THE DISTILLERY: Forrest's bind

Jotters question how Fortescue got into such a sticky situation, with one charting Andrew Forrest's options by iron ore price.

Fortescue Metals Group founder Andrew Forrest has proved the sceptics wrong yet again. But questions for the iron ore company remain. How did the company allow itself to get into this situation in the first place? What level does the iron ore price have to settle at for the company to avoid asset sales outright?

The Australian Financial Review’s Chanticleer columnist Tony Boyd says Fortescue needs to look at its corporate governance after this episode.

"Forrest should be asking chief executive Nev Power, chief financial officer Stephen Pearce and treasurer Ian Wells how Fortescue ended up in that sticky situation. A not unreasonable theory is that Forrest, who is known to dip in and out of management decision making, opted for the BAML loan because shorter-term debt is cheaper than long-term debt. Pearce’s involvement in a failed management buyout of Alinta Energy in 2007 raised questions at the time about his judgement. Wells has probably handled more debt funding and refinancing over the past five years than any other treasurer in Australia. Forrest’s post mortem of what happened on the debt front probably needs the involvement of an independent Fortescue director.”

The Australian’s John Durie couldn’t help but notice the absence of Merrill Lynch from the banks underwriting the debt facility.

"The agreement achieves three key objectives, giving the company longer-dated, covenant-free debt and liquidity to hopefully best manage its future. The deal that nearly undid Fortescue was the $1.5 billion Merrill Lynch bond, which was intended to fast-forward the firm's iron ore expansion to 155 million tonnes a year. It was poorly conceived and smacked of Forrest's hubris that the odds would continue to favour him into infinity… History now shows the iron price collapsed to $US87 a tonne, Merrill couldn't syndicate the bond issue, the rumourtrage started and the share price collapsed from $4.18 on August 3 when the Merrill deal was announced to a low of $2.81 on September 6. The collapse in the iron ore price had meant the Merrill covenants based on debt to earnings before interest tax, depreciation and amortisation were virtually in breach from day one.”

The Australian’s Barry Fitzgerald writes that Forrest will have his eye on an iron ore price of $US120 a tonne. With the commodity currently sitting at $US100, it just might be within striking distance.

"Such a $US20-a-tonne increase would deliver an additional $US2.4 billion ($2.2 billion) in free cash flow on Fortescue getting to an annual production rate of 115 million tonnes from March next year. Surely that would put to bed any of the lingering doubts Fortescue can go on as planned, with Andrew Forrest still very much in control with his 32 per cent stake. But until $US120 a tonne arrives, Fortescue is best advised to continue on with what its chief executive Nev Power described as the ‘hierarchy' of options at its disposal should iron ore prices fall.”

Fairfax’s Elizabeth Knight reminds readers that Fortescue’s share price surge yesterday was seriously bad news for a number of the iron ore miner’s shareholders.

"There had been a huge bet placed on Andrew Forrest's West Australian iron ore producer collapsing under a weight of debt – unable to trade profitably in the face of a tumbling iron ore price. Investors have been engaged in the exercise of punting on a share price decline. It's called short selling, and for months those who have invested in this trade have been making a killing. But yesterday the tables turned. The company announced a major financial restructuring – which came back to bite the short-sellers who, according to Forrest, had ‘engaged in an exercise of misinforming the market’. Almost 14 per cent of the shares in Fortescue that are not owned by Forrest have been shorted. These players now need to scramble back into the market to soak up Fortescue shares to cover these short positions.”

And The Australian Financial Review’s Mike Smith reports on the frustrations of Fortescue’s management that this episode had to be played out publicly.

"Power is angry that confidentialities with lenders were allegedly broken and that The Australian Financial Review got wind of the fact the company had asked lenders for more breathing space. Whether or not Fortescue was obligated to disclose the details of talks with its lenders or not, it could have avoided the problem by keeping shareholders better informed in the first place. The 15 per cent share price fall on Thursday now looks like an over-reaction and there is no doubt short-sellers were partly to blame. However, it raises questions about the way Fortescue managed the events of last week and why investors panicked in the first place.”

The Australian’s Bryan Frith says the secured debt facility should put concerns about Fortescue’s financial position to rest for the moment.

In other company news, Fairfax’s banking writer Eric Johnston says National Australia Bank is pushing for a serious slice of the online trading market for brokers and self managed superannuation funds.

The Australian’s Barry Fitzgerald has picked up some good initial signs from the Nova nickel-copper site, which was discovered by Australia’s prospector extraordinaire Mark Creasy.

Meanwhile, Fairfax’s Michael Pascoe carefully reads through the Reserve Bank’s minutes to find that the retailers that the central bank spoke to recently reported better conditions in August.

Fairfax’s national affairs correspondent Lenore Taylor says employers pushing for lower penalty rates on weekends won’t find support from the Gillard government.

And Fairfax’s Adele Ferguson picks up on the report on the Australian Council of Superannuation Investors remuneration report that her colleague Eric Johnston examined yesterday.

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