Activist investment fund Casablanca Capital is pressing for a break-up of Cliffs Natural Resources (NYSE: CLF ) after acquiring a large chunk of the company's shares, becoming the majority shareholder.
In short, Casablanca is demanding that Cliffs replace its management, spin off or sell its Asian operations, and return more capital to shareholders. It would appear that the majority of Casablanca's demands are well thought out, with the potential to unlock serious value for investors.
However, before we get into the nitty gritty of the battle between Cliffs and Casablanca, let's take a look at the key points of Casablanca's argument for a break-up of Cliffs.
The key points of Casablanca's case against Cliffs and the current management team are:
- Domestically focused Cliffs would be better positioned to realize full potential value
- Cost cutting and the sale of Asia Pacific business would allow for an increase of capital returns to shareholders
- Six highly qualified candidates have been nominated to Cliffs' board for election at the company's AGM
This battle reminds me of the infamous film Wall Street. If you've seen it then you'll know what I mean; if not, I won't go into it here. According to Casablanca, however, Cliffs' management team (including the CEO, Executive Chairman, and other board members) have purchased only 3,460 shares in Cliffs for cash, which shows almost no faith in the company.
In total, the management team has been granted 229,000 shares through incentives. In comparison, Lourenco Goncalves, a board member Casablanca is putting up for election, has purchased 50,000 shares in Cliffs. This shows that he already has more faith in Cliffs' recovery than the current management team.
The management team needs to go
Casablanca's strategy revolves around the replacement of what it calls Cliffs' "value destroying" management team. The activist fund notes that almost all of Cliffs' current board have been in place while the company has destroyed nearly $9 billion of shareholder value.
Breaking down this cumulative $9 billion value destruction, $6.4 billion has been wasted on the Bloom Lake acquisition, which has so far failed to yield results. $1.2 billion was spent on coal projects that are not expected to break even until this year, and $500 million was spent on a Chromite project that suspended during the second quarter of 2013. An additional $285 million was spent on the Wabush project, which idled during the first quarter of this year. Finally, there's the Amapa project, which was acquired for $500 million but sold for a "nominal amount" during the third quarter of 2013.
What's more, Casablanca claims that Cliffs is "hoarding cash." Specifically, Cliffs' management wants the company to hold $671 million in cash at the end of 2014, up from $336 million at the end of 2013. This cash is supposedly earmarked for the purpose of repaying debt. However, Cliffs' has no debt up for maturity until 2018 when a $497 million repayment is required. The next repayment is not due until 2020.
What does Casablanca intend to do?
First and foremost, Casablanca intends to divest Cliffs' Asian assets, which it claims to have unsolicited expressions of interest for. Casablanca intends to return the cash from this sale to investors and finance obligations at Bloom Lake to bring the asset into production.
Casablanca believes that Cliffs' remaining U.S. business can hold its own and has enough iron ore for 40+ years of mine production. In addition, Cliffs' existing U.S. assets could enable the company to leverage its experience within North America to establish attractive economies of scale, becoming the largest iron ore producer in the country.
Most importantly however, Casablanca believes that a management change is needed at Cliffs. The fund is recommending six new candidates for the company's board. All six candidates come with impressive CV's and the group is led by Lourenco Goncalves, who comes highly acclaimed with many decades of experience in the mining, iron, and steel industries.
Work cut out
Still, looking at figures from Cliffs' mining peers around the world, it would appear that the company has its work cut out if it wants to become competitive on a global scale. This is why Casablanca believes the company needs a new, more experienced management team.
Cliffs' main peers on the international stage are BHP Billiton (NYSE: BHP ) and Rio Tinto (NYSE: RIO ) . These two mining behemoths are currently producing such vast quantities of iron ore that their cost of production per ton is far below the key $100 per ton level.
Actually, Rio and BHP are both producing iron ore for less than $60 per ton, while Cliffs' cost of production ranges from $127 per ton in Canada to $71 per ton in the United States.
These costs show how much work needs to be done at Cliffs, and the picture looks even worse if we dig into the numbers. Specifically, Cliffs' cash cost of production, which is the cost of production excluding depreciation and depletion, was reported to be between $60 and $85 per ton during 2013.
In comparison, Rio's management told investors earlier this year that the company's cash cost of production per ton of ore was $20.80. Analysts at UBS estimate that Rio's all-in sustaining cash cost of production is $43 a ton and that BHP's cost is slightly higher at $45 per ton, indicating a profit margin of 150% per ton at the current iron ore spot price.
Overall, it would appear that Casablanca has big plans for Cliffs. Many of these plans are well founded and look as if they could create significant value for investors. Nevertheless, one thing is apparent when looking through Casablanca's case against Cliffs and that is the fact that without intervention, Cliffs is going to flounder for many years to come.
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