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Fortescue’s future in the hands of the bankers

Rumours surrounding Fortescue and the options to resolve its debt issues are raging. What’s the company to do?

Much has been written and said about iron ore miner, Fortescue Metals Group (ASX: FMG) in the last few days. Shares in the company fell 13% in around 10 mins yesterday, following news that it had asked its bankers to waive its debt covenants for the next 12 months.

If you don’t know what a debt covenant is, it’s a safety mechanism added to debt contracts so the bankers feel safer. As a simple example, one covenant might be that earnings before interest and tax (EBIT) must be more than 3 times higher than the interest the company has to pay on its total debt. Should the company breach that covenant, then it could face dire consequences such as having to immediately repay the debt outstanding.

With over US$8 billion in debt, and a falling iron ore price, Fortescue was concerned that it might have trouble meeting those debt covenants when they were next reviewed, in December 2012. Falling prices reduce revenues, earnings and profit, putting some of those covenants at risk of being breached. The usual way of fixing the issue is that the banks tell the company to raise equity and pay back some of its debts.

Rumours in the media are flying thick and fast about how Fortescue may be able to avoid an equity raising. The Australian Financial Review reports that Fortescue may sell 15% of the company to Chinese steel producer BaoSteel, Fortescue’s biggest customer, or it could try to sell off some of its unfinished projects, or sell all or part of its railway line.

The main reason Fortescue wants to avoid an equity raising is that chairman ‘Andrew ‘Twiggy’ Forrest, who holds 32% of the company, doesn’t want to have his stake diluted, otherwise, he may lose control of the company.

Several other iron ore miners could be facing equity raisings, including Arrium Limited (ASX: ARI) the ex-OneSteel business, Mount Gibson Iron (ASX: MGX) and Gindalbie Metals Ltd (ASX: GBG).

The Foolish bottom line

Should the bankers waive Fortescue’s debt covenants, the company should be able to continue on its merry way for the next 12 months. However, bankers aren’t known as charitable types, so my money’s on asset sales, an equity partner or so-called ‘white-knight’, and if those fail, an equity raising.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned. The Motley Fool’s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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