Cliffs Acquisition Aimed at Growth, Foothold in Asia

Cliffs Natural Resources (NYSE:CLF) is an international mining and natural resources company. It is the largest producer of iron ore pellets in North America and a major supplier of direct-shipping lump and fines iron ore out of Australia. It is also a significant producer of metallurgical coal. Competitors include Vale (NYSE:VALE), BHP Billiton (NYSE:BBL) and the Rio Tinto group.

Recently, Cliffs announced its intention to acquire Canadian rival Consolidated Thompson Iron Mines Ltd in a $4.9 billion all-cash deal ^[1]. This deal will consolidate Cliffs position as North America’s largest producer of iron ore pellets with an added capacity of 8 million tons.

The North American Iron Ore division already accounts for most of Cliffs’ value…

As we had pointed out earlier in our launch article for Cliffs Natural Resources, the North American Iron Ore division produces about 27 million tons of iron ore pellets annually. This represents almost 30% of the total production capacity of 85 million tons in North America. The strong position has helped the North American Iron Ore division sign long-term supply contracts with some of the world’s biggest steel manufacturers including ArcelorMittal and Severstal.

… and Consolidated Thompson will make it bigger

Consolidated Thompson operates the Canadian Bloom Lake mine, which commenced iron ore concentrates production in May 2010, and has an initial production capacity of 8 million tons. This capacity is expected to be upgraded to 16 million tons in late 2012 ^[2].

Besides boosting Cliffs’ production capacity, the acquisition adds about $75 million in operational synergies for Cliffs. But most importantly, the deal also helps the North American Iron Ore division cater to the rising iron ore demand in Asia – most particularly in China. Consolidated Thompson has a long-term supply agreement with Wuhan Iron and Steel, one of China’s biggest steel manufacturers and also a 19% stakeholder in Consolidated Thompson. The agreement for the sale of at least 4 million tons of iron ore will make Wuhan one of Cliffs biggest customers.

What this means for Cliffs investors

The acquisition of Consolidated Thompson is in-line with Cliffs strategy to diversify its geographical presence. Almost all its sale of iron ore in China is currently through its Asia Pacific Iron Ore Division, which has a limited supply capacity of 9 million metric tonnes of iron ore. The added capacity would allow Cliffs to garner a bigger share of the seaborne iron ore trade with Asia ^[3].

We believe that production at the newly acquired Bloom Lake mine should reach its peak annual capacity of 8 million tons in 2012. The capacity upgrade to 16 million tons is assumed to be realized gradually until the end of the Trefis forecast period.

Based on the predicted increase in iron ore production for Cliffs for the rest of the Trefis forecast period, we expect an upside of more than 10% to our initial share price for Cliffs. The 10% upside forecast includes the effect of reduction in Cliffs’ cash and equivalents due to the all-cash acquisition of Consolidated Thompson (a 10% reduction in value) combined with the 20% addition in value due to increased production capacity.

See our full analysis for the Cliffs Natural Resources stock here.

1. Definitive Agreement to Acquire Consolidated Thompson, Cliffs Investor Relations, Jan 11 2011 [↩]
2. Consolidated Thompson files technical feasibility report, Consolidated Thompson Investor News, July 6 2010 [↩]
3. Cliffs Aims for Asia in $5B Iron Ore Deal, The Street, Jan 12 2011 [↩]