Great Northern Iron Ore Proper GNI S
December 15, 2008 - 5:51am EST by
2008 2009
Price: 74.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 112 P/FCF
Net Debt (in $M): 0 EBIT 0 0
Borrow Cost: NA

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As a short sale, GNI has an amazing characteristic—one can state with 100% certainty that it is going to zero. Doomsday for GNI is April 6, 2015, which is exactly 20 years after the death of the last of a group of named persons, who were heirs of a wealthy industrialist of a century ago. The trust (GNI is a trust, not a corporation) dissolves then, and all assets, regardless of their worth at the time, revert to another company, with GNI holders given only one last liquidating dividend, estimated at $8 to $10 per share.
Of course, it isn’t quite that easy to make money on this short, even though we know for sure it will drop from $74.50 to zero in a little more than six years. The big problem is that the short seller is responsible for all dividends, so if they are high enough, one could still come out behind. Dividends have been generous of late, and perhaps the largest ever was declared on Friday, but there is good reason to expect them to be considerably lower for the next few years at least; and if you disagree on that point, there is an excellent way to hedge that risk. The other problem is that borrow is always impossible in size (there are only 1.5M shares outstanding) and often very difficult even very small. I have no solution to that, other than keep trying.
GNI was formed in 1906 to collect royalties on mineral rights on about 12,000 acres of land in the Mesabi Iron Range formation in northeastern Minnesota owned by James J. Hill, founder of the Great Northern Railway, to provide an income for the youngest generation of his descendents.  The land contains vast amounts of taconite, a low grade iron bearing ore. Several mining companies excavate the ore, process it into pellets where the percentage of iron is upgraded from about 20%-30% to about 65%, and ship it to traditional blast furnace type steel mills. The trust is paid a royalty which depends on how much ore is mined from its lands, as well as various factors mostly related to iron and steel prices.  Close to all of that royalty income, net of the expenses of running the trust, is paid in distributions.
The exact royalty calculations, unlike the somewhat similar Mesabi Trust, are not revealed. This may be because, while MSB which has one customer who sells iron ore at arms length to various steel companies, GNI has several customers and multiple leases with each customer, with varying terms. In addition, about two thirds of GNI’s taconite is mined by U.S. Steel, which uses it internally, so the transfer price between X’s mines and X’s steel mills is inherently too arbitrary to be used as a basis for calculating the royalty owed GNI. Rather, the royalty income on that ore is determined based upon a hypothetical price for the ore that is calculated in some unknown (to the public) fashion involving both the Producer Price Index and particularly the iron and steel subgroup of that index. This is published monthly by the Bureau of Labor Statistics. To find it, go to this site: , check the box on “Iron and steel - WPU101” , and click “retrieve data” to see the index for the last ten years.
I previously wrote up this stock here as a short in 2004 when it was selling for about $100. Since then, the world economy enjoyed a boom that resulted in a massive increase in iron and steel prices.  On Friday GNI announced its dividend for Q4 2008, and at $4.50/share, it resulted in annual dividends of $11.70 for the year, the highest level in GNI’s 102 year history.
Nevertheless, GNI is an attractive short now because there is an excellent chance that dividends in 2009 and for at least several years thereafter will be down from this year, probably substantially so. There are only 25 more quarterly dividends to go, plus the final liquidating dividend of $8-$10, before GNI closes up shop. Even if you assume that there is no time value for money, dividends have to exceed $10/share/year for the buyer at this price to break even, and at least for 2009 that is unlikely to be the case.
Already, its customers are reducing demand. CLF has announced production cuts of about 30% at a number of its plants, although it hasn’t yet mentioned any specific cuts at its Hibtac operation, which uses about 1/3 of GNI’s ore. U.S. Steel has “temporarily” (we’ll see about that) closed its Keetac operation, which uses about 12% of GNI’s ore. There hasn’t been any word yet of layoffs or closures of Minntac, owned by U.S. Steel and GNI’s biggest royalty payer, but both it and Hibtac are vulnerable if steel demand continues to drop.
The actual tonnage for GNI ore may hold up fairly well Y/Y in 2009, despite production cutbacks and the closure of Keetac, because production in early 2008 was reduced by massive rains in that area. But a key factor is the price indices. That BLS iron and steel index, that has a big impact on royalties due GNI, finished up 2007 at 200.6 . This year it shot up as high as 296.4 in August, but has plummeted since, hitting 211 in November, subject to revision. Given the collapse in construction and consumer spending, one would expect Y/Y declines to begin in January, if not this month. The combination of lower physical volume by the second half of the year and much lower assumed prices should reduce GNI’s royalties significantly in 2009.
No one knows how long the weak economy will continue. I am of the belief that, since the debt expansion bubble in the economy took many decades to unfold, we could have a debt contraction decline that could easily last a decade anyway to correct those excesses. Reasonable people may differ. In fact, there is a bullish case that incoming Pres. Obama will push Keynesian type infrastructure investments, many of which will result in higher steel demand for bridges, etc., and hence a greater demand for iron ore. That may happen, but such projects take a few years for engineering, environmental impact statements, NIMBY lawsuits, etc., and probably wouldn’t result in any increase in steel demand before well into 2010 at the earliest. Meanwhile, if the world economy continues weak, there will be a lot of excess steel capacity everywhere that can meet that need and, at least, keep downward pressure on steel prices, and hence royalties due to GNI.
If, contrary to my opinion, you are optimistic on the strength of the US economy, you can still short GNI and hedge by going long MSB. They are similar, in that they will both terminate a fixed number of years after the death of the last of a group of named persons. That even already happened to GNI, hence its April 6, 2015 doom. In MSB’s case, termination occurs 21 years after the death of the last of 25 people, the youngest of which is 47. So MSB could easily be around for another 40 to 60 years. In addition, it has no employees, just a few trustees, keeping expenses a lot lower than GNI, which has quite a few well paid employees. MSB is by far the better buy if you are less pessimistic on the economy than I am.

The surprising thing is that GNI makes no secret about its upcoming termination date. With dividends probably dropping well below $10 for the next few years, and perhaps staying there for the remainder of its lifespan, GNI should probably be selling not much more than half the current price. I feel cautious in claiming that buyers are so clueless that they haven’t figured out that GNI is not a corporation with infinite life, but a very limited term trust nearing its demise. How can they miss that point? Yet there is the stock price—go figure.  My guess is that most buyers are unsophisticated individuals who take the most recent dividend, multiply by four, and project their returns accordingly.


1) Lower distributions in 2009
2) Eventually, realization that GNI will be shut down in about six years.
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