Update Fortescue Metals Group (FSUMF.PK)

10/01/2009 11:44 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Fortescue Metals Group (FSUMF.PK) announced on September 30 that a proposed $6 billion financing deal with Chinese investors had fallen through. That hasn't helped the stock price.

I sold Fortescue Metalsout of my 12-18 month Jubak's Picks portfolio on September 24 and the stock is down 11.3% from that sell as of 11 a.m. (ET) on October 1.  But the stock is still a member of my long-term The Jubak Picks 50 portfolio.

The news that the deal had fallen through wouldn't have hurt the stock so much if Fortescue hadn't trumpeted the package quite so loudly just a month ago. The deal, Fortescue said at the time, would provide critical financing in the company's drive to hit an annual production rate of 95 million metric tons of iron ore, up from the current 50 million ton rate. The company needs about $3 billion for its next stage of expansion to build ports, ship loaders and a 260-kilometer railroad. Fortescue also has about $2.5 billion in debt.

In retrospect the financing wasn't as secure as the company implied last month when it announced a package that combined iron ore sales to and financing from China. As part of the package, Fortescue agreed to supply China's steel mills with iron ore at a 35% reduction in price from 2007-2008 levels. In annual negotiations dominant iron ore producers Vale (VALE), Rio Tinto (RTP), and BHP Billiton (BHP) agreed to a 33% reduction with Japanese and Korean steel makers. China's steel makers have so far refused to sign onto that deal and have been fighting for a bigger cut, perhaps as much as 45%. The lower price from Fortescue was widely seen as strengthening China's hand in these talks.

At the time Fortescue said that the supply deal was linked to the provision of $6 billion in financing and the company set a deadline of September 30 for getting the financial deal signed. That turned out to be harder than expected--either because the Chinese never agreed to link the supply and financing ends of the deal in the first place or because once they had the supply deal in place the Chinese decided to drag their feet in arranging the loans.

Now that the loan deal has fallen through, it's not at all clear what will happen to the supply side of the package. Statements from Fortescue have been ambiguous: "Fortescue intends to continue working cooperatively with CISA [China Iron & Steel Association] including the provision of attractive iron ore pricing if requested."

This news has drawn increased attention to a court case brought by the Australian Securities and Investments Commission against Fortescue and its founder and majority shareholder Andrew Forest. The regulators allege that Forrest and Fortescue mislead investors over announcements of deals with China Railway Engineering and China Metallurgical.

Things are certainly never dull on the new frontier in iron ore.

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