Although Cliffs Natural Resources (NYSE:CLF) is a leading iron ore miner, its U.S.-facing business is a different animal in many respects than its international operations, which makes the consolidated business really two different companies. Casablanca Capital, an activist investor that recently acquired a better than 5% stake in the miner, believes Cliffs can do better by recognizing those separate qualities by dividing itself into two distinct companies, Cliffs USA and Cliffs International, and use the more focused attention it will give to its business to double the dividend.
There's a lot to commend the plan the private equity firm developed, but lots of risk, too, and though both sides have said the conversations were constructive, Cliffs management was noncommittal in saying it will investigate the proposal.
The case for Casablanca's plan is based on the premise its international assets are directly exposed to the highly competitive seaborne iron ore market largely headed for the Asia-Pacific markets, while its U.S. assets present a low-risk profile tied to recovery in the automotive and construction industries.
Because Cliffs has to go up against global iron ore giants like BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO) that have financial resources beyond its own capacity, management's ability to jockey the two segments that have little synergy between them serves as a drain on performance. It would be better for both if the international assets were spun off into a separate company and add in the undeveloped Bloom Lake project in eastern Canada, which has been subject to delays, rising costs, and revised expectations.
The U.S. ore and metallurgical coal business, in contrast, would serve as the springboard for new growth. Freed from the vagaries of the seaborne trade, Cliffs could partake in the recovery of the U.S. economy that will spur greater demand for its output. To ensure maximum shareholder value was realized, the assets should be put into a master limited partnership that would pay out a dividend twice as large as it currently pays, which would command a premium in the marketplace once they were no longer saddled with the international albatross.
As I said, there is some sense to the plan, and focusing on core competencies has been the hallmark of both management and activist investors everywhere. Miners, in particular, have been shedding assets and whittling down operations to a smaller, more manageable size. Yet there are significant risks, too.
While the seaborne trade is highly competitive, spinning out those assets at the moment might very well create a weakened entity unable to effectively compete. Rio Tinto has been trying to unload its Canadian iron ore assets for some time now, and though there has been interest, potential buyers feel the asking price is too high for existing conditions. Moreover, China's economy is slowing precipitously and steel production is expected to grow this year at less than half the rate it did in 2013, or 3.1%. That suggests Cliffs International wouldn't offer shareholders much value at all as it would likely trade at a severe discount to its intrinsic value. Moreover, Cliffs has viewed Bloom Lake as key to its future growth prospects and significant earnings potential.
As for the U.S. recovery, that's not engraved in stone, either. Auto sales, while better than they have been, are slowing and haven't exhibited the same robust expansion they did a year ago. Construction, although also better than it's been in a long while, has similarly tailed off. If China's economy does go flat -- or worse, contracts -- then a new global slowdown won't be far behind and a divided Cliffs could be at a disadvantage.
Certainly, the markets haven't been kind to Cliffs as it was one of the worst performers last year, second only to gold miner Newmont Mining. It's intriguing to think that cleaving the company in two could mysteriously unlock value, yet the hurdles facing it are no less high than they would be if things were kept as they are, and it would deny it the benefits that would accrue if the economic growth story doesn't pan out.
I'd like to think Cliffs Natural Resources would be worth $53 a share, double its current level, if it traded as a U.S.-focused resources company as Casablanca contends, but with a new CEO soon assuming the role (having come from Barrick Gold, he's getting a feel for the job by serving first as COO and president), it's a big change and not one he might willingly accept. And I'm not sold that in this case two is bigger (or better) than one.