Push to Break Up Cliffs Natural Resources Turns Hostile

NEW YORK (TheStreet) -- Casablanca Capital, a small activist fund that recently called for Cliffs Natural Resources (CLF) to spin off its international businesses and double its dividend, said on Wednesday it has nominated Lourenco Goncalves to replace the mining giant's CEO James Kirsch and will nominate a slate of directors to reconstitute the company's current board.

The move comes after Cliffs Natural Resources appeared to downplay Casablanca Capital's breakup proposals on Tuesday, announcing that it would cut its 2014 capital expenditure by more than 50% to between $375 million and $425 million, and idle production at its Wabush Mine by the end of the first quarter. Cliffs also maintained its current quarterly dividend of 15 cents a share on Tuesday.

"Sharper capital allocation must drive our decisions. Today's announcement to reduce overall capital spending is an important first step," Gary Halverson, Cliffs' chief operating officer, said in a press release.

Halverson added that Cliffs would continue to operate phase 1 development of its controversial Bloom Lake mine in Quebec, but sharply reduce capex. "Given the wide range of outlooks for iron ore prices, we reduced our 2014 capital expenditures at Bloom Lake Mine as we evaluate the best alternatives for this asset as part of our overall focus on enhancing value for shareholders," Halverson said.

On Jan. 28, Cliffs said it would evaluate the strategic fit of its assets and was open to constructive dialogue with its shareholders. "Cliffs will continue to review and consider ideas that may create additional value," the company said, and disclosed it had hired J.P. Morgan as a financial adviser.

Casablanca Capital said on Wednesday morning that the capital expenditure plan unveiled by Cliffs was a "knee-jerk response to our call for change," and argued it would be inadequate in addressing the company's need to cut costs and realize the value of its North American and international assets for shareholders.

Those statements and a letter that Casablanca Capital sent to Cliffs' board indicates that the investment has turned hostile.

When disclosing a 5.2% stake in Cliffs Natural Resources earlier this year, Casablanca Capital said it had spent weeks meeting with the company's management. In late January, the fund then disclosed a proposal to split up Cliffs, spinning its international iron ore businesses to shareholders, while converting its North American assets to a master limited partnership (MLP).

That proposal would effectively spin Cliffs' Bloom Lake iron ore mine with the company's assets in the Asia Pacific region. Since buying Bloom Lake for $4.9 billion in 2011, Cliffs has seen delays and spiraling costs in developing the mine, and at a time when falling iron ore prices depress the asset's long-term value. Removing Bloom Lake and Cliffs' seaborne iron ore businesses might also uncover value in the company's legacy North American iron ore business, according to Casablanca's plan.

Casablanca said it believes Cliffs' remaining businesses in the Great Lakes region of the U.S. -- called Cliffs USA -- would attract a dividend-seeking institutional investor base and warrant a conversion to a MLP structure. The fund's plan also stipulated a divestiture of Cliffs logistics assets, a focus on reducing costs across the company and a doubling of its dividend.

However, since that late January proposal was disclosed, Casablanca appears to have lost the ear of Cliffs' management.  

"In spite of its public statements, Cliffs hasn't engaged us in any meaningful dialogue on the issues we've raised or provided a timetable for doing so," the fund said on Wednesday.

Casablanca now is trying to impart change by nominating Goncalves, former CEO of Metals USA, as the company's new CEO, in addition to a slate of nominees that would reconstitute Cliffs' board. "We will shortly announce a slate of highly qualified Board nominees to oversee this effort," Casablanca said.

That Casablanca's investment in Cliffs Natural Resources has turned hostile within weeks of being disclosed to the public is just one twist in what is one of the most unusual activist investments to hit Wall Street in recent memory.

Casablanca Capital has a limited history in the world of activist investing or fund management. Meanwhile, the firm also doesn't have a large investment portfolio filled with other passive or activist investments. Casablanca spent much of 2013 raising money to make a single change-based investment, which it executed by buying shares in Cliffs Natural Resources starting in November 2013.

So far, the investment is off to an inauspicious start. Based on a filing with the Securities and Exchange Commission, Casablanca appears to have acquired Cliffs shares at an average price in excess of $25 apiece, putting its overall investment at just above $200 million.

Shares currently stand well below those levels.

When Casablanca disclosed its proposals, the fund's activist plan was met with a lukewarm reception from stock analysts covering Cliffs Natural Resources. Credit Suisse analyst Nathan Littlewood recommended investors use Casablanca's Jan. 28 disclosure to establish fresh short positions in Cliffs Natural Resources, a company he rates 'underperform' with a $10 price target.

Analysts at Bank of America Merrill Lynch, BMO Capital Markets and Clarkson Capital Markets expressed doubts that Cliffs Natural Resources' international iron ore assets have the longevity and financial strength to stand on their own.

Now Casablanca is now committing to a hostile course of action that will need significant outside shareholder support.

The fund's co-founders -- Donald G. Drapkin, chairman, and Douglas Taylor, CEO -- met in the investment banking division at Lazard (LAZ). In an interview with TheStreet, Taylor characterized Casablanca's experience with M&A transactions and the like as a positive as it worked to make an impact in the world of activist investing.

Drapkin was a long-time top lieutenant to Ronald Perelman and helped the buyout billionaire's holding company McAndrews & Forbes structure some of its biggest acquisitions such as the takeovers of Marvel comics, Revlon and AlliedBarton Security Services. Prior to his 20-year career at McAndrews & Forbes, Drapkin was a partner in the M&A department at law firm Skadden, Arps, Slate, Meagher & Flom. Between 2007 and 2010, Drapkin was vice chairman of Lazard International and was chairman of the firm's investment committee.

At Lazard, Drapkin met Taylor, a long-time banker at the firm who was also one of Bruce Wasserstein's first hires after he became CEO of the boutique investment bank in the early 2000s. Some of Casablanca's partners such as Gregory S. Donat, also trace their roots to Lazard.

CEO Taylor said in his interview with TheStreet that Casablanca's favorite outcome was "to have an engaging and constructive dialogue" with a company's management. In that sense, the fund appears to be onto its Plan B for Cliffs Natural Resources.

For more on Casablanca Capital, see TheStreet's Feb3. report on the fund and its history.

-- Written by Antoine Gara

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