How on earth they did it - Fortescue Metal's remarkable bond issue

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Jonathan Shapiro looks behind Fortescue Metals Group’s record breaking US$2 billion bond issue.

WHEN A BELL rang in Citigroup’s New York offices late on Friday August 11, it completed one of corporate Australia’s most remarkable capital markets deals. 

Western Australia’s Fortescue Metals Group had successfully raised the equivalent of US$2.05 billion (A$2.7 billion) in the international bond market, to fund its iron ore mining and infrastructure project in the Pilbara.

The deal was a record breaker. It was the largest single high yield transaction to come out of Asia-Pacific, the largest high yield bond project financing ever, one of the largest corporate bonds out of Australia and one of the largest global bond issues in the sector.

Many observers didn’t believe that Fortescue could raise that amount from the capital markets, but long hours, meticulous planning, yield hungry global investors and sheer grit, proved them wrong.

The Start

Fortescue Metals Group is a reincarnation of controversial mining magnate Andrew Forrest, the man behind Anaconda Nickel. Forrest is renowned for his ambition.

Fortescue’s plan to extract value from iron ore through infrastructure lacked neither scale, risk or complexity.

The company became Australia’s largest explorer, drilling in the Pilbara, the backyard of resource giants, BHP Billiton and Rio Tinto.

And the exploration yielded results.

Fortescue had uncovered one of the largest bedrock hosted iron ore deposits in Australia, along the Chichester Range. The reserves would provide sufficient ore for a 20 year mine life.

Fortescue could now focus on infrastructure, and the construction of a 260 kilometre railway system running north from the heart of the Pilbara basin, alongside BHP’s existing line, to a new facility in Port Hedland.

“You could truck a ton of iron ore to the coast, but it could cost you more to truck it than you would get in revenue, so the only way an iron business is viable is through very low cost transport,” says Christopher Catlow, chief financial officer, Fortescue Metals Group.

The cost of the rail and port system was estimated to be in the region of A$1.92 billion.

Capital gain

The venture would clearly require significant funding and Fortescue examined its options. Fortescue’s senior management did have experience in capital markets. In the late 1990s, Forrest had managed to raise US$420 million (A$575 million) from the US bond market to provide funding for Anaconda Nickel.

Catlow had also accessed the bond market during his time at Iluka Resources. It was not until March this year that an international bond issue emerged as the likely source of funds.

Citigroup arranged an interim bridge financing facility of US$200 million for Fortescue. The debt was privately placed to Asian hedge funds, eager for yield. “The demand was strong. It made us realise that there had been a step change in the type of Australian credit and exposure that investors globally were looking to buy,” says Jason Murray, managing director – fixed income, Citigroup.

“This demonstrated that Fortescue, although not traditionally something that would go to capital markets – given it is a ‘greenfields’ mining project – would have huge appeal internationally.”

Getting equity

The first phase of the funding process, before the debt could be raised, was to tie up equity financing.

Hong Kong’s Noble Group was initially linked to a stake but Fortescue opted for a US$400 million placement to Leucadia National Corporation, a low profile listed US investment company.

The deal included the purchase of 9.9 per cent of Fortescue’s shares for US$300 million and a US$100 million thirteen year deeply subordinated loan. The agreement was conditional on Fortescue raising the required senior debt in the international capital market.

Leucadia did its homework on Fortescue, and undertook an extensive due diligence process at Fortescue’s headquarters in Perth.

“Complete persistence is why we are here.” – Chris Catlow.

“They trawled through our data room. We were very impressed with the calibre of people; they were extremely thorough in the due diligence and asked the smartest questions we have ever been asked by any group,” says Catlow.

Ready to go

With the equity financing in place, Fortescue was now ready to sell its bonds. But it needed to act quickly if it hoped to complete a deal before the Northern hemisphere summer break.

“We decided to go for the pre-holiday market which was a bit of a rush and we worked long and hard to get the documents ready,” says Catlow.

Weeks of structuring preceded the deal being taken to market, to put in place security agreements and covenants that would meet the needs of investors, whilst still allowing Fortescue the flexibility they required.

Discussions with the rating agencies also began, to ensure that the structure of the transaction would provide a ratings profile that was marketable to investors.

Mother of all roadshows

An exhaustive globe-scouring roadshow followed with Citigroup and co-manager Jefferies & Co. In a three week period, over 500 institutions from three continents were visited.

The campaign began in Asia, where investors had had a taste of the FMG story at an earlier Citigroup fixed income conference. The region’s hedge funds once again expressed their interest in the credit.

From Hong Kong and Singapore, the group, which included Mr Forrest himself, and most of the senior management team, jetted to Europe to visit the investor heavy capital cities, including London, Paris and Frankfurt.

“The roadshow really conveyed that this wasn’t just an Andrew Forrest story but was about the underlying strength of the asset, the ore body in the Pilbara, and Fortescue’s strong management team,” says Murray.

The team then crossed the Atlantic for what Murray describes as one of the most thorough US roadshows in recent history, for any bond deal.

Fortescue made stops in New York, Boston, Chicago, Milwaukee, Minneapolis, Houston and Los Angeles and paid visits to hedge funds scattered along the east and west coasts. The roadshow culminated in a bookbuild process by Citigroup in New York.

“The company made itself physically available to virtually every single one of those 500 institutions and were grilled by investors from every corner of the earth on just about every aspect of the project,” adds Murray.

Investors were stunned as to how Fortescue had come from nowhere to provide them with a convincing story.

“The most frequent question was, ‘how on earth have you done this? How did you pick up this massive ore deposit right under BHP and Rio Tinto’s noses?’,” said Catlow. Investors did express concerns whether sufficient funds were to be raised. The deal was launched at US$1.9 billion but was upsized to US$2.0 billion.

“They heard us, understood our analysis, and were convinced that we could do it for the price, but they had looked around and had seen other projects struggling to complete within budget. They preferred us to increase our funding to include an even larger overrun reserve,” Catlow said.

On the 11 August in New York, details of the new issue were announced.

The notes, rated BB-/Ba3 by S&P and Moodys, and totalling US$2.05 billion were offered in four tranches, three denominated in US dollars and one in Euros.

The US tranches consisted of US$250 million five year senior secured floating rate notes priced at 400 basis points over Libor, US$320 million seven year fixed rate notes paying a coupon 10.00 per cent, and US$1.08 billion ten year fixed rate notes paying 10.625 per cent. The Euro tranche of €315 million seven year fixed rate notes paid 9.75 per cent.

About 65 per cent of investment came from North America, 20 per cent from Europe and 15 per cent from Asia.

While the 144a document memorandum was circulated to domestic investors, there was little participation from Australian funds.

“It just didn’t really fit the profile of the typical mandate of fixed income investors in Australia although this is slowly changing,” said Murray.

At settlement on 18 August, Fortescue had over US$2 billion ready to be poured into the project.

“As part of the covenant package we have obligations in how we spend the money,” said Catlow.

The funds are held in various reserve accounts. Every month the independent engineer must sign off to the collateral trustee that Fortescue and various subsidiary companies can complete the project within the available funds.

“If at any stage in their opinion we are unable to do so, then we are unable to continue to draw down that money,” Catlow said.

With financing in place, the race is now on to deliver on the project. Construction on the mine has commenced, but a start on the railway has been pushed back to November, following delays in obtaining final bureaucratic approval.

Fortescue, and its backers, appear to be under no illusions in a new era where risk is a resource.

As Catlow said: “It’s better in life to be lucky than smart. I think there is a heck of a lot of luck, as well as smarts and hard work, but I also like to believe that we set the stage with a vision and we never stopped believing it. Complete persistence is why we are here.”