Drama to come in this iron ore play

Andrew Forrest and his Fortescue Metals Group are determined to build a new iron ore mine in the Pilbara, but the closer an outsider looks at the financial structure being created for the project, the less certain it is that FMG will be the long-term owner.

Last week’s on/off/on first-stage financing arrangements by FMG provided a glimpse into the complexity of a small company trying to develop an integrated $2.5 billion mine, rail and port system.

One day it was Hong Kong-based Noble Group named as a preferred equity/finance partner. Next it was a mob out of New York called Leucadia National, a business no-one in Australia had heard of before, but one which Briefcase found to be absolutely fascinating after delving into its background. (See For the Record, page 23.)

Leucadia, according to FMG’s announcement to the stock exchange is a company: “Engaged in a variety of businesses, including mining, manufacturing, telecommunications, real estate and agricultural operations” – all of which is perfectly true, though putting mining first on that list might be a touch of gilding the lily.

A little digging reveals that Leucadia’s interest in mining only goes as far as a financing arrangement with Canadian-based Inmet Corporation on its Las Cruces copper project, in Spain.

The Inmet deal, which earned “mining” top billing in FMG’s description of Leucadia, is listed in the “other investments” category of Leucadia. It’s not a footnote, but it’s awfully close.

The real business of Leucadia is opportunistic trading, and it appears to be rather good at it. Last year, it sold a telecommunications business for a fat profit, acquired a forestry business called Idaho Timber, operated healthcare and plastics businesses, sold the Waikiki Beach hotel for a fat profit, and operated two wineries.

Idaho Timber and plastics dominated the company’s revenue, followed by healthcare, telecommunications and real estate.

What interest Leucadia has in iron ore mining is a seriously interesting question, and the only answer Briefcase can provide is that it smells more fat profits by being a timely provider of finance for a project which, well, needs a timely provider of finance.

While finding a friend in a slick New York asset trader and financier seems to be good news for FMG it does raise questions, such as why? Or, to be more specific why are more conventional financiers with a deeper knowledge of the mining industry not doing the job?

Briefcase will probably be proved wrong in time, but it seems that there are many details yet to be worked out in the FMG/Leucadia arrangement.

Not the least of these is that the $US300 million offered for a placement of 26.4 million FMG shares, plus other financing arrangements is: “conditional on reaching financial close, which is described as the date when FMG raises the total debt capital (including leases) of a minimum of $US2 billion to finance the project”.

That seems to be saying that Leucadia’s money is provided after the debt financing is complete, which sounds more like a promise to help rather than actually providing the help.

But wait, there’s more. As well as waiting until the debt finance is complete, Leucadia has a veto on the debt package as shown in FMG’s comment that “the terms of the debt package must be acceptable to Leucadia”.

It’s those sort of terms, a promise backed by a veto, from a company that has minimal interest in mining, and maximum interest in buying and selling assets, which led Briefcase to ponder who will actually be the long-term controller of FMG’s project.

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While the money side of FMG’s affairs is attracting most attention, as it should, there are other aspects to the iron ore project which are equally interesting, such as a start being made on building a port before finalising all financing arrangements for the mine.

Briefcase understands the need to make an early start on aspects of a project that will take a long time to build, but after taking a look last week at FMG’s port work and the dredge sitting alongside, it seemed that there really is enormous confidence that raising $2.5 billion is a simple affair.

In some ways, the early port work reminded Briefcase of a similar fast start made on the port of Oakajee about 10 years ago, when Kingstream Steel was going to create a revolutionary iron and steel business north of Geraldton.

Back then, a similar explanation was offered, that early site works were essential. Unfortunately, the rest of Kingstream’s plans came unstuck and only now is Oakajee being dusted off again by a syndicate of small iron ore miners.

FMG will get further down the path than Kingstream because it is a much simpler business; a classic dig and deliver exercise based on a belief that fast work today will ensure that the benefits of high iron ore prices are captured.

But the rush to catch the high tide of the iron ore market means the next few months are critical for FMG, not just in raising the $2.5 billion needed to complete the mine, rail and port system, but also in finalising financing before the next round of iron ore talks gets under way.

Strange as it might seem, with the last round of price negotiations settling less than three months ago, but the next round will kick-off early next year. And the slightest whiff of an iron ore price cut, which is very much what Chinese steel mills want, will send a shiver through FMG and its supporters.

True believers in FMG’s plans dismiss any possibility of a price cut because demand for iron ore remains strong.

But Briefcase has been around long enough to see the ebb and flow of iron ore supply and demand, and right now it reckons a sea change in the market might be starting.

Two clues point to the iron ore market being at a peak. First, there has been a sharp fall in the cost of chartering ships over the past few years, which indicates an abundance of supply. Secondly, the iron ore stockpiles at north-west ports are surprisingly full, and not near-empty as they have been in other periods of great demand.

Straws in the wind?

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“Never speak ill of yourself, your friends will always say enough on that subject.” Charles-Maurice de Talleyrand