Wall Street Journal

Hedge Fund Casablanca Pushes for Breakup of Iron-Ore Miner

By David Benoit

Jan. 28, 2014 12:07 a.m. ET

A hedge fund is pressing for a breakup at Cliffs Natural Resources Inc., CLF +0.36% the company with the worst-performing stock in the S&P 500 index over the past year.

New York hedge fund Casablanca Capital LP wants to see the iron-ore miner divide its international and domestic operations, according to a letter sent Monday to the Cleveland-based company's management that is expected to be disclosed in a securities filing Tuesday morning.

The letter, reviewed by The Wall Street Journal, says Casablanca has been building a position in Cliffs and now owns about 5.2% of the shares outstanding. The two sides have engaged in discussions for more than a month, the letter said.

In a statement, Cliffs called the conversations with Casablanca productive and said it is open to more talks. It added that it has made "significant changes to strengthen its board" and taken steps to improve its financial and operating performance.

"Cliffs will continue to evaluate the strategic fit and value creation potential of all the Company's assets as part of that process," the company said.

Cliffs shares are down about 46% over the past 12 months, versus a 19% rise in the S&P 500. They closed up 0.4% at $19.40 Monday.

With a market capitalization of about $3 billion, Cliffs is also the index's most shorted stock, according to data provider Markit.

Casablanca was started in 2010 by former mergers-and-acquisitions banker Donald Drapkin, along with Douglas Taylor, also a former M&A adviser.

Activists regularly push for corporate breakups. Casablanca executives contend that splitting up Cliffs' international and U.S. operations could help it reverse its fortunes, the letter said.

Concerns about falling demand for iron-ore in China and elsewhere have hurt many international miners. Many analysts have proclaimed the end of the so-called commodity supercycle, in which mining companies aggressively expanded in recent decades in response to rising prices but lately have retrenched amid slowing demand.

Benchmark iron ore prices are currently around $135 a ton, down 10% since a year ago, just as more production is coming online. That has pressured many mining stocks, and the biggest miners, including Rio Tinto PLC and BHP Billiton Ltd. BHP.AU -1.97% , have changed executives and written down billions in acquisitions.

"When most major mining companies have announced sharp revisions to their capital allocation and cost management policies, Cliffs' Board and management have, from our perspective, been slow to respond to the end of the commodities supercycle," said the letter to Cliffs' executive chairman, James Kirsch.

A Canadian mine Cliffs acquired in 2011 has cost billions and produced little so far, adding to concerns around Cliffs.

Cliffs has already undertaken some changes. Former Chairman and Chief Executive Joseph Carrabba retired in November, handing the reins to Mr. Kirsch. The company in October hired Gary Halverson, a former executive at gold miner Barrick Gold Corp. ABX.T -2.09% , as chief operating officer and said he would eventually take over as CEO. Several other executives have departed. The company has made cost-cuts a priority and slowed spending on projects, it has said.

The company is looking at options for the struggling Canadian mine, Bloom Lake, including joint-venture partners, the company has said. The company has reduced spending plans for the project.

The Casablanca letter said Cliffs' domestic operations are well placed to benefit from a resurgent U.S. auto and manufacturing industry. The U.S. business—in iron ore and coal—has long-term contracts with customers that provide investors with visibility, and steel demand in the U.S. has been rising.

To be sure, the U.S. business could also be vulnerable. "There's a lot of new iron ore production coming on in the next few years, in Minnesota for example, and no new [steel mills] being built" that use iron ore, says Charles Bradford, an analyst with Bradford Research Inc.

By spinning off the international operations, Cliffs could create a company that would be more volatile but have the growth potential that can lure some investors, the letter said. Casablanca feels the stock drop is an overreaction to the macroeconomic concerns, the people said.

Meanwhile, the U.S. operations, the letter said, could double the current dividend, slash costs, sell noncore assets, and form a master-limited partnership backed by Cliffs' assets.

All of those moves, the letter said, could boost Cliffs shares to a combined $53 a share.

In the first nine months of 2013, Cliffs' U.S. operations made up 61% of revenue and 76% of the company's gross margin.

—John W. Miller contributed to this article.

Write to David Benoit at david.benoit@wsj.com