Wednesday, July 16, 2008

Thoughts on Cleveland Cliffs (CLF), Alpha Natural Resources (ANR) Deal

First, I have a flood of emails this morning on this subject. I don't have time to answer each individually so please consider this topic my email response.
  • Iron ore and coal miner Cleveland-Cliffs Inc (NYSE:CLF - News) said on Wednesday that it would acquire Alpha Natural Resources Inc (NYSE:ANR - News) for $10 billion in cash and stock, expanding its coal assets and positioning itself to capitalize on the boom in the global steel industry.
  • Alpha mines vast amounts of metallurgical coal, which is used primarily to make coke, a key component in steel making. It also produces steam coal, used mainly by utilities as fuel for electricity generation.
  • Stockholders of Alpha, an Appalachian coal producer, will receive 0.95 Cleveland-Cliffs share and $22.23 cash for each of their shares.
  • Based on closing stock prices on Tuesday, the deal values Alpha at $128.12 per share, a premium of 35 percent, the companies said in a statement.
  • The combined company, which will be named Cliffs Natural Resources, will include nine iron ore facilities and more than 60 coal mines located across North America, South America and Australia.
  • The boards of both companies have approved the deal, which is expected to close by the end of 2008. JPMorgan Chase Bank is providing an underwriting commitment for up to $1.9 billion to finance the deal.
  • The combined company will have a reserve base of about one billion tons of iron ore and about one billion tons of metallurgical and thermal coal, with annual sales volume of over 30 million tons of iron ore and nearly 18 million tons of metallurgical coal. It will ship about 17 million tons of thermal coal annually.
My initial thoughts on today's "merger" (really a buyout) of our #1 position Alpha Natural Resources (ANR) by Cleveland Cliffs (CLF) which is just under a 2% position after adding some yesterday.
  1. At current prices, this is outright thievery by Cleveland Cliffs
  2. This is a poor price for Alpha Natural Resources - based on my projections for 2009/2010 pricing ANR would be a $200+ stock in 12-15 months
  3. 2 scenarios from here - either the deal goes through as is, or a new bidder emerges
  4. If deal goes through as is, Cleveland Cliffs is a massive strong buy as you have just combined the #1 and #3 metallurgical coal exporters in the US into 1, and thrown in the iron ore business of CLF to boot
  5. If other bidders emerge, Alpha Natural Resources is a massive strong buy for obvious reasons
  6. This deal is mostly stock, with a bit of cash thrown in - so effectively ANR will now trade with CLF, directionally and in magnitude.
  7. ANR was my favorite coal play, so this leaves us 1 less "long term" stock to own. People appear giddy but I'd rather have another 100%+ gain over the next 12-15 months than settle for a quick 20-30% pop.
  8. If the deal goes through we effectively own 6.5% of the new Cliffs Natural Resources, which is fine considering this combines 2 of our top 5 ideas into 1 company.
  9. This puts Massey Energy (MEE) as the #2 US exporter of metallurgical coal as the next logical candidate
  10. Walter Industries (WLT) is another metallurgical coal producer although not of the same scale
  11. A contrarian might argue when you see deals like this it marks the "top" in the industry and/or if Alpha Natural Resources is willing to sell out as such a price, maybe they are not as bullish on the long term as I've been. While I disagree with that thesis, it is something to consider.
  12. I continue to believe we own the correct stocks, but we will be punished along with everyone else as stocks do not trade in a vacuum. But today's actions shows how quickly you can lose when you are out of the "right" stocks even in an "awful" market.
Folks, I've written multiple times on how I differ with Ken Heebner on playing the steel trend - I've chosen to play the inputs (metallurgical coal/iron ore) versus the actual steel producers where he is overweight. I think both strategies work, but I think the inputs have some inherent advantages as I've written out multiple reasons, including takeover potential. [Jul 6: Is the Buck Finally Stopping in Steel?]

Ironically, I think I've written at least 5 times that I've been amazed that Cleveland Cliffs (CLF) has not been taken over and still remains an independent company. [Jul 9: Cleveland Cliffs Up 15% on Guidance and Starting a Dividend] So to see them actually be the acquirer is sort of funny. I still think a combined Cliffs Natural Resources - if the merger goes through - would be a very attractive target for one of the major steel players such as Mittal (MT).

So I did think this was a likely scenario, but frankly I thought a major worldwide steel player would be acquiring the metallurgical coal players in the US to protect the costs in their supply chain. This is a bit of a curve ball but gives me even more respect for foresight of Cleveland Cliffs management who has been criticized in the past for people focused on the short term, when they have made some very smart long term acquisitions
  • The company's then chief executive John Brinzo didn't stop there. In early 2005, flush with cash, the company bought into an Australian iron ore company called Portman Ltd. The move didn't sit well at the time with Cliffs investors who chastized Brinzo. They thought a better use of Cliffs' new-found wealth was to buy back shares, thereby rewarding current shareholders with instant gains.
  • Last year, Cleveland-Cliffs expanded again under Brinzo's successor Joe Carrabba, this time into metallurgical coal. Cliffs' paid $450 million and absorbed $150 million in debt for PinnOak Resources LLC, which included coal mines in West Virginia and Alabama.
We've been all over this story - newer readers, you can follow the posts below. More later.

[Jun 24: Cleveland Cliffs - A Man Among Boys]
[May 5: Alpha Natural Resources Booming Earnings - Just the Start]
[May 1: Walter Industries - the Most Fascinating Company]
[Apr 8: Changing Coal Allocation - Peabody Energy Out - Alpha Natural Resources In]
[Apr 7: ArcelorMittal (MT) Sees Metallurgical Coal Prices Rising 150-200%]
[Dec 6: Coal Stocks Quietly in a Bull Market]

Long Cleveland Cliffs, Alpha Natural Resources, Walter Industries, Massey Energy in fund and personal account

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