Tuesday 10 March 2015 by Alen Golubovic Company updates

Fortescue’s bond buyback – what you need to know

Fortescue’s proposed bond tender offer represents an interesting case study for bond investors. In this article we answer the key questions around the tender offer and what we think it means for the remaining bonds.

What has Fortescue proposed?

Fortescue has proposed to repurchase the full amount of the 2017 and 2018 bonds and up to US$700 million of the 2019 bonds. It is planning to repay these bonds by issuing a new US$2.5m senior secured facility which will most likely be bank debt. A link to our original article on the proposed tender can be found here.

Why did they do this?

The 2017, 2018 and 2019 bonds are the next maturing debt and are relatively expensive for the issuer compared to cheaper secured bank debt. By raising new secured debt to repurchase the bonds, Fortescue is effectively halving its interest bill on the replaced debt facilities, which could save the company about US$60m in interest cost per annum, as well as extending the average maturity of its debt facilities.

The new secured facility is expected to have a maturity date in 2022, which means that after the refinancing Fortescue will have no scheduled debt maturities until 2019.

Is this the same as Fortescue calling their bonds early? What is the cash price offered?

A tender offer is not the same as an early call, as the issuer is buying back the bonds as opposed to redeeming the bonds early. Each of the bonds does have early call provisions, and this is how the early call prices compare to what Fortescue is offering:

  • The 2017 bonds are callable from 1 April 2015 at a call price of $103. The total consideration of $103.25 proposed by Fortescue under the tender offer represents a premium of $0.25 to the earliest call price
  • The 2018 bonds are callable from 1 February 2015 at a call price of $103.438. The total consideration of $103.75 proposed by Fortescue under the tender offer represents a premium of $0.312 to the current call price
  • The 2019 bonds are callable from 1 November 2015 at a call price of $104.125. The total consideration of $100 proposed by Fortescue represents a discount of $4.125 to the earliest call price

Has this been done before?

Bond tenders are not uncommon in the US bond market. Peabody Energy (a weaker credit than Fortescue) announced a very similar bond tender process in February. However, instead of offering par for its bonds (which were priced below par prior to the announcement), Peabody offered investors $110.27. In comparison to Peabody’s offer, FMG’s par offer on the 2019 bonds looks low, particularly given the November call price of $104.125.

Therefore, it will be interesting to see whether the full US$700m tender cap is used up on the 2019’s. At face value, the offer on the 2019’s looks low and it seems like the company is testing the waters to see if it could buy them back below the call price. Having said this, there will be 2019 bondholders who are happy to exit at par given the bond was recently trading in the high $80s.

Is it a positive or a negative for the remaining 2019 and 2022 bonds?

The proposed refinancing is a mixed result for the remaining Fortescue bonds. On balance though, we think it’s a positive result for the bonds over the long run, because it gives Fortescue breathing space to manage the headwinds in iron ore at present. With no scheduled maturities until 2019, Fortescue has no major bullet debt repayments for up to four years. The 2019 bonds will be the next maturing debt following the refinancing which will make them relatively more attractive. With significantly less bond supply available in Fortescue following the refinancing, we could see also upward pressure on bond prices.

In addition, Fortescue has timed the refinancing well, given borrowing costs are almost at record lows, and the cost of the new secured facility will be about half of what it is on the bonds.

The main negative is that the recovery level on the bonds would be lower in the event of a default. This is because there will be more secured debt in the capital structure. S&P estimates that the recovery would be negligible for the bonds on default, and will likely downgrade the bond rating by one notch following the refinancing. However, the company fully owns its mine, rail and port assets which are valued at US$18bn as at 1H15, versus net debt of US$7.5bn, so we think the rating agency may be somewhat conservative in its recovery assessment.

When will we know the full details of the tender offer and refinancing?

The tender offer expires on the 31st March, so by then the company will know how many bondholders have tendered their bonds. We expect all of the 2017 and 2018 bondholders will tender their bonds, while it’s not so clear what 2019 bondholders will do. We think there will be some bondholders who don’t want to take the iron ore risk and will be happy to exit at par, while others may see further value in holding onto the bonds with the expectation of an early call at $104.125.

We note that the proposed tender from Fortescue is subject to a number of conditions, including, but not limited to, the successful completion of the US$2.5 billion senior secured debt raising announced by the company which will be applied to repurchase the bonds.

Does Fortescue still represent good value after this news?

We believe Fortescue continues to represent a buying opportunity following this announcement. The 2019 and 2022 bonds are indicatively offered at yields to maturity of 8.78% ($98) and 10.21% ($83.50) respectively. At $98 the 2019’s bonds are looking like particularly good value at the moment given the company has offered to buy them back at par and they will be the first maturing debt following the refinancing. With iron ore prices falling below US$60/tonne, we do, however, expect there will be volatility in the bonds in the shorter term.

Information for existing Fortescue bondholders

FIIG has emailed existing Fortescue 2017, 2018 and 2019 bondholders outlining the proposed tender offer and the steps involved for those investors who wish to participate. In summary:

  • To accept the offer and receive the ‘early participation payment’, bondholders will need to respond to the email from FIIG before close of business this Thursday 12th March
  • Later acceptances may be submitted up to close of business 26th March – however these will not be eligible for the ‘early participation payment’

Disclaimer

The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced or  distributed to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.

Certain statements contained in the information may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of the company which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. Opinions expressed are present opinions only and are subject to change without further notice.

No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.

FIIG shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information. In no event will FIIG be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using information even if it has been advised of the possibility of such damages.

FIIG provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not provide tax advice and is not a registered tax agent or tax (financial) advisor, nor are any of FIIG’s staff or authorised representatives. FIIG does not make a market in the securities or products that may be referred to in this document. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg.

An investment in notes or corporate bonds should not be compared to a bank deposit. Notes and corporate bonds have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described on any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions such as a 2.5% p.a. assumed rate of inflation, foreign exchange rates or forward interest rate curves generally available at the time and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG is not licensed to provide foreign exchange hedging or deal in foreign exchange contracts services. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.

The FIIG research analyst certifies that any views expressed in this document accurately reflect their views about the companies and financial products referred to in this document and that their remuneration is not directly or indirectly related to the views of the research analyst. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG. FIIG, its directors and employees and related parties may have an interest in the company and any securities issued by the company and earn fees or revenue in relation to dealing in those securities.