KWG and Cliffs have been embroiled in a legal battle over the surface rights for a transportation route to mineral deposits in the Ring of Fire. On Sept. 10, the Ontario Mining and Lands Commissioner released its decision (you can download it from KWG’s website) and KWG won. It wasn’t a close decision judging by the wording:

[…] the law is clear; the application must fail.

Cliffs could find an alternate route, though it could cost hundreds of millions more. It makes more sense for them to buy the rights from KWG. KWG is sitting on an asset that is worth tens of millions of dollars to Cliffs, if not more.

Cliffs is run by a bunch of idiots

Cliffs has been trying to screw over its partner (KWG) and has gained nothing from it. I didn’t understand how acrimonious their relationship was until I read the decision document:

The hearing of this matter was made unduly complicated by the actions of the parties as well as the entrenched conduct of their counsel. Rarely was a step taken by either side that did not raise some procedural issue that had to then be dealt with by this tribunal. It may have been a case of “familiarity breeds contempt” as both parties knew each other and had even shared strategies before pursuing divergent paths. A great deal of time was spent by the tribunal sorting out the issues that arose and rendering interim decisions. Counsel for Cliffs was adamant that the allegations having to do with the relationship between the parties and which had arisen during the course of the hearing should not form part of the tribunal’s decision. The tribunal has taken his words into account. However, the fact is, the changed relationship was a source of acrimony throughout the hearing and the tribunal is left thinking that it formed some, if not all, of the basis for the hearing. The tribunal is of the opinion that there is still an opportunity for the parties to work out a solution that will prove mutually beneficial to them both as it concerns the Ring of Fire.

I really don’t understand what Cliffs has gained from waging a legal battle against its business partner, of which Cliffs is the largest shareholder. As I have stated before on this blog, Cliffs has decided to wage a wasteful legal battle against itself. I really, really don’t understand what Cliffs is thinking.

Cliffs destructive actions are a minor negative for KWG shareholders. Because of the sour business relationship, both Cliffs and KWG will have to waste resources on duplicate engineering studies. On the political front, the clashes are destructive as Cliffs and KWG are trying to pull the government in different directions. If Cliffs acted rationally, a future mine would be built faster*. This would increase the present value of the future cash flows.

*Cliffs’ own investor presentation shows that their proposed chromite mine is quite uneconomic at current commodity prices. I would make the argument that it shouldn’t be built in the first place.

Where KWG stands

KWG is in a much better position now. The highest price they can get is the difference between the best route and an alternate route that KWG hasn’t staked. KWG has staked multiple routes so the best alternate route may cost significantly more… possibly hundreds of millions of dollars. Cliffs has been saying that a road would cost $600M for the route controlled by KWG. Unfortunately, I am no civil engineer and it is unlikely that Cliffs will share engineering estimates for the cost of an alternate route. Regardless, KWG now owns an asset that may be worth a lot more than its market cap ($38M at 5.5 cents/share). KWG also owns 30% of the Big Daddy deposit, which Cliffs will likely ultimately mine if it mines Black Thor.

In the past, Cliffs was willing pay pay 13 cents/share for either KWG or Spider. Back then, both KWG and Spider owned (what would now be) 30% of Big Daddy. KWG also owned a royalty on the chromite deposits which was later sold for $18M. Cliffs should have bought the royalty because it will bring in around $180M in future cash flows (undiscounted). At the time, it was unclear if the mine would be economic or if it would be built so selling the royalty for $18M vaguely made sense for KWG. Anyways, Cliffs ultimately bought out Spider for 19 cents/share to top a competing bid/merger from KWG. If Cliffs were to pay the same valuation now, KWG would be worth well over 19 cents/share. Cliffs should arguably pay a higher valuation because it is clearer now that Cliffs will likely build a mine. A takeover offer that is well above 19 cents/share could happen. But Cliffs does a lot of things that don’t make sense (e.g. not buying the chromite royalty). I can’t accurately predict what a future takeover price will be.

I’m not surprised that Frank Smeenk and Moe Lavigne (VP Exploration) have been buying shares on the open market for a while now.

*Disclosure: Long KWG.