Why Casablanca Capital’s proposals for Cliffs don’t make sense

Market Realist

Must-know: Should you own Cliffs Natural Resources right now? (Part 6 of 10)

(Continued from Part 5)

Casablanca Capital and Cliffs Natural Resources

Casablanca Capital is an activist hedge fund that owns a 5.2% stake in Cliffs Natural Resources (CLF). The fund wants to take over board control and install its own CEO.

Casablanca Capital says Cliffs’ current management is incompetent. The fund holds the management team responsible for $9 billion in a wasteful acquisition spree over the last few years. As a result of these moves, Cliffs’ balance sheet has become unduly levered. The fund also claims that the board hasn’t delivered any meaningful cash flow, that it has diverted resources from its legacy U.S. iron ore operations, and that it hasn’t returned anything to shareholders. Casablanca Capital wants the company to sell all its assets except its U.S. iron ore business.

The fund also wants Cliffs to convert its U.S. business into a master limited partnership, or MLP.

A myopic view

We think Casablanca’s bid to sell assets at the trough of the cycle, or close to trough, is not in shareholders’ long-term interest.

The fund’s view is myopic. Casablanca has held Cliffs shares just since November 2013. The fund’s claim comes during a commodity down cycle, when everything with the company seems wrong.

Some of Casablanca’s points make sense. For example, most of Cliffs’ value comes from U.S. iron ore operations. These operations comprise about 62% of the company’s EBITDA for 2013 from only 13% assets. The company’s Eastern Canadian iron ore accounts for 63% of segment assets and nothing in terms of EBITDA since it’s loss-making at that level.

However, generalizing this trend for all Cliffs’ international operations and demanding the company sell all of these operations doesn’t make much sense.

Outlook

The board’s fate will be decided at Cliffs’ annual general meeting on July 29, 2014.

This issue remains an overhang for Cliffs Natural Resources’ (CLF) share price as the market waits for the meeting’s outcome. Meanwhile, some of Cliffs’ peers can give you exposure to this sector with fewer issues.

While Rio Tinto (RIO) and BHP Billiton (BHP) provide exposure to many commodities, Vale SA (VALE) is primarily an iron ore play.

The SPDR S&P Metals & Mining ETF (XME) also offers exposure to the sector with fewer risks.

Continue to Part 7

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