Is Fortescue Metals Group Limited a takeover target?

Media reports are suggesting the Foreign Investment Review Board has received applications for an investment in Fortescue Metals Group Limited (ASX:FMG).

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Andrew "Twiggy" Forrest is once again making news headlines, this time because of reports that his company is being targeted by a number of Chinese-linked companies.

Fortescue Metals Group Limted's (ASX:FMG) shares have come under selling pressure in recent years as a result of the crashing iron ore price. As companies such as BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO), Vale and Fortescue itself have ramped up their production rates, the price of iron ore has crashed to roughly US$60 a tonne, down from US$135 in January 2014.

Is Fortescue a takeover target?

While some investors have argued that Fortescue could be a takeover target for BHP or Rio Tinto, such a prospect remains unlikely due to the pressure from BHP and Rio shareholders for greater returns, as highlighted by my colleague Brendon Lau yesterday.

But as has been reported by the Fairfax press, the Foreign Investment Review Board (FIRB) has recently received a number of applications from offshore companies – likely China's largest conglomerate CITIC or steel producer Baosteel – seeking permission for an investment in the miner.

To be clear, it is believed that there have been no moves to takeover Fortescue, but that Chinese investors are instead interested in stakes in the world's fourth largest iron ore miner at an arguably opportune time.

Since January 2014, Fortescue's shares have fallen more than 62% due to the miner's higher-cost of production, together with its enormous debt load. Should an offshore entity succeed with its application to the FIRB, Fortescue could use some of the proceeds to repay a considerable portion of that debt, which is currently sitting well over US$7 billion. Most of that will fall due in 2019.

As highlighted by Fairfax, any deal would likely involve a partial sell-down of equity by Forrest who owns roughly 30% of the entity, having bought more shares progressively as the stock has fallen in recent years.

While such a move could help to ease the pressure on Fortescue's balance sheet; it will first be heavily scrutinised by the FIRB. China is the biggest importer of global seaborne iron ore and an increase in power over one of the world's largest iron ore producers could enable it to force the commodity's price even lower over the long term. Given that iron ore is one of Australia's most important exports, such a move could compromise Australia's future economic prospects.

Should you buy Fortescue?

Although the recent media speculation could have some effect on the share prices of Australia's iron ore miners in the near-term, rumours of a takeover or strategic investment are no reason to base investment decisions on. The fact is iron ore prices remain depressed and are likely to continue falling over the coming years, which will likely have a major impact on the sector's earnings potential.

Investors would be wise to focus their attention on other less risky investment prospects which still have the potential to generate significant returns over the coming years.

Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned. You can follow Ryan on Twitter @ASXvalueinvest. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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