Fortescue has decided not to pursue the previously announced US$2.5bn senior secured bond offering. As a result, Fortescue is also not proceeding with the refinancing of its existing senior unsecured bonds.
Fortescue has cited volatility in the US credit markets resulting in terms and conditions for the new issue that have not met the company’s ‘disciplined cost’ objectives, and as a result Fortescue has chosen not to pursue the refinancing at this time. It was rumoured that the coupon on the new bond issue reached 9% levels before the deal was withdrawn.
While no explicit mention has been made of the tender offer, we can infer that the tender offer for the existing 2017, 2018 and 2019 bonds has been cancelled given this announcement.
Commentary on the Fortescue bond withdrawal:
- Fortescue came to the market with a conditional tender offer. The new issue was always subject to acceptable terms and conditions, and the tender offer would only be completed if the new debt was successfully raised
- The new bond issue was impacted by a confluence of market conditions; iron ore prices have fallen significantly since the initial announcement, high yield mining credits have taken a hit generally and, a number of metals and mining companies began a rush to tap the US high yield market last week
- It didn’t make sense for the company to launch a senior secured bond with an interest cost of 9%, when it pays 3.75% on its existing secured term loan and its existing senior unsecured bonds are cheaper to the company than the new secured bond
- Fortescue still has 2 years before its next maturing debt in 2017, so there’s no imminent cause for alarm that the new issue was withdrawn. The terms of the new debt issue were not acceptable to the company and it had the right to withdraw its offer
- If market conditions improve, it is highly likely that Fortescue will come back into the market at some stage and relaunch a new debt issuance
In short, while it was disappointing for the company to pull a deal that had already been announced, we think it was a prudent decision for the company to withdraw the senior secured offer with pricing at 9%, and wait until conditions improve to relaunch a refinancing process. While extending the maturity of the debt ultimately makes sense, the cost and terms of extending that maturity were too costly in the current market environment and in doing so, Fortescue would have increased their all-in production cost at a time when iron ore prices were falling.
At the time of writing, the Fortescue lines were indicatively trading in the bid-offer price range below. However we expect prices could fluctuate significantly over the next day or so as the dust settles on the withdrawal of the bond issue and the US market reopens.
- 2017’s: $99.625 - $102.625
- 2018’s: $98.000 - $101.000
- 2019’s: $89.750 - $92.750
- 2022’s: $75.500 - $78.500
If pricing remains at/around these levels, we believe Fortescue remains a buying opportunity, especially with the 2017’s, 2018’s and 2019’s currently priced below their respective tender offer prices. However, we reiterate that volatility will remain in this name and we will see a high degree of correlation between the iron ore price and bond prices, particularly at the longer end of the Fortescue curve.
For investors who remain concerned about the longer term prospects for iron ore, the 2017s and 2018s represent a combination of a capital structure and credit play on Fortescue. Both bonds have come off below the proposed tender prices, and the company has already signalled they are prepared to pay above par to buy back these bonds. Alternatively, they have the option to call the bonds, each of which are callable before their maturity dates. It is likely that if Fortescue goes back to the market, we expect that they will look to repay these two bonds in full, given the company has signalled that extending the debt maturity profile is the priority.
For investors who have a higher risk appetite and believe in a recovery in iron ore within the near-to-medium term, the 2019s and 2022s offer a higher yield in exchange for taking a longer credit exposure in iron ore. Relatively speaking, the 2019’s in particular look like good value at current pricing levels, given the company was prepared to buy a portion of these back at par.
While it goes without saying, the high yields on offer in Fortescue’s bonds given current base interest rates comes with a relatively high degree of risk. We note that a prolonged fall in the iron ore price remains a key risk for the company. Its current cash breakeven price is estimated to be between US$53-$55 per tonne, subject to foreign exchange rates and oil prices. At current prices, it would be generating minimal free cash flow however it is still covering its ongoing interest cost and ongoing capex requirements.