ELIZABETH KNIGHT July 13, 2012
'Andrew Forrest's buying is designed to send a message'. Photo: Bloomberg
FORTESCUE Metals founder Andrew Forrest is not the only one out there who thinks the company is a takeover target. It may be one of the most talked-about corporate ''situations'' in Australia but the share price is not reflecting the possibility of predators. Instead, Fortescue shares seem to track increasing fears about the tempering growth in the Chinese economy.
In theory, Fortescue's falling share price (BHP Billiton and Rio Tinto have experienced similar falls) should be attracting even more attention as would-be prey.
But investors feel Forrest, its major shareholder, will only sell for a hefty price. As such, there is no bargain-basement deal to be had.
Forrest waded into the market a few weeks back and attempted to pick up almost $300 million of Fortescue stock. He couldn't get it at the price he was offering and had to walk away with only one-third of his target.
But he won't be going away and it could come as no surprise to see him soak up any orphaned parcels.
Like most broking analysts, Forrest takes the view that the company's shares are worth more - and represent good value at the current level of about $4.50.
But his motives extend beyond value. He is in a contest with a major international hedge fund run by Jim Chanos, who has been critical of Fortescue for months, calling the stock a ''value trap''. The US player has been investing in a position that will yield him a profit if the Fortescue stock price falls. (It is a bit like betting on a horse to come last in a race.) This type of investment is known as short-selling or shorting.
Forrest is engaged in a fightback. His buying is designed to send a message to those that have shorted the stock.
Despite the fact Forrest has been applying the whip, to date the shorters have been winning.
Meanwhile, Canadian mining house Teck has taken a strategic holding of just below 5 per cent and is clearly watching in the event Fortescue goes live in a corporate sense.
Fortescue has a real appeal for anyone wanting to break into the Pilbara. It should be producing 155 million tonnes a year of iron ore - the same amount BHP produced in 2011.
The market ascribes some risk to the company reaching this target but Forrest has demonstrated on most occasions that he has achieved his targets.
The quarterly production report due for release next week should confirm the company is on schedule.
While there are international players that would dearly love to get their hands on Fortescue's reserves, the company's most attractive asset must be considered its infrastructure.
Its rail and port facilities are strategic to anyone who wants a slice of, or wants to expand in, the iron ore-rich Pilbara region of Western Australia.
But the list of companies of sufficient size to take a shot at Fortescue is short.
Teck has been most regularly cited because of its existing cosy relationship with Fortescue. But realistically it is not large enough to digest such a purchase without a partner. A Chinese iron ore buyer is considered the most likely possibility to team with Teck. Glencore-Xstrata is another that insiders mention as a possible suitor. It has the thirst for iron ore assets and the capital to satisfy it. But it is busy right now sorting out its own merger.
South African-based Anglo American is also on the list, given its stated intention of increasing its exposure to iron ore.
Perhaps the best fit lies closer to home. BHP Billiton is currently in an infrastructure bind. It wants to expand its iron ore production over the next five years but is limited by the infrastructure bottleneck in the Port Hedland harbour.
The estimated cost of clearing this bottleneck is $20 billion over the medium term but the cost of building the facilities in this region is blowing out at the same time that cash flow to fund such an expansion is coming under pressure, as commodity prices (including iron ore) have fallen.
BHP chief executive Marius Kloppers has not closed the door on the port expansion but has made it pretty clear in recent remarks that the approval for the project has been put back to a date yet to be determined. With Fortescue's share price sliding, the market is now starting to question whether buying Fortescue and its four to five berths at Port Hedland would be a less-expensive solution.
One of the big factors in BHP's attempts to buy Rio a few years back and it subsequent tilt at a merger of the iron ore assets was the need to get its hands on Rio's infrastructure. At current prices, Fortescue is trading at less than $15 billion. For that, one gets rail, port and producing mines, prospective tenements, plus some debt.
The other appealing feature of taking Fortescue out of the market is that it would restrict the supply or iron ore and, in doing so, enhance the commodity's price. (Having said this, the iron ore price has some natural support at about $120 per tonne. Below this, a large slab of the lower-quality, higher-cost suppliers from China will stop production.)
But it's not that simple. BHP shareholders have made it abundantly clear they would prefer the company to keep its powder dry in the current uncertain environment.
Many remain sceptical about the gas assets BHP acquired in the US last year and there is an increasing expectation these will need to be written down this year or next.