Hedge Fund Cliffhanger at Cliffs Natural Resources Inc (CLF)

Many hedge funds purchased the shares of Cliffs Natural Resources Inc (NYSE:CLF) during the fourth quarter of 2013, including David Shaw of D E Shaw, Jim Simons of Renaissance Technologies and Ken Griffin of Citadel Investment Group. Other shareholders of the basic materials company include John Levin of Levin Capital Strategies, John Griffin of Blue Ridge Capital and Sanford Colen of Apex Capital.

David E. Shaw

Cliffs Natural Resources Inc (NYSE:CLF) is a $2.9 billion market cap mining and natural resources company engaged in the exploration and production of iron ore and high and low volatile metallurgical coal. It operates iron ore and coalmines in North America and an iron ore-mining complex in Western Australia. The stock has been weak in 2013, dropping by 32%, due to weak commodity prices, decreased volumes and rising costs. To reset the strategic direction of the company and impose financial and operating discipline, in November 2013, Cliffs hired Gary Halverson as COO, who halted or idled uneconomic projects, paid off $380 million in debt and reduced its 2014 capital expenditure budget. Shortly thereafter, Halverson was appointed CEO.

In late January, hedge fund Casablanca Capital, led by former M&A bankers Donald Drapkin and Douglas Taylor, disclosed a 5% stake in Cliffs, becoming the fourth largest shareholder. Moreover, the new investor sent a letter to management proposing to separate the company into two entities: its more stable U.S. operations, which could double its dividend and transition to a master limited partnership (MLP) structure, and its higher growth but more volatile international operations. Casablanca believes the stock could be worth $53 under such a scenario (which would be more than double in comparison with the current levels). The fund also intends to replace the CEO and the majority of its 11-member board with its own picks.

Relative to its peer group of steel companies, Cliffs Natural Resources Inc (NYSE:CLF) trades at a discount on both a forward P/E (14.3X versus 16.0X for peers) and EV/EBITDA (7.0X versus 7.2X for peers) basis. From a financial perspective, the company’s fundamentals look better than its stock price would imply, with above-average margins and return on invested capital, in-line credit metrics (although this could be at risk if it were to separate its U.S. and international businesses, according to Moody’s) and stronger free cash flow generation. However, growth projections for Cliffs are negative versus the low single digit revenue growth and stronger earnings growth estimated for its peer group.

With a renewed focus on profitability and shareholder returns, combined with continued pressure from a vocal activist investor, Cliffs Natural Resources Inc (NYSE:CLF) seems like a natural candidate for improving financial performance. Although iron ore prices remain a wildcard, Cliff’s fundamental turnaround should provide enough ammunition for bulls interested in gaining exposure to a sector that is one of the most sensitive to a recovering global economy, especially in China.

Disclosure: none

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