Pedal to the Metal
10/15/2010 3:09 pm EST
There’s been some movement this week in simplifying the complicated balance sheet of Fortescue Metals Group (OTC: 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 (NYSE: JPM) and Royal Bank of Scotland Group (NYSE: RBS) 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, up 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 (NYSE: LUK).
Fortescue borrowed $100 million from Leucadia back in 2006. That subordinated debt gave Leucadia interest equivalent to 4% of sales, after government royalty payments, of iron ore produced from 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 limited 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 said it “Never would agree” to any dilution of its interest, and sought an injunction restraining Fortescue from issuing further notes.
Fortescue’s bank loans may not 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, is said to be considering raising as much as $6 billion to fund the further expansion of the Solomon mine (the subject of Thursday’s bank loans) and the Chichester projects. The $6 billion would allow Fortescue to develop both projects simultaneously, according to the company.
Next week, Fortescue is set to begin marketing a $2-billion bond offering in the United States and Europe, The Wall Street Journal reported on October 14. JPMorgan and RBS are reportedly managing the offering.
That news of a $2-billion bond offering makes sense—interest rates on corporate debt are really low, and JPM and RBS 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 chief executive officer 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 US ADR FSUMY has an average daily volume of just 1,400 units. The over-the-counter-traded shares FSUMF exchange just 34,783 shares per day, on average.)
You need discipline to make money on this one, because the swings are 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 run I think you’ll do well. The stock is a member of my long-term (five years or longer holding period) Jubak Picks 50 portfolio.
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.