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A stock that's guaranteed to fall to zero

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May 24, 2010 – Comments (2) | RELATED TICKERS: GNI

 

I've seen this short idea mentioned several times over the past year or so, but I decided to shed some light on it here now that I'm officially adding it to my CAPS portfolio.

The name of the stock is Great Northern Iron Ore Properties (GNI).  GNI is a trust that owns the mineral rights to a section of the Mesabi Iron Range in Minnesota.  In April 2015, the mineral rights to this land will be transferred to a subsidiary of Conoco Philips and GNI and it will essentially be worth nothing.  OK, not completely zero, but a little over eight bucks per share ($12.5 million final distribution / 1.5 million shares), a far cry from today's $88.

The problem is that GNI pays a hefty dividend that anyone who shorts it will have to doll out quarter after quarter after quarter (20 to be exact) until this puppy is dissolved.  Assuming a dividend payment of $8.00 to $10.00/share, were talking about paying out between 9% and 11% annually to short this stock. This is not something that I'd be thrilled about doing in real life...but in CAPS where it's not my money let's do it.

Another problem with shorting GNI in real life is that it only has about a million and a half shares outstanding, of course once again that's not a problem here in CAPS.

Let's look at this trade as simply as possible, ignoring all of the IRR, present value, rigmarole. Barring an explosion in the price of iron ore, by shorting GNI today you will have to pay anywhere from $40 to $50 in dividends along the way and a $8.50 (rounded up) final payment in 2015.  Add all of that up and we arrive at total cost of $48 to $58/share compared with today's share price of $88/share for GNI. That's a profit of $30 to $40/share on the short, not a killer return over five years...but a respectable one.

Not only will GNI be worth practically nothing by the year 2015, but it is entirely possible that iron ore prices will drop significantly in the future if the global economic recovery slows or if China implodes.  A drop in the price of iron ore will lower Great Northern Iron's distributions to shareholders and make this trade less painful for shorts.  Furthermore, GNI's stock tends to move in tandem with the S&P 500, providing protection of the recent market weakness continues.  I like to sprinkle a handful of shorts in as protection for my mostly long special situations CAPS portfolio and I have chosen Great Northern Iron as one of them.

Deej 

No position in GNI 

2 Comments – Post Your Own

#1) On May 24, 2010 at 2:45 PM, dickseacup (66.90) wrote:

Apropos of nothing, in March I was speaking with the owner of a business that deals in mining machinery up in the Mesabi Range. When I inquired as to how business was fairing, thinking it would be down due to the economy, he told me that the mines were operating near maximum and that his company had orders that extended two years out before they'd be able to fill them all.

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#2) On May 24, 2010 at 2:52 PM, TMFDeej (99.32) wrote:

Interesting insight.  Thanks for sharing.  If that is indeed the case for right now and the foreseeable future then GNI would probably payout around $10/share in dividends using the example that I talked about above.

Even with two years worth of orders, there's still time for GNI's royalties to drop before the rights are relinquished.  

There's enough wiggle room here for prices to fluctuate a decent amount without the trade entirely blowing up.  Of course, if iron ore prices are rock solid over the next five years to use a terrible pun then the upside of this trade is considerably less.  I still don't think that there's much downside, especially compared to a normal short of a regular company.

Deej 

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