While hedge funds aren’t always known for having companies’ long-term interests at heart, the Harbinger Capital fund seems to be doing Cleveland Cliffs a big favor. Cleveland Cliffs recently announced a roughly $10 billion agreement to buy Alpha Natural in what seems to be a classic case of a misguided consolidation strategy, but Harbinger Capital is using its 16% stake in Cleveland Cliffs to oppose, and probably block, the deal. Other Cleveland Cliffs shareholders should send Harbinger manager Phil Falcone big wet kisses.
Cleveland Cliffs, which sells iron pellets, says Alpha Natural and its coal operations are a natural fit because iron and coal are both used in making steel. But, if you get really specific, what does that mean? Do customers benefit from buying iron and coal from the same supplier? Not much, if at all. Both Cleveland Cliffs and Alpha Natural are already huge companies that deliver their supplies by the boatload, and it’s not as though the iron and coal will share a train car or barge. Would a combined company have increased pricing power? Again, not much. There are plenty of other suppliers of iron and coal, keeping a lid on prices. Cleveland Cliffs says it will generate $200 million in cost savings from efficiencies in coal processing and administration, but that claim seems dubious, too. Cleveland Cliffs’ iron-ore operations and Alpha Natural’s coal operations have little overlap, so there isn’t much duplication to be eliminated. Our research found that companies often overestimate the benefits that come from scale, and Cleveland Cliffs seems to be falling into that trap.
Companies also tend to underestimate the complexity that comes with scale, especially when the increased size comes from entering a new market. Oglebay Norton, for instance, thought its experience in shipping iron ore would translate into shipping limestone, but the limestone couldn’t be delivered at the Great Lakes ports where the iron ore was delivered. Limestone needed to be delivered on rivers that connected to the Great Lakes, meaning it had to be on ships that were 600 to 700 feet long–not the 1,000-foot ships that Oglebay Norton used on the Great Lakes. The 100-plus-year-old company, which had survived numerous downturns in the market for natural resources, went into bankruptcy proceedings because of the various problems with its move into limestone and was eventually sold. Cleveland Cliffs may be making a variant of the Oglebay Norton mistake. There may well be significant differences between iron ore and coal that Cleveland Cliffs is discounting.
The deal would make sense if Cleveland Cliffs is right that the global steel industry will stay hot and prices for the components of steel will keep rising rapidly. We’re not equipped to judge what will happen with those prices. But we do know that Alpha Natural has already had a big runup in its stock price because supplies of coal used in steel making have been tight, and that Cleveland Cliffs needs big future increases in coal prices to justify the 35% premium it would pay over the already lofty Alpha Natural market price.
What often happens in consolidating industries is that companies decide they want to be the buyers, not the sellers. That’s natural enough. There’s no glory in selling–there’s also probably no job for the executives of the companies being bought, while the executives doing the buying will likely wind up with raises because they’re running a bigger company. Cleveland Cliffs has long been rumored as a candidate to be acquired, so it’s no great surprise that management would prepare a strategy that would make the company so big and complex that it would be hard to acquire. But that doesn’t mean the strategy is a good idea.
Go, Harbinger! Go, Phil Falcone!
