Casablanca’s vision for Cliffs
Casablanca’s concern has been the mismatch between the invested capital and return profile for Cliffs. 63% of the iron ore assets are tied up in the eastern Canadian iron ore segment, which generates negative free cash flow based on earnings before interest, taxes, depreciation, and amortization (or EBITDA) metrics. On the other hand, 13% assets in U.S. iron ore operations are producing 63% of EBITDA. As a result, Casablanca wants to spin off or sell all of Cliff’s non-U.S. operations.
Converting U.S. iron ore operations into MLP
Casablanca wants Cliffs to focus all of the company’s resources to its legacy U.S. operations, which are more profitable and predictable and less prone to volatile spot prices. It also wants to convert the U.S. iron ore operations into a master limited partnership (or MLP), which will reduce the company’s tax and increase shareholders’ dividends significantly.
Cost cutting measures
Casablanca wanted Cliffs’ management to control costs. It wasn’t even happy with the cost cutting efforts management had already made in the capital expenditure and selling, general, and administrative expense (or SG&A) areas. It believes an additional $75–$100 million per year of overhead can be cut.
Returning capital to the shareholders
Casablanca had contended that Cliffs hasn’t returned enough capital to the shareholders either in the form of dividends or share buybacks. According to Casablanca “Shareholder returns can no longer be an afterthought.” However, this concern might not be fully justified given the decreasing iron ore and coal pricing environment Cliffs is operating in. Paying-off the debt was given priority over paying bloated dividends to the shareholders, which could have led to increasing debt position for the company and worsening its credit profile.
In our view, spinning off international assets might not be possible because most of the international assets are losing money. So, “fire sale” might be one option, but even for that it might be difficult to find a buyer at this stage of the market environment where iron ore and coal prices are in a downward spiral. We’ll look at it in more detail in the later part of this series.
While overhang remains for Cliffs Natural Resources (CLF) in view of the above listed factors, low-cost producers like Rio Tinto (RIO), BHP Billiton (BHP), and Vale SA (VALE) could provide exposure to iron ore. The SPDR S&P Metals & Mining ETF (XME) is also a good way of gaining exposure to this sector.