Update Fortescue Metals (FSUMY)

10/15/2010 12:19 pm EST


Jim Jubak

Founder and Editor, JubakPicks.com

Some movement this week in simplifying the complicated balance sheet of Fortescue Metals Group (FSUMY), the third largest iron ore mining company in Australia.

The company’s stock climbed 7.8% on October 11 after Fortescue announced that it had signed a $2.04 billion loan agreement to expand its mining operations. The loan from JPMorgan Chase and Royal Bank of Scotland matures in 2015 with an initial interest rate of 7.5% linked to LIBOR (London Interbank Offered Rate). The bank loan replaces senior notes issued in August 2006 to fund Fortescue’s initial mine, and the construction of a port and railroad. Those notes will be paid off at a $605 million premium.

The money will let Fortescue expand its Solomon and Western Hub projects more quickly, the company said. Fortescue’s goal is to expand annual production to 155 million metric tons by fiscal 2014 from 40 million tons currently.

Also on October 11 Fitch Ratings gave Fortescue a BB+ credit rating. That’s Fitch’s highest non-investment grade rating.

This deal may, and it’s always wise to say may with Fortescue, help resolve the company’s nasty dispute with its third-largest investor Leucadia National. Fortescue borrowed $100 million from Laucadia back in 2006. That subordinated debt gave Leucadia interest equivalent to 4% of sales, after government royalty payments, of iron ore produced from the part of the company’s mines through 2019.

But the terms of the senior debt that this bank financing replaced had constrained Fortescue’s ability to expand (and pay Leucadia) and the terms of Leucadia’s note have constrained Fortescue’s ability to raise more capital. On September 1 Leucadia sued to prevent Fortescue from raising more subordinated debt that could reduce the payments that Leucadia receives. Leucadia “never would agree,” the company said to any dilution of its interest and sought an injunction restraining Fortescue from issuing further notes.

It’s possible that Fortescue’s bank loans don’t violate the terms of its subordinated debt with Leucadia—because the Leucadia note might be limited to the Chichester Hub mines of Cloud Break and Christmas Creek. At least that is what Fortescue has argued.

But Fortescue, according to news stories out of Australia today, is said to be considering raising as much as $6 billion to fund the further expansion of the Solomon mine, the subject of today’s bank loans, and the Chichester projects. The $6 billion would allow Fortescue to develop both projects simultaneously, according to Fortescue.

Fortescue is set t begin marketing a $2 billion bond offering in the United States and Europe, next week, the Wall Street Journal reported on October 14. JPMorgan Chase and Royal Bank of Scotland are reportedly managing the offering.

That news of a $2 billion bond offering makes sense—interest rates on corporate debt are really low currently and JPMorgan Chase and Royal Bank of Scotland are the banks that just finished lending $2.04 billion to Fortescue.

But at this point I can’t tell whether the company—which was cash-constrained to the point of near-starvation during the global financial crisis—really has any sources lined up for the rest of the $6 billion, or whether the announcement is part of some negotiating tactic with Leucadia or, most likely, both.

What does seem clear though is that the days when Fortescue had lots of iron ore in the ground and no way to pay for mining it are over. At least until the next global or company induced crisis.

The company is run by a wild and wooly management team headed by CEO Andrew Forrest that has previously talked up financing deals and prospects that were a mite less certain than they seemed. Add that to the stock’s reputation as a speculative delight for traders and this one will take you on a ride that is wilder than many investors can stomach. (The U.S. ADR (FSUMY) trades an average daily volume of just 1,400 units. The OTC-traded shares (FSUMF) trade just 34,783 shares a day on average.)

You need discipline to make money on this one because the swings as enough to drive many investors to buy high—like now when almost everything seems rosy—and sell low—when nothing but disaster seems to loom.

Buy this one when everybody hates it, and in the long term I think you’ll do well. The stock is a member of my long-term (five years of longer holding period) Jubak Picks 50 portfolio. (http://jubakpicks.com// ) I wouldn’t buy at the moment—too many people love it. The shares are up 40% since September 1.

Full disclosure: I don’t own shares of any company mentioned in this post in my personal portfolio.
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