How Much Is Cliffs Natural Resources Worth? A Business Owner's Perspective

seekingalpha.com
By: Siming Ma
Aug. 29, 2014

Summary

• Cliffs Natural Resources is a good bargain at the current price level.
• Enterprise Value: $7.4B (net debt $4.6B + market capitalization $2.8B).
• US Iron Ore business alone is worth $4.7B; need another $2.7B from asset sale to break even.
• Asset-to-cash conversion rate higher than 30% will benefit long-term shareholders significantly.

Mr. Buffett suggests that the stock of a company should be evaluated from a business owner's perspective, i.e. how much is a private buyer willing to pay to acquire the entire business? This requires us to understand two parts of an equation: (1) how much money is needed to purchase the business? (2) how much money will the business generate over its life time? When (2) is significantly larger than (1), it represents an attractive bargain.

Given the recent development at Cliffs Natural Resources (NYSE:CLF) (see Wall Street Journal report and my Instablog), I believe this company may be a potential bargain. In this article, I will evaluate CLF using simple, back-of-the-envelope calculations, to illustrate the mismatch between the current market valuation and its intrinsic value to a business owner.

Valuation of CLF

Source: Figure created by author. The numbers are based on Form 10K and author's own calculations and estimates.
How much money is needed to purchase the business?

From a business owner's perspective, part (1) is relatively straightforward. The cost to acquire the entire business can be represented by "Enterprise Value", which in its simplest form is equal to market capitalization plus net debt.

• Market capitalization represents the amount of money needed to buy all outstanding shares. For CLF the figure is around $2.8B, assuming $16 per share and 175M shares (after the conversion of all preferred to common; for simplicity, non-controlling interest is ignored here).
• Net debt represents the amount of money needed to pay back all borrowings. At 2014Q2, CLF has total liabilities of $6.3B. They can be paid back first using current assets of the company ($1.7B), leaving us with net debt of $4.6B. Further repayment will have to come from future earnings and/or sale of non-current assets.
  

Adding these two numbers together, the cost of acquiring the entire business is therefore $7.4B.
How much money will the business generate over its life time?

To answer part (2), we need to calculate present value of future cash flow. While the concept is relatively simple, implementation is not always easy. It depends heavily on predicted future cash flow as well as discount rate used.

For a mine, we may look from a slightly different angle and ask a simple question: how much profit will we get if we dig up and sell all the minerals today? Of course this is entirely hypothetical and unrealistic, but from the evaluation point of view it is equivalent to discounted future cash flow. In other words, the value of a mine is a function of the total amount of minerals available for sale and the margin per unit of mineral sold. In the case of CLF, I focus on US Iron Ore business, since it is considered a core asset of the company.

For the entire article, click How Much Is Cliffs Natural Resources Worth? A Business Owner's Perspective

seekingalpha.com
By: Siming Ma
Aug. 29, 2014