#1

Capital Allocation

Commodity businesses require capital to grow and maintain productive capacity. That makes the returns a commodity producer achieves on capital a key determinant of long-term value, one that differentiates the true value creators from those simply treading water.

How does a company achieve high returns on capital in a commodity business? One of the best ways is to acquire assets at prices below replacement costs from motivated sellers or when they go on sale during cycle troughs. Champion Iron has done just that.

Champion Iron has quietly assembled a collection of iron ore assets in Northern Quebec and Western Labrador for pennies on the dollar. The company bought a package of assets that included its lone producing asset, Bloom Lake, for just over $10 million in 2016. After spending incremental capital first to restart operations and more recently to double production, the company today has substantially less than a billion dollars invested in the property. We believe Bloom Lake as it exists today can generate $450 million to $950 million in free cash flow, depending on the state of the iron ore markets.

Less than a billion dollars invested in a property that generates a half billion or more in free cash flow is the kind of return on capital we like. Returns like that in a commodity business are made possible only by Champion’s strategic, value-oriented acquisition program.

The secret sauce in Champion’s acquisition of Bloom Lake is the amount of capital the previous owner had sunk into the property before essentially abandoning it. Cliffs had spent about $3.5 billion on the property building the mine, buying and installing much of the processing equipment, and creating the necessary infrastructure to support the current operations of the mine. During the last downturn in the iron ore markets, the previous owner placed the almost-finished Bloom Lake property into receivership. Champion bought the property out of receivership.

Champion, in short, paid just $10 million for a property containing several billion dollars of sunk capital. Much of that sunk capital funded machinery and infrastructure that Champion used to offset the capital needed to initially restart operations and then double the productive capacity at the mine.

It was that thrifty acquisition that gave Champion the opportunity to invest incremental capital of less than a billion dollars on an asset capable of producing free cash flow of nearly a billion dollars in a good year and half a billion dollars in a bad year.

In addition to Bloom Lake, Champion has a portfolio of non-producing assets in the vicinity of Bloom Lake that were likewise bought at prices substantially below both replacement costs and underlying value. Although these non-producing assets do not contribute to earnings or cash flow at the moment, we believe they represent substantial underlying value, value that could run into the billions of dollars.