Cliffs Doesn’t Pass the Hess Test – by Liam Denning (Wall Street Journal – January 28, 2014)

Despite the name, Casablanca Capital’s approach to Cliffs Natural Resources CLF +2.11% is likely to be anything but the beginning of a beautiful friendship.

Cliffs, one of the worst U.S. stocks to own in 2013, has joined the rapidly swelling ranks of companies targeted by an activist. The iron-ore miner is being urged to split its international operations from its U.S. iron-ore and coal-mining operations. Casablanca says this could push the share price to $53, far above Monday’s closing level of $19.40 and the $25 and change the fund paid to amass its 5.2% stake. Having jumped as much as 13% Tuesday morning, Cliffs stock finished the day’s trading up just 2%.

The plan makes some sense on paper. Cliffs’s U.S. iron-ore output sells mainly to semicaptive domestic steel mills and so is somewhat shielded from big swings in global prices. As Chinese economic growth slows, global iron-ore prices look vulnerable. A separated U.S. business would appeal to those investors wanting to dial back exposure to China. The real bulls could stick with the newly separate international business.

There likely is some value in that—but nearly three times as much? Casablanca values the resulting entities at six or seven times earnings before interest, tax, depreciation and amortization. As Dan Rohr at Morningstar says, those multiples “might be reasonable for a cost-advantaged miner in ‘mid-cycle’ price conditions,” but that isn’t the situation here, particularly for the international business.

In addition, Casablanca’s plan to turn the U.S. operations into a tax-advantaged master limited partnership—adding $10 per share of value, in the fund’s opinion—also looks suspect. The business likely can generate cash for some years to pay the high distributions MLP investors demand.

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