Major iron ore and coal producer Cliffs Natural Resources (NYSE:CLF) and Casablanca Capital, which owns about 5.2 percent of Cliffs, have different ideas about how Cliffs should operate moving forward.
Put simply, so-called activist investor Casablanca wants Ohio-based Cliffs to spin off its international assets, while Cliffs believes the path to success lies in more stringent cost-cutting measures.
In an effort to discern whose idea is better, Iron Investing News takes a look at what Cliffs and Casablanca have said to each other in the last few weeks and what market watchers think is the superior proposition.
To split or not to split?
As mentioned, the central tenet of Casablanca’s plan for Cliffs, put forward in a letter sent to Cliffs at the end of last month, is that the company’s international assets — namely the Bloom Lake mine, located in Quebec, and the company’s Asia Pacific-based assets — should be spun off.
Casablanca’s reasoning is that Cliffs’ international and domestic iron ore businesses have “very different risk/reward profiles.” Specifically, the company’s Asia Pacific assets are “directly exposed to the competitive ‘seaborne’ iron ore market, and the large Bloom Lake project is still in the development stage,” while the company’s US iron ore assets “benefit from unique supply and demand characteristics and barriers to entry in the Great Lakes, generate strong cash flow and enjoy long-term contracts, which provide volume and price visibility.”
Cliffs, however, doesn’t see such a split as necessary. Last Tuesday, the company said that in 2014 it will spend significantly less than it did in 2013 — specifically, $375 to $425 million compared to $862 million last year.
Making that reduction possible, the company explained, will be “a significant reduction in the Company’s expansion and tailings and water management capital spending at its Bloom Lake Mine,” along with the idling of production at the Wabush mine, where, over the past three years, pricing has dropped while costs have escalated. About 500 employees at the mine, which is located in Newfoundland and Labrador, are expected to lose their jobs.
It didn’t take long for Cliffs’ news to ruffle Casablanca’s feathers. The day after the company’s big announcement, Donald Drapkin, chairman of Casablanca, lambasted the proposed changes as “a knee-jerk response” to Casablanca’s call for change.
He continued, “[w]e believe they are inadequate to address Cliffs’ issues, including the need for dramatic cost savings, and do not demonstrate the strong leadership needed to create substantial value for shareholders.” In closing, Drapkin called for Cliffs to be “refocused under a dynamic and experienced CEO, Lourenco Goncalves, supported by a significantly reconstituted Board of Directors.”
Cliffs responded just as quickly, reiterating the points made in its Tuesday release and stating that “Casablanca’s overall proposal fails to provide a sustainable, long-term value enhancing alternative.” The company also expressed disappointment that Casablanca “seems intent on waging a public campaign” rather than speaking privately.
Further slamming Casablanca’s plan, Cliffs on Thursday appointed Gary B. Halverson to the position of president and CEO; Halverson was formerly the company’s president and COO. Cliffs then released its Q4 and full-year 2013 results, incurring some fanfare due to the fact that it “posted profitability far above analyst consensus,” as per The Street.
The week ended with Cliffs releasing an open letter to shareholders; much of it is devoted to critiquing the changes that Casablanca has in mind for the company. Unsurprisingly, Casablanca’s “incorrect assumptions and omissions” and “lack of familiarity with the mining sector” are strong themes running through the document.
Who’s in the right?
Opinions vary on whether Cliffs or Casablanca has the right idea. Some, such as Benjamin Cox, managing director of boutique merchant bank Oreninc, see the idea of splitting Cliffs up as “completely bogus” because doing so will make it ”a riskier company … than [it is] together.”
As Cox explains in a video posted at the beginning of the month, that’s because the end result will be two companies “that are each going to be bid for by third parties — they’re going to be two weak parties. You’re not going to get full value for either of them, they’re going to disappear in five or 10 years.” He concludes, “if you’ve got one and you split it into two, sometimes you don’t end up with two halves, but two quarters.”
Similarly, Rich Duprey of the Motley Fool has doubts about Casablanca’s idea because it is informed by “the expected recovery of the U.S. auto and steel industries” despite the fact that all of Cliffs’ segments are “inextricably linked to China.” Further, if divided, the company might be “left in a vulnerable position to have” ArcelorMittal (NYSE:MT) “come in and snatch up what’s left.”
Others, however, like 24/7 Wall St.’s Paul Ausick, believe that given Cliffs’ gain of less than 0.5 percent over the past five years, the company “needs some help from somewhere.”
At close of day on Friday, shares of Cliffs were selling for $23.16 each, up 5.75 percent. If the events of the past week are anything to go by, those interested in the company should consider keeping an eye out for a response to Cliffs from Casablanca.
Securities Disclosure: I, Charlotte McLeod, hold no direct investment interest in any company mentioned in this article.