The sheer ineptitude of Fortescue Metals Group — ably advised by Swiss investment bank Credit Suisse, it’s well worth noting — failing not once, but twice, in two weeks to tap the markets for US$2.3 billion not only beggars belief, but raises serious questions about the company’s future.
There is surely only one reason that a company the size of FMG would attempt to raise more than half its market value in debt as the price of its only product is falling, and with demand from its only market, China, flat (at the very best). That reason is desperation, because FMG feared that things would only get worse. How right it was.
The failed debt-raising fiasco sent the company’s shares down by more than 5.33% to $1.87 last night, although they clawed back a few cents in morning trading today. But yesterday, as if on cue, iron ore prices themselves took a frightening 5.4% tumble to close at US$54.50 last night for the benchmark Dalian Port rate, its lowest mark since 2008 — and a price at which it’s uncertain whether FMG is still cash flow positive.
As Crikey noted almost two weeks ago, raising doubts via tipsters only days after the fundraising was announced on March 5, the desperate money-raising bid was potentially a making-or-breaking exercise for the company. Pitched as “business as usual” refinancing, it was, in fact, nothing of the sort. FMG is now stuck with the substantial debt pile of US$7 billion; once more well in excess of the company’s US$4.55 billion market capitalisation and still almost US$1 billion short of equity plus cash.
In fact, analysts at Morgan Stanley yesterday estimated that FMG needs an iron ore price in the mid -US$70s to repay all of its debt. Well, good luck with that. Do the maths and mid-US$70s — the current price is $US54.50 — looks very much like pie in the sky. Steel demand in China is flat to negative this year, and iron ore supplies will continue to surge for the next two years. Housing starts in China are off by north of 20% this year on the back of similar numbers last year, housing has accounted for 40-50% of steel demand in China — demand ain’t returning in a real hurry.
Two years sounds like a long time, but, in April 2017, FMG must stump up US$1 billion to repay bond holders. There’s another US$400 million due the following year and a whopping US$4.9 billion due to bondholders and banks in 2019. While the company likes to point to its US$1.6 billion cash pile, it’s remarkable how quickly such stashes can dissipate. Exactly when its cash flow will start turning negative at today’s prices and exchange rates FMG won’t say, but analysts forecast that it is between US$53 per tonne and US$55 per tonne. So it’s in the zone. One would also think this is cruising close to the territory that the Australian Securities and Investments Commission should be looking at under Australia’s very patchily applied “continuous disclosure” rules. Surely shareholders have a right to know?
Those shareholders who bought as the share price climbed to $12 and then dipped before reaching almost $6 in December 2013 — and who were game enough to hang onto the company’s stock as it became clear that the iron ore price was headed for lows not seen since the global financial crisis — must be sweating.
Even more disturbing for FMG’s rusted-on supporters — and it’s worth noting that more than 10% of its stock is already held by short-sellers — chairman and major shareholder Andrew Forrest appears to have lost his knack for selling the unsellable, and for timing.
It’s hard to know why lead advisers Credit Suisse and JPMorgan were involved. Taking a punt? Why not, that’s the nature of the beast. Sound advice would have warned against this, and the fact the the offer was not under-written by either institution says volumes about investment banks: happy to take the upside, but get landed with the risk for a deal they would have been spruiking for all the world as very, very safe? Not on your nelly.
Again, FMG won’t say, but reports say it was seeking a syndicated loan at about 5%. That’s well above the market rate, but cheaper than the bonds it was to replace, which had coupon rates of between 6% and 8.25%. Once it was clear that this was not going to fly, the company decided to try to issue bonds instead. These bonds reportedly offered interest rates between 8.5% and 9% — above the 8.25% FMG is currently paying for its loans. This reveals the real reason behind FMG’s refinancing — it wants to push its repayments out to 2017 and 2018, even if this costs more in interest payments, because it fears it won’t be able to make payments due earlier than that, due to the rapidly falling iron ore price. Yet that attempt, too, failed. FMG has blamed volatile bond markets, but supply and demand, the price the balance creates, are the basics that guide such things.
As well as the odour around the iron ore market in general, where prices are now just 25% off their 2011 highs, the fall in the oil price in the past week hasn’t helped. In general, the oil price tends to be the tide that lifts and washes out prices for most commodities, despite the fact that oil is a decent-sized input for miners and also helps determine sea-freight rates.
FMG will now be fervently hoping that the Australian dollar continues its slide; the depreciation against the US dollar has been a huge bonus for it and its larger rivals, Rio Tinto and BHP Billiton as they pay their expenses in Australia in Aussie dollars and get paid for their ore in US dollars, so as the AUD fades against the greenback, their at-mine “cash costs” are reduced. So it’s worth noting here that a fair portion — about 50% according to FMG insiders — of this amazingly well-executed austerity by FMG and other miners is really just a trick of the light played by currency markets. The good news for them is that the Aussie dollar is far more likely to get weaker than stronger in the next two years when D-Day — in the shape of the US$1 billion debt repayment — arrives in April 2017.
In the nervous two years between now and then, as well as wishing the dollar down, FMG will be looking at other ways to restructure its balance sheet. With debt out of the picture for now, the official line is that the company is now “taking a breather”. But without any substantial lift in the iron ore price, that option is off the table for some time. Asset sales as well as production cuts must now surely be on the boardroom table. Ouch.
And not much relief is in sight. Even in the mid-US$50s, iron ore is well above the historical levels of the US$20s it traded at only a decade ago, so listen to those that say this “is just a dip” at your own peril.
Andrew Forrest was seared by his last experience of starting a mining company, Anaconda Nickel, after it was snatched away from him when he was forced to sell shares to cover debt. He continues to buy FMG shares in the dips to bolster his stake, which is still over 30%. But whether he will get another window to raise debt is now in doubt; selling equity — and cheaply — could once again be the only way out.
Playing on his mind must be the lurking presence of Glencore, the Swiss miner/trader that merged with Xstrata last year to form the world’s fourth-largest mining group. Iron ore is the big hole, excuse the pun, in the company’s diversified mining portfolio. It had, until recently, been sniffing around Rio Tinto, whose share price has proven remarkably resilient during the commodities slump. But FMG’s share price has collapsed, making it far more vulnerable.
It was Glencore’s now-triumphant chief executive Ivan Glasenberg, as a more junior executive, who helped boot Forrest unceremoniously out of Anaconda, leaving him a shattered man. Surely history could not repeat itself?