Forrest puts up 'for sale' sign for rail and port
ANDREW Forrest's third force in iron ore, Fortescue Metals, is negotiating with half a dozen potential buyers to offload a 40 per cent stake in its rail and port infrastructure business in the hope the company can raise as much as $US4 billion ($A3.8 billion).
Fortescue, which has been on an aggressive growth trajectory to increase production from 55 million tonnes a year to 155 million, has been caught by the huge reduction in the price of iron ore from $US140 a tonne to recent lows of closer to $US90 a tonne.
While the iron ore price is now hovering just north of $US120, there remains a need to lower the company's debt burden, which will peak at $US12 billion. This level of gearing makes the company too highly leveraged to any sharp moves in the price of iron ore.
Taking out costs was Fortescue's first line of defence, but it has been a race against time to get the lower-cost production from its Solomon mine on stream to get sufficient tonnage and revenue to make a dent in the debt.
In recent months, Fortescue has eased off its expansion plans on the Kings mine to reduce its cost burden.
Selling a portion of his highly prized infrastructure is an option Forrest would have preferred to avoid.
Before the iron ore price crunch Forrest's plan was to use cash flow from higher tonnage revenues to repay debt - a meaningful part of which would have been paid down in only a couple of years.
But Forrest narrowly lost this race against time.
Over the past six months, the debt has been restructured and smaller asset sales have been announced.
But, even after reducing the work force by 1000 and paring back all expenses, it wasn't enough.
While selling a part of infrastructure will bring cash through the door and improve the shape of the balance sheet, it will mean that Fortescue will need to pay for the use of these assets in perpetuity.
As a rule of thumb, experts say, investors are prepared to pay up to 1.5 times what is referred to as the regulated asset base.
Based on Fortescue's book value, the entire infrastructure business is worth about $US9-10 billion, putting the upper limit on 40 per cent of that at about $US4 billion.
Thus the deal will be a financing transaction. Fortescue is looking to enter into a long-term contract with whichever party buys the 40 per cent of the infrastructure assets.
It makes sense for Fortescue, whose weighted average cost of capital to fund the infrastructure assets - at least for the already operating infrastructure assets - was 9.16 per cent at June 2012, according the West Australia's Economic Regulation Authority.
(This is based on a nominal risk-free rate of 3.24 per cent, inflation of 2.35 per cent and a debt-risk premium of 3.234 per cent.)
The deal works for would-be buyers that have a lower rate of debt - the likes of specialist infrastructure funds, pension funds and strategic buyers like QR National.
These sorts of transactions are not unusual. A few years ago the broadcast towers used by the ABC and SBS were sold in this way.
While there may be a single industry buyer, it is also possible that the assets could be acquired by or placed in a fund.
Over the past month there has been plenty of speculation as to how Fortescue could alleviate its debt situation. There has been interest in acquiring direct stakes in iron ore-producing projects but none have found agreements between seller and buyer on price.
Given the volatility in the iron ore price, this outcome is not all that surprising.
Selling a sizeable slab of Fortescue's impressive infrastructure assets is probably an easy deal to negotiate. The fact that the company has chosen to confirm to the market that the talks are even taking place in part reflects its sensitivity to disclosure issues but also suggests that it is sufficiently advanced and germane that investors should be made aware.
Fortescue has retained Lazard and Macquarie Capital to advise on the sale.
"These [potential] investors recognise the world-class infrastructure assets that Fortescue has developed. They are also attracted by the fact that The Pilbara Infrastructure (TPI) is the only provider of third-party infrastructure in the Pilbara and the logistics chain is fully operational. This provides an outstanding investment opportunity," said Fortescue chief executive Nev Power.
Investors seemed to appreciate some of the risk being taken out of the stock, with the price moving up strongly on the back of the news.
While Fortescue's stock performance is extremely leveraged to the iron ore price, the move to sell assets to reduce debt will weigh in its favour.
The completion of this deal may also hasten the move to ramp up the plans to increase production to 155 million tonnes a year - an aspiration the company has been working towards for years.