Alpha Natural Resources Inc.’s $2 billion acquisition of Foundation Coal Holdings Inc. gives the company access to low-cost Wyoming surface mines as stricter regulation makes work in Appalachia more costly.

Alpha will become the third biggest U.S. coal producer when the purchase is completed in September, with pro forma 2008 revenue of $4.2 billion from 59 coal mines and 14 preparation plants and reserves of more than 2.3 billion tons.

Alpha Chief Executive Officer Michael Quillen has been looking for partners after a plan to be acquired by Cliffs Natural Resources Inc. for $2.88 billion failed in November because of a steel glut. With Foundation, Alpha gains entry to the largest and least expensive U.S. reserves in Wyoming’s Powder River Basin and access to more coal types for blending.

“Alpha’s found a great way to move into the Powder River Basin at a pretty good price,” said James Rollyson, an analyst at Raymond James Financial in Houston who rates both companies “outperform” and owns neither. “From a long term growth standpoint, this is a smart move because Eastern mines have a lot more regulatory headaches.”

Foundation Coal, based in Linthicum Heights, Maryland, jumped $4.82, or 21 percent, to $28.06 a share in New York Stock Exchange composite trading and has doubled since the start of the year. Alpha fell $1.80, or 6.2 percent, to $27.06, and has gained 67 percent this year.

Ownership Structure

Foundation stockholders will get 1.084 shares of the new company for each share they own, worth an estimated $32.73 per share based on Alpha’s May 8 closing price. The deal, including $530 million of Foundation’s net debt, comes with a 37 percent premium to Foundation’s average share price.

“Size and scale gets us more recognition and we can go to customers with a full range of products,” Quillen said today in an interview by phone. “We can blend some of our Central and Northern Appalachia supplies and give our customers exactly what they want. That takes away the ability to negotiate discounts.”

Production costs at Alpha, the largest U.S. supplier of metallurgical coal, averaged $58.61 a ton in the first quarter, triple Foundation’s $19.28 a ton average. Alpha’s costs are higher because mines in Central Appalachia are deep underground and require more earth removal and disposal, as well as more safety regulations.

The two largest U.S. producers, St. Louis-based Peabody Energy Corp. and Arch Coal Inc., shed most of their Eastern mines to focus on the lower-cost surface mines in the West.

Western Pricing

Peabody sold 169.7 million tons of coal from its Western operations at an average price of $14.93 per ton in 2008 and Arch sold 102.6 million tons of coal in the Powder River Basin last year at an average price of $11.30 a ton.

Becoming a top producer also gives Alpha an advantage over smaller rivals in buying mining machinery from suppliers such as Caterpillar Inc. and Joy Global Inc., Quillen said.

“As a larger buyer, we get a rebate that will automatically come in,” he said. “Those benefits aren’t even included in the $45 million in synergies we expect.”

Lower prices pressured producers to reduce global output by as much as 50 million tons this year, Quillen said.

“More mine closures are expected in the future,” Quillen said. Alpha may make additional acquisitions as opportunities arise, he said. “Central Appalachia has more small players and more opportunities than any other region.”

Foundation stockholders will hold about 41 percent and Alpha stockholders approximately 59 percent of the new company on a fully diluted basis. Savings from the merger will be at least $45 million a year starting in 2010, the companies said on a conference call.

Alpha was advised by Citigroup Inc. and Foundation by Barclays Plc. Alpha will retain its headquarters in Abingdon, Virginia.

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