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"Bulletproof" Fortescue Pulls $2.5 Billion Offering Amid Slumping Iron Ore Prices

Fortescue Metals Group, the fourth largest miner of a commodity that’s collapsed some 50% over the past year, had the novel idea to tap the frothy high yield market for cash in order to refinance more than $2 billion in debt maturing over the next four years. Unfortunately, the company ran into a problem: investors wanted 9%. That doesn’t look particularly good considering the paper the company was looking to repay has coupons ranging from 6% to 8.25%, so rather than refinance at a higher rate, Fortescue decided to take the “disciplined and prudent” step to pull the offering entirely. Here’s FT

Fortescue Metals Group pulled a proposed US$2.5bn bond and refinancing of the company’s debt on Wednesday in a sign of deepening distress in the iron ore market.

 

The company, founded by entrepreneur Andrew “Twiggy” Forrest, blamed volatility in US credit markets for pushing up the cost of the bond issue. The decision to cancel the refinancing comes days after Fortescue decided not to proceed with a US$2.5bn secured loan when investors demanded better terms. 

 

“Debt capital markets were not favourable at this time and as a result we think it is a disciplined and prudent decision to defer the voluntary refinancing at this stage,” said Nev Power, Fortescue chief executive.

 

Shares in the miner fell as much as 7 per cent to an eight-year low on Wednesday, before closing down 5.3 per cent at A$1.87 on the Australian Stock Exchange.

While those of a cynical persuasion will undoubtedly place some of the blame for the lackluster reception on iron ore prices, Fortescue was quick to note that not only does a 70% drop in prices over four years not really matter, the company is in fact invincible when it comes to costs. Here’s Bloomberg: 

Fortescue Metals Group Chief Financial Officer Stephen Pearce said his company’s position on the iron cost curve is “bulletproof” and production costs weren’t an issue in recent discussions with debt investors.


 “We’re making a positive cash margin on every single ton we produce and that wasn’t an issue at all in the discussions that we had with the investors,” Pearce said in interview from New York. “They are very satisfied with the progress we’ve made on our cost reductions.”

That’s good because it turns out that decelerating Chinese economic growth just might be hurting demand as indicated by the fact that prices continue to slide on the back of the most fundamental of fundamental factors, a supply/demand imbalance. More from Bloomberg

Iron ore Sept. contract on Dalian commodity exchange falls 2.6% to 443 yuan/MT, weakest since Sept. 17 when contract started.

 

Australia, the world’s biggest iron ore exporter, lowered its outlook for prices this year as rising shipments expand a global glut.

 

Rates will average $60 a metric ton this year, the Department of Industry and Science said in a report. That compares with $63 forecast in December and $88 in 2014, it said.

 

Iron ore sank 47 percent in 2014 and extended losses this year as surging low-cost supply from Australia and Brazil spurred a surplus just as demand growth slowed in China.

 

China accounts for more than two-thirds of global iron ore imports and produces as much steel as the rest of the world combined. The government set a 2015 economic expansion goal of about 7 percent, the lowest in more than 15 years, as leaders tackle industrial overcapacity and a property slump.

 

Steel output in China will shrink this year as demand has peaked, China & Iron Steel Association Deputy Secretary-General Li Xinchuang told a conference in Perth, Australia, last week, predicting a decline to 814 million tons from 823 million tons last year. Production will probably drop this year for the first time since the early 1980s, UBS Group AG said on March 10.

Despite the dramatic decline in prices, Fortescue notes that its all-in delivered price to China is around $41 and CFO Stephen Pearce says he’s confident the company can count on “tremendous support” from US capital markets going forward. 

More, from Citi:

Fortescue has withdrawn the previously announced US$2.5b senior secured note offering as the interest cost objectives were not met. FMG was planning to use the proceeds to repay the US$1b in notes maturing in 2017 (coupon 6%), US$400m in 2018 (coupon 6.875%) and US$700m of the US$1.5b due in 2019 (coupon 8.25%), with the US$300m balance topping up working capital.

 

Rather than lowering the interest cost, we understand the funding cost for the proposed US$2.5b secured note was likely to be 8.5-9%, hence why the offering was pulled.

 

Although there is no near-term liquidity issue, FMG has ~US$1.6b in cash and no debt maturities until 2017, investors will now have to monitor the health of the US credit market, in addition to the all-important iron ore price, as at some point FMG will still have to refinance debt facilities. At our bearish iron ore price forecasts that bottom at US$53/t in 3Q15, before a modest recovery in 2016 to US$62/t, we forecast notional free cash flow generation for FMG in FY15 & FY16, before cash generation improves in FY17+.

 

On top of the notes that were going to be refinanced, FMG also has a US$1b unsecured note due in 2022 (coupon 6.88%) and a senior secured credit facility of US$4.9b that matures in 2019. As part of the planned refinancing the target was to push out the maturity of the secured facility until 2021+.

 

Given the aborted re-financing FMG may look to additional customer prepayments (currently ~US$1.2b to be delivered over the next few years) as a means to boost cash flow and repay maturing debt.

 

Meanwhile, these same "tremendously supportive" capital markets are actually not proving to be all that supportive...

  • FMGAU 8.25% 2019 down 3.7%, FMGAU 6.875% 2022 dropped 1.6%, and FMGAU 6% 2017 slid 0.5%

...and although Fortescue says it can afford to be patient in the event markets mistakenly price in a massive decline in what the company sells, Goldman notes that in fact, paying the bills may turn out to be increasingly difficult: 

FMG is not expected to generate sufficient cash  to repay near-term maturities based on iron ore price forecast which is expected to fall from $74.50 in 2015 to $62 per tonne in 2016 and $60 in 2017.