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’