"Twiggy's" grand bet on Australian iron ore turns sour

Sun Sep 16, 2012 4:00pm EDT

* Fortescue Metals borrowed big to ride China steel boom

* Plunge in iron ore price coincided with peak debt and mine expansion

* Announcement on debt restructure due by Tuesday

* Founder Forrest fighting dilution of $3 bln stake

By Sonali Paul

MELBOURNE, Sept 17 (Reuters) - Andrew "Twiggy" Forrest bet $15 billion of mostly borrowed money on a China steelmaking boom, defying doubters to build mines, a railway and a port to create the world's no.4 iron ore miner under the noses of giants Rio Tinto and BHP Billiton.

Now, hammered by a halving in iron ore prices in the past year and saddled with $10 billion in debt, his Fortescue Metals Group faces a critical week.

Fortescue plans to announce a debt restructuring with bankers by Tuesday, likely to involve the sale of assets or shares as it seeks to secure access to much needed funding lines and to see off hedge funds "shorting" the stock in a wager its fortunes will suffer further.

The crisis is the latest episode in what has been a wild ride for mining magnate Forrest and his backers.

"He builds iron ore mines on a vast scale. Then he borrows money on a vast scale. And he presumes the iron ore price will deliver him a pile of loot that is also unimaginable to mortals," said John Hempton, chief investment officer at Bronte Capital, one of many funds that have betted against the stock. "The world is not complying."

From 2001, Forrest started snapping up remote iron ore assets in Western Australia's red Pilbara desert, which were at the time stranded without access to railways or ports to export the product, saying no one understood how fast China's hunger for iron ore would grow as its steel production took off.

In 2003, Forrest pitched the company as the "new force in iron ore", lining up Chinese customers who did not want to be captive to the three iron ore giants - Brazil's Vale, Rio Tinto and BHP - at a time when they were extracting massive hikes in iron ore contract prices.

"FMG is the creation of a hyperactive, smart, energetic Australian entrepreneur named Andrew Forrest; imagine the Energizer Bunny," Ian Cumming and Joseph Steinberg, the chairman and president of U.S.-listed diversified investment company Leucadia National Corp, Fortescue's first big backer, said in a letter to shareholders in 2007.

He was so exuberant in the early days that it landed him in trouble with Australia's securities regulator, which took him to court over allegations the company exaggerated claims about lining up Chinese companies to build a mine, port and railway.

Forrest, who declined to be interviewed for this article, is awaiting a High Court ruling on the company's appeal against a lower court decision that Fortescue's public announcements had misled investors about the level of commitment from the Chinese firms. The company has argued that it believed the commitments were binding.

Fortescue also declined a request from Reuters to speak to Chief Executive Nev Power, and CFO Stephen Pearce did not return a telephone call seeking comment.

SHORT SELLERS

Between 2006 and 2008, Forrest and Fortescue secured $3 billion in debt and equity, built a mine, a port, and a 256-km (160-mile) rail line, and the company shipped its first ore.

Shares rocketed from 3 Australian cents in 2003 to a record high of A$13.15 shortly after its first shipment, which made Forrest Australia's richest person at the time. Leucadia, which sold its stake between 2011 and July 2012, reaped a profit of more than $1 billion on its $444 million investment in Fortescue.

The production ramp-up went so well that in 2011, when iron ore was trading at record levels above $180 a tonne, the firm fast-tracked its expansion plans, aiming to triple annual capacity to 155 million tonnes over two years instead of three so it could reap revenue faster at the top of the market.

But the market and China did not cooperate.

The $9 billion expansion was to be almost entirely debt funded, with $645 million in equity from China's Hunan Valin Iron & Steel Group plus cash from its existing operation.

Unlike its larger, more diversified neighbours Rio and BHP, Fortescue is totally dependent on selling iron ore to China - it has no other product and virtually no other customers.

Hedge funds spotting those factors pounced earlier this year, betting the company would not be able to withstand a drop in iron ore prices likely if Chinese growth slowed.

Short-selling interest in Fortescue - investors betting its share price will fall - has been mounting this year as the iron ore price slides amid weak demand from Chinese steel mills.

As of early September, short-sold positions accounted for almost 8 percent of shares in Fortescue, up from less than 4 percent in May and under 2 percent at the start of the year, data from the Australian Securities and Investments Commission shows.

"When management got up and said they didn't think iron ore could go below $120 for a sustained period they were talking about things they could not possibly know," said Bronte Capital's Hempton.

In July, iron ore prices dropped below $120 a tonne, a level at which all the major miners had - wrongly - expected China's high-cost miners to stop producing. But prices kept sliding, to a three-year low of $86.70 this month.

Fortescue's value has halved since March to $9.3 billion. Forrest's stake has shrunk to $3 billion.

SURVIVOR

Caught out by the steep drop in iron ore prices, the company earlier this month put on hold nearly half of the 100 million tonnes expansion to save $1.6 billion in capital and slashed around 1,000 jobs, with even some long-serving lieutenants sacked, to cut $300 million in operating costs.

The moves, quickly followed by the $300 million sale of a power plant at one of the mines, shocked investors as they came less than a week after Fortescue CEO Power had said the company was comfortable with its funding, remained on track with its expansion and was confident iron ore prices would recover in the near term.

The U-turn sent the shares crashing below A$3 for the first time since the depths of the financial crisis. Forrest has spent close to $180 million during the share price slide to take his stake to 32.8 percent.

The company is pulling every lever possible to avoid diluting his one-third stake to shore up funding - selling assets, cutting spending and seeking debt waivers - even as speculation builds it may need to sell new shares.

"Twiggy's not someone who's going to hand over control of his business very readily," said John Robinson, chairman of Global Mining Investments, a $172 million fund that owns a small stake in Fortescue.

A relative of the first premier of Western Australia, the 50-year-old father-of-three is a passionate advocate for improving conditions for Aborigines and works on a number of affirmative action projects.

While analysts, bankers and deal advisers say Fortescue may have to bring in a new partner or sell its prized railway, Forrest is unlikely to engage in a fire sale.

"He will keep everyone at the negotiating table until all hours of the morning if necessary, always looking for the better deal, leaving no stones unturned," said an executive for another mining company who has known Forrest for more than a decade.

For the one-time Perth stockbroker raised on a cattle station in Australia's outback, the iron ore downturn may only be a temporary setback.

"Hard work and survival are in his DNA," Leucadia's leaders said in 2007.