Fortescue Metals: Ore-some

The financing for Fortescue Metals Group's Pilbara iron ore and infrastructure project was the largest high-yield bond financing in the Asia-Pacific region in 2006. But it is also probably the largest high-yield financing ever for a mining project, and possibly the largest ever pure debt deal for a mining project. Fortescue faced considerable scepticism from analysts when it decided to pursue its resource alone, but raised a respectable A$3.23 million ($2.54 billion at today's rates) in debt and equity in 2006.

Fortescue owns extensive leases in the Pilbara region of Western Australia, where Rio Tinto and BHP Billiton already have operations. The area has been active in iron ore production since the 1960s, has produced 3.5 billion tonnes to date, and currently produces 200 million tonnes per year.

Fortescue is the renamed Iron Ore Australia, which signed an agreement with The Metal Group Pty in April 2003 to develop the asset. The controller of The Metal Group, and now owner of roughly 38% of Fortescue, is Andrew Forrest, a businessman with a long local pedigree and a past as a developer of the Anaconda Nickel project. Forrest and Fortescue have gained solid political support through their state government connections for the project, but have struggled to raise the necessary debt financing for a project this size.

While the resource is promising, and the means of exploiting it low-cost and technically undemanding, the necessary infrastructure for upgrading and transporting the ore to the coast and thence to Asia is expensive. The project includes a 260km single-track railway to take the ore from the Cloud Break Resource to Port Hedland, where there is already a port for exporting BHP Billiton and Rio Tinto production. The line, for much of its route, will run alongside BHP's line.

All told, the associated rail and port infrastructure for the mine has a total cost of A$1.922 billion, while the mining equipment, including a crushing ad screening plant, will cost roughly A$550 million. The engineering, procurement and construction contractor is WorleyParsons. Fortescue had spent A$183 million in equity on the project in the period up to financial close.

The developer struggled to get all of the relevant approvals in place, especially gaining BHP's permission to build its infrastructure near the more established operator's property. While gaining major project facilitation allowed it access to government agencies and gained it a faster permitting process, co-ordinating the infrastructure development, while at the same time laying out a convincing cost structure, and securing financeable marketing and resource studies, was challenging.

Probably the most important element of the financing process was raising the required equity. While Fortescue had raised some equity through domestic placements, the scale of the project made bringing in a trade partner with a single strategic investment less cumbersome. In July, Fortescue signed an agreement with Leucadia National Corporation, a US holding company for timber, resources, healthcare, and telecoms interests, for a $500 million equity and subdebt investment. Leucadia has provided $300 million in exchange for 26.4 million Fortescue shares, and is also providing a $100 million subordinated facility, which would be repaid with a 4% share of the mine's output.

The underwriter on the senior debt is Citigroup, which won the sole bookrunner mandate after providing $200 million in syndicated debt to Fortescue in March 2006, long before the developer had all of the necessary financing elements in place. But the bonds sold down strongly, and gained a BB- rating from Standard & Poor's.

The $2 billion debt consists of $250 million in senior secured floating rate notes due 2011, $320 million in senior notes due 2013 with a 10% coupon, Eu315 million ($400 million) in notes with a seven-year maturity and a 9.75% coupon, and $1.08 billion of 10.625% senior secured notes due 2016. Citi underwrote the debt and was sole global book runner and lead manager, while Jeffries & Co was a co-manager.

The remainder of the financing for the project came from roughly $90 million in operating leases, although Fortescue will also look to place in operation a beneficiation plant at the site from 2015, and has engaged in initial talks with Chinese contractors for this facility.

The project is highly leveraged, and a large, and lumpy addition to the global seaborne iron ore supply industry. BHP, Rio Tinto and CVRD dominate this business, and are all experienced, low-cost operators. While Fortescue said in its prospectus that it could produce at a cost of less than all but one of BHP Billiton's operations, analysts have been sceptical that the operator can keep these costs under control. Moreover, Rio Tinto is currently expanding its operations, in a joint venture with Hancock Prospecting, at Hope Downs. BNP Paribas, National Australia Bank, Royal Bank of Scotland provided Hancock with A$300 million in debt in November 2006 for this project.

That these commercial banks are willing to bet on continued strong prices for iron ore is an indication that Fortescue's belief in a demand overhang for the raw material is not misplaced. Moreover, Fortescue has solid offtake contracts in place for 39 million tonnes of the project's predicted annual capacity. The resource has just over 1 billion tonnes of reserves, of which 121 million tonnes are proven.

But the project faces challenges in getting to fruition, not the least of which was the recent Cyclone George, which passed through the region. The cyclone killed two Fortescue workers and has delayed work at the site. While the project benefits from a two-year $342 million debt service reserve, and has a cost overrun account of $223 million, such large projects often suffer from the vagaries of a sprawling construction process. But even reaching close on the senior debt is a near-miraculous achievement.

FMG Finance Pty Ltd

Status: closed 11 August 2006
Size: A$3.23 billion
Location: Western Australia
Description: High-yield financing for the development of 45 million tonnes per year iron ore project
Sponsor: Fortescue Metals Group
Senior debt: $2 billion
Global bookrunner and lead manager: Citigroup
Co-manager: Jeffries & Company
Sponsor legal: Clayton Utz (Australia), Jones Day (US)
Underwriter legal: Freehills (Australia), Sullivan & Cromwell (US)
EPC contractor: WorleyParsons
Independent engineer: Winters, Dorsey & Company
Mining consultant: Snowden
Market consultant: CRU Strategies