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Paulo Santos, Think Finance (377 clicks)
Long/short equity, arbitrage, event-driven, research analyst
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Sometimes the general craziness in the market produces amazing opportunities. This is an article on one of those opportunities, which, unfortunately, you cannot take advantage of.

First, here's a little background information. There's this stock, Great Northern Iron Ore Properties (GNI) that isn't really the stock of a company, as much as the stock on a trust. This trust was created back in December 7, 1906, to provide for the welfare of eighteen persons named in the Trust Agreement. For this, the trust owns interests in fees for both mineral and nonmineral lands on the Mesabi Iron Range in northeastern Minnesota. The Trust's properties, which span two counties (St. Louis and Itasca) in northeastern Minnesota extend from Hoyt Lakes on the east end of the Mesabi Iron Range to Grand Rapids on the west end of the Mesabi Iron Range. Many of these properties are leased to steel and mining companies that mine the mineral lands for taconite iron ore. (source: GNI, "Profile of the Trust of Great Northern Iron Ore Properties").

But this is where it gets interesting:

The Trust, by its terms, will dissolve on April 6, 2015, 20 years after the death of the last survivor named in the original December 7, 1906 Trust Agreement;

The last survivor of these eighteen persons died on April 6, 1995. Accordingly, the Trust terminates twenty years from April 6, 1995, that being April 6, 2015.

So we are talking about a trust that has little more than 3 years until it gets dissolved. And what happens when it gets dissolved? (source: GNI, "Termination of the Trust of Great Northern Iron Ore Properties")

At the end of the Trust on April 6, 2015, the certificates of beneficial interest (shares) in the Trust will cease to trade on the New York Stock Exchange and thereafter will represent only the right to receive certain distributions payable to the certificate holders of record at the time of the termination of the Trust. Upon termination, the Trust is obligated to distribute ratably to these certificate holders the net monies remaining in the hands of the Trustees (after paying and providing for all expenses and obligations of the Trust), plus the balance in the Principal Charges account (this account is explained in the Trust's Annual Report within the Notes to Financial Statements). All other Trust property (most notably the Trust's mineral properties and the active leases) must be conveyed and transferred to the reversioner (currently Glacier Park Company, a wholly owned subsidiary of ConocoPhillips Company) under the terms of the Trust Agreement.

The exact final distribution, though not determinable at this time, will generally consist of the sum of the Trust's net monies (essentially, total assets less liabilities and properties) and the balance in the Principal Charges account, less any and all expenses and obligations of the Trust upon termination. To offer a hypothetical example, without factoring in any expenses and obligations of the Trust upon its termination, and using the financial statement values as of December 31, 2011, the net monies were approximately $7,927,000 and the Principal Charges account balance was approximately $4,962,000, resulting in a final distribution payable of approximately $12,889,000, or about $8.59 per share. After payment of this final distribution, the certificates of beneficial interest (shares) would be cancelled and have no further value. It is important to note, however, that the actual net monies on hand and the Principal Charges account balance will most likely fluctuate during the ensuing years and will not be "final" until after the termination and wind-down of the Trust. The Trust offers this example to further inform investors about the conceptual nature of the final distribution and does not imply or guarantee a specific known final distribution amount.

This means that upon dissolution, all the assets are transferred to ConocoPhillips (COP) and the shareholders receive a final distribution amounting to less than $10. So all the value in this trust is enclosed on the dividends it will pay between today and April 6, 2015, plus this final distribution presently estimated at just $8.59 per share.

So what can we expect in terms of dividends?

GNI has historically paid less than $4 per quarter in dividends, though in the last quarter it paid $5.75. This isn't expected to continue, and it's much more likely that the dividend rate will be closer to, or below, $4 per quarter, especially taking into account probable iron ore oricing weakness. With 12 payments still to go, this means GNI will still generate around $48 per share in dividends.

However, this is one of the reasons why the stock can be so overvalued: many superficial analysts just annualize the latest dividend, coming to a yearly dividend of $23 for a yield of 18.5%, or they add up the dividends across the last 4 quarters, coming to a yearly dividend of $15 for a yield of 12%. Either way, you get people pumping the stock on its "incredible yield" - which is simply wrong, because as we've seen it won't last by design.

So the total value is …

Bearing in mind that all of GNI's value is in the dividends plus the final distribution, we can confidently say that the total value here is around $48 + $9, or $57. Yet, the stock trades at $124 …

So is this is an incredible short opportunity?

Amazingly, the answer is "No". This isn't an incredible short opportunity as some might think. Although GNI's short interest is low (just 73.9k of the 1.5 million shares are sold short), it's very expensive to stay short GNI. The short rebate, or what you pay to borrow GNI shares, is around 21.5% per year - and this is paid on the short balance, meaning if you were to short GNI for 3 years and it didn't break down much, you'd have to pay $124 * 21.5% = $26.7 per share per year you held the short. Obviously, the stock should at some time weaken and lower this charge a bit, but right now you'd be looking at around $80 just to hold it short for 3 years, which actually consumes all of the overvaluation from here until maturity (because $57 + $80 = $137, which is more than the $124 it trades for).

Conclusion

GNI is a clear sell if you hold the stock, however given the short rebate rates on borrowing the stock, it's not presently a short. Close monitoring should be given to these rates, because if they go meaningfully lower, the stock becomes an obvious short.

Source: Great Northern Iron Ore: The Greatest Short Play You Can't Make