Baffinland Iron Mines Corporation

Prepared for: SHAWKAT KAMAL COURSE INSTRUCTOR PORTFOLIO MANAGEMENT AND INVESTMENT ANALYSIS (F605)

Prepared by: Group 8
HASNAT AHSAN MOHAMMAD ZILLUR RAHMAN AFM RIASAT HOSSAIN MD. RAIHAN SHOUROV CHALAN KANTI ROY DAMIL ALAM PRAKASH 43 E-10 46 D-132 46 D-134 46 D-139 46 D-141 47 D-37

Concerns
• • • • The Mary River Property Baffinland Iron Mines Corporation Nunavut Iron Ore Acquisition Inc Arcelormittal

The Mary River Property
• Located 3000 kilometers directly north of Toronto. • High grade iron ore deposit first discovered in the 1960s by Murray Watts and Ron Sheardown. • First exploratory work “indicated a resource of about 120 million tonnes grading approx. 68 percent iron.

Problems of The Mary River Property
• Is in Arctic Circle • There was permafrost on the ground, which may cause surface to become unstable • Was no infrastructure to speak of • Average temperature in winter was 28 C • Due to latitude and location, used to remain dark for many continuous months

Baffinland Iron Mines Corporation
• Incorporated in 1963 as Baffinland Iron Mines Limited. • McCloskey and McCreary acquired a significant share of Mary River Property in 2003 and then created Baffinland Iron Mines Corporation in 2004. • Both became chairman and ceo of Baffinland respectively. • Raised $14 million via a reverse takeover and conducted a preliminary study on Mary River • After exploration it was found that Mary River had significant and high quality iron ore deposits • Initially planned on building a 230 kilometers rail line from Mary River to Steensby Port. • Due to global financial crisis, they failed to move the project and thus their share price reduced

ArcelorMittal
• Formed in 2006, after takeover of Arcelor by India’s Mittal steel • Accounted for 10 percent of global steel production • A joint venture proposal to Baffinland was placed in 2009 • Proposal was in final stage when Nunavut launched its unsolicited bid

Nunavut Iron Ore Acquisition Inc
• Was incorporated on August 27, 2010 • Was a wholly owned subsidiary of Iron Ore Holdings • Iron Ore Holdings is owned by Jowdat Waheed, a consultant formerly employed by Baffinland • On September’ 2009, nunavut purchased 20 million shares of Baffinland for $12.1 milllion • On September’ 2010, they offered $0.80 per share for all the shares

Resources

Project Overview

 7 deposits of iron with high grade direct shipping ore.  Deposits 1 to 3 amounts to 865m tonnes  365m tonnes are proven and probable( grading 64.7% iron)  52m tonnes are measured and indicated(grading 64.6% iron)  448m tonnes are inferred (grading 65.5% iron)  18m tonnes of iron ore shipment per year with 20 years of mine life.

Capital Expenditure
Capital required(m) Production Capital intensity (mt)

Railway (including 1.2b Rail line and 760m Steensby port) Rent

4100 4100 2799 2799 2898 2898

365 865 365 865 365 865

11.23 4.74 7.67 3.24 7.94 3.35

Road

Own

Capital Expenditure
Company Rio Tinto BHP Billiton Vale Project Simandou Waiq 220 mt Carjas Serra Capital(m) 12000 7400 8039 Production 95 65 90 Capital Intesity 126 114 89

Anglo Americal

Minas-Rio

5004

26.5

190

The Capital intensity of the project is very low compared to the other project in this industry. It means the project is very attractive.

Shipping cost
Port Australia South Africa Western Africa China 3400 9700 12600 Europe 9900 7300 4400

Brazil
Canada

13500
14300

6200
3000

• Geographically Canada posses less shipping distances with Europe, which confirms lower transportation cost. • Moreover the shipping rate in Canada is of 2.5 to 3 times lower than that of Australian iron ore producers. That gives exclusive competitive advantage to ship iron ore to china which is the 60% importer of worlds iron ore.

Special Considerations
To negotiate any hostile takeover Baffinland creates some barriers become vital while determining the value of Baffinland.

– Poison Pills – Shareholders rights plan – Superior proposal support agreement – Price of Ore

Special Considerations (Contd.)
Poison Pills
• Issued options on 11.392 million shares at different prices and expiry dates. • 7 Million are issued to their executives at exercise rates from $0.25 to $0.58. Deep in the money in case of a buyout

Special Considerations (Contd.)
Poison Pills
• 42.334 million warrants issued that work like call options • valued at $0.70 per share, likely to be in the money in case of a takeover.

Special Considerations (Contd.)
Shareholders rights plan
• Any unsolicited bid needs to be a take-over bid (buying all the diluted common shares)

Superior proposal support agreement
• Full payment at once • No diligence condition • No undue delay taking into account all legal, financial, regulatory and such other issues.

Special Considerations (Contd.)
Superior proposal support agreement
• ArcelorMittal will be paid by Baffinlands of $19.5 Million as “Break fee”.
• $ 15.5 million plus reimbursement of expenses of $ 4 million

• Then, the cost is the responsibility of the purchasing company.

Special Considerations (Contd.)
Price of Ore • For decades since 1970s pricing was benchmarked by first agreement between a global miner and steel maker each year.
Year Until 2004 2004 2008 2010 2015 Onwards Fine Ore (>62% Ore) (>62% Ore) (>62% Ore) (>62% Ore) (>62% Ore) Price per Ton $ 10 to 15 $ 28.11 $ 61.57 $ 146 $115

Project Evaluation
• 2008 study (Deposit 1):
Discounted @7% Pre-Tax After Tax

NPV IRR Payback Period

20.5% 3.7 years

$2.7 billion 15.9% 4.3 years

• Production-365m tons • Project life-21 years • Lump price $67 per ton and Fines price $55 per ton

Project Evaluation2010
Calculation of Tax Pre Tax Cash Flow $ Billion After Tax Cash Flow $ Billion Tax Rate 18.1 11.2 38.12%

• Production (deposit 1): 365 million tons • Forecasted sales price for fines (no lumps) • Shipment- 18m tons by railway and 5m tons by road • Project life- 21 years (railway) and 73 years (road)

Project Evaluation2010
• Capital Budget: – $4.1 billion for 7 years (railway) – $2.8 billion in 2012 (truck by contract) – $2.9 billion in 2012 (truck by Baffinland)

• Working Capital $400m • Straight Line Depreciation

Project Evaluation2010
• Operating Cost:
– $14.62 / ton (railway) – $63 / ton (truck by contract) – $29 / ton (truck by Baffinland)

• Discount rate-7% (same as 2008 study)
– Equity financing but possible necessity of debt exists (riskiness will increase) – Deposit 2-7 will reduce riskiness

Project Evaluation2010
Comparison of alternatives:
Road Road Rail Way (managed by (contract) Baffinland)

NPV at 7%
Per Share NPV Per Share NPV (Diluted) IRR

7% 342
393 0.1

$4,430.79 -756.102 $12.96
$11.27 16.13%

458.2663 1.33996
1.166072 8.02%

-2.21083
-1.92392 5.19%

Project Evaluation2010
Comparison of alternatives: • Railway option overrides with $4.43 billion NPV • Exploration of deposit 2 &3 will have more NPV (no data available) • Data about deposit 4-7 yet to be published

Acquisition Offers
• Nunavut offered $274 million @ .80 per share (.24 of NAV)
NAVBaffinland =$1141.67 million Per share $3.34 or $2.91 (diluted)

• ArcelorMittal offered $433 million @ $1.1 per share (.33 of NAV) • Baffinland selected the latter

2nd round of offers
• Nunavut offered $463 million for 50.1% @ $1.35 per share (.41 of NAV) • ArcelorMittal offered $429 million for 50% +1 share @ $1.25 (.38 of NAV) • Baffinland again selected the latter
• because Nunavut’s plan was to replace the BOD, president and CEO of Baffinland • Permitted bid (60 days) or take-over bid (full value of common share)

2nd offer by Nunavut
• 2nd offer includes:
– Purchasing 162 million shares – Providing 50% finance of $4.1 billion capital budget – Payment of 2% gross revenue (49.9%)

• 50% break fee ($9.75 million) • Total > $2.5 billion • Capital Provider:
– Barclays denied – Energy & Mineral group provided $200 million – E& M’s usual investment ranges from $150m to $400m

ArcelorMittal’s strategy
• Acquisition of London Mining: acquisition price/ton=$1.2462

• Deposit 1: 365 million tons @$1.2462
Acquisition price- 40% of NAV and$1.33 per share

• Deposit 1,2,3: 865 million tons @$1.2462
Acquisition Price – 94% of NAV (Acquisition avg.) Acquisition Price per share- $3.14 (NAV per share$3.34)

ArcelorMittal’s strategy
• 72 acquisitions (2003-2010)
– Avg. $1130 million ( 98.9% of Baffinland’s NAV)

• Cash Reserve-$5.919 billion (2009) • Strategic intent:
– Backward integration – Iron ore production 150 million tons by 2020.

• Credibility report: BBB- (stable)

Strategic Position
• Advantage of ArcelorMittal
– Operational Capability in Iron Ore Mining
• London Mining South America - August, 2008 • Iron Ore facility of Adriana Resources - August, 2008 • Quebec Cartier Mines - June, 2005

– Forward Integration (Mary River’s perspective)
• Purchaser (in case supply outstrip demand) • Price (Quarterly arrear pricing model)

– Available Cash
• $5.919 Billion in Dec, 2009

Strategic position
• Advantage of Nunavut
– Credit Rating (Aa1 Over BBB-) – Existing shareholdings (8.82% of fully diluted)

• Nunavut has financial leverage • ArcelorMittal has operating leverage

Strategic Directions
• Nunavut should forgo majority shareholdings
– – – – ArcelorMittal’s operating leverage ArcelorMittal’s cash position Resource Capital Fund (Tender 23% of shares) Right to waive minimum tender condition (45%)

• Propose Arcelor for joint-venture purchase
– ArcelorMittal = 50% + 1 Share = $1.25 per share – ArcelorMittal = All 2007 warrants = $0.10 per share – Nunavet = 41.12% share @ $1.25 per share

Strategic Direction
• Reduced acquisition cost = $203.616 Million • Cost saving in Acquisition = $26.04 Million • Saving from 2% participation = $248.73 Million

Discrepancies
• NAV
– $1.141 Billion Analyst’s estimation – $4.431 Billion (7% NPV)

• Total number of Diluted Share
– Case suggested = 393,389,284 – Summed = 402,642,322 (342,934,199+11,392,000+5,981,988+42,334,135)