Fortescue pair pirouette through the panic

By convincing bankers of their commitment to right the ship, and thus securing refinancing which then enabled them to ditch their Leucadia drag, Fortescue's top two have turned a tight spot into a positive.

You’ve got to hand it to Twiggy Forrest and his chief executive Nev Power. Their response to a crisis that could have engulfed Fortescue Metals was textbook and now they’ve turned it into an opportunity.

Only a fortnight ago Fortescue was on the verge of something very unpleasant as iron ore prices plunged below $US90 a tonne and the over-leveraged "fourth force" in seaborne iron ore was at risk of falling under the control of its bankers.

Out of the blue Forrest and Power took some dramatic action. They shelved the planned third leg of Fortescue’s ambitious expansion plans, saving $1.6 billion of capital expenditure, announced plans to slash $300 million from their cost base and sold a power station for $300 million.

By itself that wouldn’t have been sufficient to secure the group, but it did signal to the group’s bankers – owed about $US10.5 billion – that they were taking the crisis seriously and were determined to respond to it.

With the support of Credit Suisse and JP Morgan they were then able to negotiate a new $US4.5 billion five-year facility to retire $US3.6 billion of existing debt, and some, and push the first principal repayment date out to November 2015. That ended the market’s clamouring for more distressed asset sales and/or a distressed capital raising that would have severely diluted Forrest’s shareholding of about a third of the company.

The problem still confronting Fortescue was that, while the iron ore price has subsequently pushed back up above $US100 a tonne, Fortescue is, by comparison with Rio Tinto, BHP Billiton and Vale, a relatively high-cost producer producing relatively low-quality ore for which it receives a discount of around $US10 a tonne relative to the majors.

That didn’t matter when the iron ore price was $US150 a tonne-plus, but certainly came into focus when it was sub-$US100. Even at the current levels of around $US110 a tonne there isn’t much margin for error given Fortescue’s capital and financing commitments and the now slightly deferred need to prepare for the eventual principal repayments.

That’s where the announcement that Fortescue has agreed to buy back the so-called Leucadia unsecured note for $US715 million comes in.

Leucadia National is a New York-based investment conglomerate that, with embattled former star hedge fund manager Philip Falcone and his Harbinger Capital, was an early big backer of Forrest and Fortescue. While Leucadia has sold down almost all of its original $US450 million or so equity investment in Fortescue (reaping nearly $US2 billion in the process) it still held the notes it paid $US100 million for in 2006.

Those notes are an expensive form of funding. Only a year ago they were valued at just under $US1 billion and at balance date this year at $US897 million. They give Leucadia the right to 4 per cent of the FOB revenue, net of government royalties, from Fortescue’s Cloudbreak and Christmas Creek mines in Western Australia.

With production from those mines destined to increase significantly, they could have become even more expensive. They’ve also been the subject of lengthy litigation between the companies over the way in which the
"interest" on the note is payable.

By redeeming those notes while the iron ore price is at relatively low levels and ahead of the ramp-up of production from Cloudbreak and Christmas Creek, Fortescue has taken advantage of its crisis – and the extra $US900 million it borrowed – and turned it into an opportunity.

Getting rid of that 4 per cent charge of revenue from the sale of iron ore from the mines effectively lowers Fortescue’s borrowing costs materially and therefore its overall operating costs, which is fundamental to enable Fortescue to operate with sufficient profitability if the iron ore price remains at current levels.

When it refinanced its borrowings earlier this week Fortescue said it had been approached by a range of parties interested in partnering with certain of its assets – it has more power stations, substantial infrastructure and a magnetite deposit it could sell or partner.

While it was under real duress and negotiating from a position of weakness asset sales might have brought in vital cash and capital to reduce debt or improve liquidity but there was a risk they would build in higher operating costs in the longer term.

The re-financing has given Fortescue the ability to negotiate without being forced into fire sales and therefore it can choose to sell or not depending on whether or not the transaction improves its cost and risk profiles.

Give Twiggy some credit. He’s seen a few crises, including some of his own, over the past few decades and has done precisely what he had to do to keep his bankers reassured and protect his own position on the register.

He’s even been able to use his predicament to Fortescue’s advantage, which in the current environment for miners is no mean feat.

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