(The author is a Reuters Breakingviews columnist. The opinions...

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

By Quentin Webb HONG KONG, Jan 25 (Reuters Breakingviews) - The Chinese are making a bold bet on thermal coal. On Tuesday, state-controlled Yancoal (YAL) agreed to buy Rio Tinto's (RIO) Coal & Allied Industries unit in a deal worth up to $2.6 billion including working capital. For Rio, the long-mooted sale swaps a non-core business for cash that could fund future deals or shareholder payouts. For the buyer, a Sydney-listed small-cap that ultimately answers to provincial officials in Shandong province, this is a huge deal with a full price tag.

A lot of so-called transformative deals are no such thing. This one is, though, doubling the buyer's sales to A$1.05 billion. Growing this fast always tests management mettle. The timing is awkward too as Canberra grows increasingly wary of Chinese investment. But this risk looks surmountable: coal for export is not a particularly strategic asset, and Yancoal is well-established in Australia.

(Reuters Breakingviews graphic: Uncertain future: http://reut.rs/2j3lRsL) A bigger hurdle is financing. Yancoal Australia, with a sub-$400 million market value, must raise $2.1 billion-plus of capital, largely in equity. Parent Yanzhou <600188.SS>, which owns 78 percent, will kick in at least $1 billion, leaving a $1.1 billion shortfall. Nor is it clear whether Noble , a troubled Singaporean trading house that owns another 13 percent, can help much. Still, if Yancoal can round up new backers, this could be a handy way to increase the group's tiny free float and broaden its investor base.

The next challenge for the buyer will be creating value. Most analysts think Yancoal is paying a robust price for the deal – $200 million above Deutsche Bank's estimated valuation of the asset, for example. That makes things harder.

To be sure, commodity asset values are moving targets. After a 65 percent rebound in benchmark coal prices last year, the business is now highly profitable. But were China to backtrack on the combined production curbs and infrastructure spending that helped power last year's rally, that could change. In the long term, concerns about climate change and pollution cannot be good for international coal demand. Yancoal needs to get the market fired up about its prospects.

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- Rio Tinto, the Anglo-Australian miner, said on Jan. 24 it agreed to sell subsidiary Coal & Allied Industries to Yancoal Australia for as much as $2.45 billion in cash.

- Yancoal can either pay $1.95 billion upfront, followed by five annual payments of $100 million, or can choose to pay $2.35 billion in one go. Rio will also collect royalties for the next 10 years, provided Newcastle benchmark thermal coal prices <0#GCLNWCPFBAVc> stay above $75 a tonne. Contracts for future delivery through April are currently pricing around $84.

- In addition, the deal assumes Coal & Allied will have A$161 million of negative working capital.

- Rio expects the sale of the business, which owns and operates thermal coal mines in Australia's Hunter Valley, to close in the second half. It requires approval from independent Rio shareholders. Thermal coal is used to fuel power stations.

- Yancoal, with a market value of A$477 million ($362 million), expects to fund the takeover through a rights issue. The group is 78 percent owned by Yanzhou Coal Mining, whose stock trades in Hong Kong, Shanghai and New York, and which is ultimately controlled by the provincial government of Shandong in China. Noble Group, a Singaporean commodity trader, owns another 13 percent.

- Rio Tinto's London-listed shares rose 4 percent on Jan. 24 to 3,614.5 pence. By late morning in Sydney on Jan. 25, Yancoal shares stood 4.2 percent higher at A$0.50.

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Rio Tinto sells coal assets to China's Yancoal for up to $2.45   

Rio Tinto statement http://www.riotinto.com/documents/170124_Rio_Tinto_agrees_sale_of_Coal_Allied.pdf Yancoal statement http://news.iguana2.com/yancoal/ASX/YAL/994915 Breakingviews graphic: Uncertain future http://reut.rs/2j3lRsL BREAKINGVIEWS-Rio Tinto takes bitter but helpful graft medicine BREAKINGVIEWS-Rio Tinto’s best is not yet good enough

BREAKINGVIEWS-China digs itself into a hole over coal

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