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Miner has to come clean with shareholders

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FORTESCUE Metals Group has a lot of explaining to do to its shareholders - and the regulators - after reports emerged yesterday afternoon that the company had written to key lenders asking for a year's headroom to draw down debt in the event that it breaches its debt covenants.

It took the company until 6.34 last night before responding to the speculation that ripped through the market yesterday afternoon, wiping almost 14 per cent off its share price, that its key banks had received a letter requesting a debt moratorium.

In its short statement to the ASX, Fortescue said it was in full compliance with its banking covenants and that it was in the process of talking to its lenders about ''potential waivers'' in the event its covenants were put under pressure next year.

It said it continued to have full access to its funding facilities and the next date these covenants are reviewed is next year.

That is all well and good but what about next year? What do the forecasts look like after December 31? Asking a bank to waive even one covenant is a big deal and the market should be given much more information on why it is talking to its banks.

It raises the question, what was in the heads of the board two weeks ago to agree to pay a dividend to shareholders; a week later announce staff cuts and the sale of assets and reconfirm liquidity wasn't an issue, then yesterday have media reports that they have asked the banks for a debt moratorium.


Most of the key banks, including Commonwealth Bank, ANZ and JPMorgan have secured a position over the company's rail, locomotives and mining-processing facilities, but Merrill Lynch's $1.5 billion debt facility is unsecured and Fortescue is understood to have drawn down $750 million of that.

Merrill Lynch underwrote the facility and is yet to offload it to third parties. The latest development will undoubtedly make it even more difficult.

If there is an equity issue, which many hedge funds are punting on, Merrill Lynch will undoubtedly be at the front of the queue wanting to do it for a fat fee.

The key for Fortescue is to remain liquid so that it can get the Solomon project up and reduce its overall mining costs and go from being one of the most expensive iron ore producers to one of the cheapest. To do that it needs to do two things: hoard cash so it can continue to build and continue to draw down debt. If it breaches its loan covenants it can't draw down its loan facilities and that means it can't expand.

Reports that it had asked its major banks to waive its debt covenants were leaked to The Australian Financial Review's website mid-yesterday afternoon. Other websites, including BusinessDay, published similar stories.

In a climate of nervousness in relation to the mining sector Fortescue needed to react immediately and inform the market what was going on. The 13.8 per cent share price fall is evidence enough that such information is market sensitive and in the spirit of continuous disclosure it needed to either quash the talk or come clean.

Unfortunately its chief executive, Neville Power, was overseas giving a presentation to investors.

It will be interesting to see how the bond holders react to this information. Fortescue's high-yield bondholders are known to be aggressive.

It prompted one industry source to speculate that Gina Rinehart, who plans to spend $10 billion building Roy Hill, might consider making a bid for Fortescue, which has a market cap of $9.3 billion. ''Why spend $10 billion on Roy Hill if you can buy Fortescue for a lot less?''

The problem facing Fortescue is a credibility issue and that everyone, including the banks, has a case of the wobbles. Confidence in the mining sector and China has unravelled quickly and brutally, which is having a knock-on effect on commodity prices, the miners and mining services companies.

Like many miners and mining services companies, Fortescue was too bullish on China and the outlook of iron ore prices. It said it would expand into a 155-million-tonne-a-year iron ore outfit and then brought its expansion plans forward. In a show of machismo it left itself exposed to a downturn.

With so much debt and high-cost iron ore, it needs iron ore prices to be at least $US105 a tonne to make money. With prices around $US100 a tonne, after falling below $US90 a tonne last week, the outlook in the next 12 months is uncertain, which is putting pressure on Fortescue's financial model for next year and therefore its debt covenants.

It is these forecasts that investors need to be made aware of so they can make informed decisions about the company.

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