Fortescue raising reveals Andrew Forrest's support
OTHER than May's headline-grabbing debut shipment of Cloud Break iron ore, nothing underscores the maturation of Fortescue Metals Group more resoundingly than the apparently competitive terms of its planned preference share issue.
For a third time since 2006, Fortescue has gone looking for cornerstone capital to secure its ambitious expansion plans.
What makes the latest campaign for a $175 million preference issue unique in Fortescue's five-year history is that the New Force in Iron Ore seems to have locked in its money at potentially commercial terms.
The preference issue is part of a $450 million raising, the bulk of which is in the form of pre-payments by Chinese steel makers, who will have to put up cash up-front to lock in a share of Fortescue's planned expansion output.
Crucially, Fortescue has already secured a precommitment from just one investor -- believed to be an existing shareholder -- for up to 80 per cent of a preference share issue, which is planned to carry a coupon rate of just 9 per cent.
Now, to put that into some sort of context, that means Fortescue will raise relatively long, highly strategic money at a premium of just 1.8 per cent over the current interbank swap rate of about 7.2 per cent.
Again, some context. Fortescue has won serious pre-issue support on a coupon only 100 basis points higher than Suncorp's most recent raising. And for the insurer -- given Suncorp can fully frank its dividend stream -- its investors are getting nearer 11 per cent.
Now, clearly, we have to wait until we see an issue price before making a final call on the cost of capital here. But, all things being equal, this has the making of a keenly commercial outcome for Fortescue.
To get some idea how far Fortescue has come in just two years recall, if you dare, the terms of the cornerstone equity that secured the company's life-giving $3.2 billion raising in August 2006.
The central player in that deal was US value investor Leucadia National Corporation.
Forrest needed new equity to get a set of bond and debt issues away. Leucadia came to the party. And didn't it get value!
The US fund spent $300 million buying a 9.99 per cent stake in Fortescue and the provided an additional $100 million through a subordinated loan note. Without that injection, Fortescue may well have failed. But the cost of life was very high indeed.
After accounting for Fortescue's subsequent 10-for-1 share split, Leucadia paid the equivalent of just $1.13 a share for its new stake. Fortescue closed at $7.63 last night. Which looks great by every standard but for the servicing terms of Leucadia's bond note.
The bond, which is repayable after 13 years, carries a coupon that is based on Fortescue's total iron ore sales. The effect of the deal is that Leucadia gets 4 per cent of all of Fortescue's post-government royalty income from iron-ore sales. To understand what that means, consider that Fortescue is expected to sell maybe $2.5 billion in iron ore in 2009 and more than $5 billion the following year.
Now, get the calculator out, divide each of those revenue expectations by 100 and then multiply that number by four and then, if you are Leucadia, pat yourself warmly on the back. Because, if all goes to Fortescue's current plan, it will make its bond money back early in year two, and nearly triple its money well inside year three.
Little wonder Forrest's people like the look of the preference share market space and tell us they intend to visit it a fair bit over the coming years. To that end, Fortescue is going to ask shareholders to approve much more than just a preference capital raising when they gather in Perth's Park Hyatt, September 30. The constitutional reform Fortescue is proposing would deliver the board the capacity to issue preference shares and redeemable preference shares without further need to again to seek specific shareholder approval.
Preference capital and other varieties of non-voting equity tools are attractive to companies like Fortescue, which is famously controlled by chairman and founding force of nature, Andrew Forrest. He controls 36 per cent of Fortescue's voting capital and he wants it to stay that way. In this, Forrest is no different to News Corporation's chairman, Rupert Murdoch.
The effect of preference capital is that finance is raised in the form of equity which can then be used to secure more debt. But because preference shares tend to carry tightly defined and limited voting rights, the balance of shareholder power is effectively not altered.
The pay-off for the preference stock owners is that their paper comes with income certainty and priority over all other shareholders in any wind-up.
Incidentally, Fortescue yesterday played down reports that Harbinger Capital was the applicant for the $140 million chunk of the preferences.
That said, the company did not rule out the idea that an existing shareholder had come back to the iron ore well for preference capital could, under some conditions, mutate into ordinary shares.
While we are on matters Fortescue, rumours continue to swirl about its production performance since first shipment in May.
There have been stories, for example, that two Australian engineering firms have been bought in to deal with structural fractures in its rail wagons and, more recently, that the innovative surface mining fleet was at a standstill after two accidents at one of the five Cloud Break pits.
Both stories have been vigorously denied by Fortescue though a company spokesman agreed yesterday that one of the surface miners had tipped over because of a problem in its stabilising mechanics.
Meanwhile, those who (like me) have been waiting patiently for a Fortescue profit announcement can forget it. While Fortescue claims very accurately to be the new productive force of Australian iron ore, under ASX listing rules it remains an explorer until it has generated revenue for two consecutive quarters. Which means the company can continue on its cash-flow-based quarterly reporting cycle until February next year.
Fegan adds to pool
WHILE we are talking funding costs, let's ponder St George Bank's decision to add another $1.051 billion to its 2009 funding pool.
St George boss Paul Fegan says the pricing of the RMBS issue is "competitive with comparable sources of funding to Australian banks".
Fegan has now locked up 40 per cent of the bank's requirements for next year, which translates to $4.6 billion of the more than $11 billion the bank is expects to raise.
Which would be a fair enough achievement except that St George is an A rated bank while its prospective partner in an $18 billion merger, Westpac, is AA rated. And that means, quite simply, Westpac can expect to raise term funding more cheaply that St George. And we are talking a more than 10 basis points difference here.
Now clearly Fegan needs to keep running his bank as a stand alone entity here. No argument there. But it is clearly beginning to irk his future partners that the funding book has been filled aggressively and early.
Perhaps that is why, to the muted relief of Westpac, Fegan indicated yesterday that St George has, for the time being, ended it search for '09 funding.
http://www.theaustralian.news.com.au/story/0,25197,24278241-5001641,00.html