X2 Turns to Coal for First Deal

X2 Resources, the private equity fund set up by former Xstrata (XSRAF.PK) boss Mick Davis, is now in initial bi-lateral talks to buy some of Rio Tinto (RTNTF)'s Australian coal assets, a source close to the situation said on Tuesday.

Davis, whose X2 fund has yet to clinch its first deal, is turning his attention to Australian coal after being outbid in a race to buy a copper mine in Chile.

The mining industry veteran is also considering buying some coal mines Anglo American has put up for sale in Australia, sources close to X2 said.

X2 was not immediately available to comment.

Davis set up X2 Resources in 2013 only months after commodity group Glencore (GLCNF) took over Xstrata. His fund has raised about $5.6 billion and has six main private investors, which include commodity trader Noble Group (NOBGF) and private equity group TPG Capital, an Abu Dhabi investment fund and a Canadian pension fund, according to sources.

But X2 has yet to find a deal to invest some of the cash it has raised.

X2's talks with major mining companies including, BHP Billiton (BHPLF) and Vale to buy out some chunks of their holdings have so far been unfruitful. And X2 was outbid in the first round of the sale of a stake in Barrick's Chilean copper mine Zaldivar, which had been a primary target for Davis this year.

Copper has attracted a lot of competition because it is perceived as one of the commodities with the biggest upside potential due to supply constraints.

In contrast, most analysts think coal prices will remain depressed for the next few years, under the weight of a heavy supply overhang. This could finally provide Davis with the opportunity to place his long-term bet and secure some assets.

"Mick Davis's forte is thermal coal and it would make sense for this to be the first foray for X2, especially given that a private equity firm should be able to take a long-term view on a commodity that is out of favour," Investec (ITCFY) analysts said in a note. Investec values the three Rio Tinto mines at around $2.4 billion. Bernstein Research analyst Paul Gait values Anglo's Australian coal assets that are up for sale at roughly $1 billion.

The Financial Times, citing people familiar with the matter, said on Tuesday that "serious" talks were taking place for X2 to purchase Rio Tinto's Australian Bengalla, Hunter Valley Operations and Mount Thorley Warkworth coal mines.

X2's failure to close a deal so far is partly to do with the higher return expectations that private equity funds have  compared with large mining companies or state-owned entities. State-owned groups, especially those from big metal consumers China and Japan, consider natural resources acquisitions as a must-have.

"The problem is once you are paying billions of dollars you are up against mining companies and Chinese investors they don't have the same return hurdles that Mick will," one industry source said. "Companies and the Chinese both have different earning requirements ... They don't have to make sure that it generates two or three times return."

X2's structure also complicates matters.

The fund's six big investors have committed $500 million each, with the option to add an extra $250 million each. But they each have veto powers on every project Davis decides to invest in.

Davis said earlier this year that he thought 2015 would be a good year to make acquisitions as commodity prices are close to the bottom. And with some X2 investors looking to find a use for their money in mining or move it to other sectors, according to sources, Davis needs his first deal.

"His investors are starting to turn nervous, you can't keep money committed for three years if nothing happens," a banking source said. "Mick Davis is definitely under a great deal of pressure."

By Silvia Antonioli