law.

Potential Violations. That theory needs some revision. Over the years, Kennecott and Peabody proved to be well suited for each other. Kennecott was able to raise money to open more Peabody mines and boost production. Peabody has the steady flow of income from long-term coal contracts to even out the wild fluctuations in copper prices. Result: both companies became stronger--more rather than less competitive in their industries.

The FTC also feared that Kennecott's purchase of Peabody marked a trend toward competition-crushing bigness in the coal business. But Peabody's share of total U.S. coal output has remained steady: about 12%. Meanwhile, since 1968, the proportional market share of the eight biggest coal companies has fallen from approximately 41% to 37%, while the share for the 50 biggest companies dropped from 69% to 66%--figures that suggest that the coal business in the U.S. has become less concentrated and more competitive in recent years.

One reason is that there has been a rush by electric utilities, mining and oil companies to acquire coal producers and pump money into them, just as Kennecott did with Peabody. Indeed, Wall Streeters give the copper company high marks for its prescience in getting into the coal industry ahead of everyone else. Yet that obviously was a mistake on Kennecott's part too. No other big purchaser of a coal company has been bothered by the FTC, even though some might provide clearer examples of potential antitrust violations than Kennecott. In other words, the FTC ruling, despite its success in court, has not been followed as a precedent, even by the FTC itself--though that hardly helps Kennecott now.

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