FMG in ‘serious’ talks with potential partner in moves to shift debt burden

Debt-ridden Australian iron ore miner Fortescue Metals Group (FMG) is at an advanced stage of talks with a potential strategic partner in a bid to boost its cash reserves, ceo Nev Power has told Steel First.

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“We have had a very high level of interest from companies looking to become our strategic partner,” Power said. “We have had serious conversations with at least one party.”

Speaking to Steel First in the northern Chinese port city of Dalian in the last week of September, Power said that the next step for the cash-strapped miner would be to sell non-core assets in a bid to reduce debts.

“We are looking at non-core asset sales, or selling a percentage of one of our projects which takes us beyond 155 million tpy,” he said.

“The next step would be a sale to a joint-venture partner,” he added. “We’d either be looking for a pure finance investor or an infrastructure operator.”

Delayed ambitions
These are humbling times for the world’s fourth-largest iron ore producer.

Fortescue emerged from obscurity to become, in less than a decade, the poster-boy for Australia’s resource boom and a rival to the world’s biggest miners.

Andrew “Twiggy” Forrest founded Fortescue in 2003, and he rapidly became one of Australia’s most colourful and controversial public figures. This reputation was cemented when the Australian federal court found that Fortescue and Forrest had misled investors in several announcements made between August 2004 and March 2005, by suggesting the binding nature of three framework agreements with Chinese companies.

Power replaced Forrest at the helm of Fortescue in June 2011 after Forrest stepped down as ceo. Power had previously held senior executive roles at engineering and services provider Theiss, Sydney’s Royal North Shore Hospital redevelopment and the Victorian desalination project in southern Victoria.

But Fortescue’s rapid ascent has come at a price beyond the loss of its founding ceo. The miner has racked up close to $10 billion in debt, by gambling that China’s appetite for the steelmaking raw material would continue to grow.

Slackening Chinese demand in the first half of 2012 sparked a major selloff in steel, prompting a collapse in iron ore prices from levels higher than $130 per tonne in June to close to $85 per tonne at the end of August.

Anglo-Australian iron ore majors BHP Billiton and Rio Tinto were quick to react to tumbling prices, by slashing jobs and delaying large capital expenditure projects.

Harder hit
Because of its reliance solely on iron ore for its revenue, however, FMG – the self-styled “new force in iron ore” – has been hit harder than its bigger, diversified rivals.

The miner’s near-term output growth target has been slashed by 40 million tonnes to 115 million tpy. It is on track to deliver 55 million tonnes of ore in 2012, but plans to increase production to 155 million tpy in 2013 have been delayed until iron ore prices recover.

Major projects, including the development of the King’s deposit in FMG’s Solomon mining hub and the construction of a fourth berth at its Herb Elliott Port in Western Australia have also been deferred in a cost-cutting push to save around $300 million.

Hundreds of jobs at the miner have been cut, and perks for those remaining on FMG’s payroll, including company barbeques, have also been shed in an attempt to make savings.

The company was downgraded by Moody’s ratings agency in August, but bought itself time to ride out the iron ore downturn by securing a $4.5 billion refinancing from banks Credit Suisse and JP Morgan in September.

Asset sales
In a bid to boost its balance sheet, Fortescue has already offloaded a number of its non-core assets.

It sold its Solomon power station to global utilities group TransAlta on September 5 for A$300 million ($307 million) and has said that it would consider selling its prized Pilbara rail infrastructure asset if approached by the right buyer.

“We have a world-class utility company running our electricity operation. Fuel costs are significant – this has taken them off our balance sheet,” Power explained.

FMG’s 88% stake in the Iron Bridge project, a joint venture with Chinese steel giant Baosteel, is also on Power’s list of possible future divestments, as are another two power stations and some 10,000 worker accommodation rooms in the Pilbara.

“We have received significant interest in all of our non-core assets,” Power said. “People recognise that we are a world-class asset.”

But raising cash through equity is not on the cards, however. “We say ‘no’ to equity,” Power said. “Equity is a very long-term funding option. We always planned to fund expansion through debt and operating cashflow.”

Pressing need
Easing the miner’s debt burden is now a pressing need. With few signs indicating which direction iron ore prices will move in the next week, let alone as far ahead as 2013, Fortescue needs to ease its balance sheet before embarking on further expansion plans.

“Our priority is to deleverage,” Power admits, adding that the miner always intended to shift its debt but agreeing that iron ore prices were pushing it to do so sooner rather than later.

“All that has changed is that we are looking at new fund injections to get us to a 30-40% level of gearing from our present level of around 60%,” he said.

Power now must steer Fortescue through the most difficult period of its short history, but he is optimistic that the miner will survive.

“We are going to put 100 million tonnes into the market in the next year and we are in the bottom third of the cost curve,” Power said. “As sea freight increases, we will become even more cost-effective.”

Price dependency
The question investors are asking is what pricing level iron ore must stay above for the miner to remain solvent.

Power is optimistic about the medium-term future for iron ore prices, pegging his bets on prices averaging out more than $10 higher than current levels of just above $105 per tonne.

“The long-term price assumptions we have are no different,” Power said. “We’ve just moved the time-frame forward. I am convinced that iron ore will return to $120 per tonne.”

Moody’s has calculated that prices need to stay above $95 per tonne for Fortescue to stave off another cash crisis. But others in the investor community believe that FMG will need iron ore prices to remain above $120 per tonne for it to stay in profit.

“The whole market was using about $130-150 per tonne as a price model and now the bubble has burst,” CLSA analyst Hayden Bairstow told Steel First.

Lacking a portfolio of other commodities to balance losses made in iron ore, FMGs’ exposure to current market weakness is severe. “If you only produce iron ore, then falling prices are going to be a bigger issue than if you are a diversified producer,” Bairstow said.

A high-profile strategic investor with long credit lines and all-important exposure to the Chinese steel market could be a lifeline for Fortescue, analysts said.

Possible suitors
Power remains circumspect about the details of the companies which have been courting Fortescue in recent weeks, but it is not difficult to imagine the profile that a strategic partner for the miner would have to fit.

A resources-focused fund – or, better still, a Chinese mill – would be an invaluable partner for Fortescue as it pursues its planned production target of 155 million tpy.

An option which has yet to be mooted by Fortescue or by market commentators is an all-out sale. However, until the miner shifts some of its debt and until the credit markets ease, a top-dollar buyout is unlikely, Bairstow said.

“FMG is not an attractive takeover target,” he concluded. “Who wants to take on a $20 billion acquisition in this market?”