Is the Fortescue Fairy story about to turn decidedly Grim?

Recent events in the fortunes of Twiggy Forrest have been savage. Once unthinkable price moves in Iron Ore have happened and with it, some unravelling of the Fortescue (FMG) success story. Some weeks ago the price of one of our major export commodities began to slide. Nev Power, the new head honcho at WA Miner Fortescue, was entertained at the Mining Club in Sydney and was as bullish as ever on the price of their only product. “The slide from $135 a tonne was fleeting. It was just a spike down before settling around $110-120”.Unfortunately for the heroes of this story, Nev and Twiggy, that has not happened. As the price plunged faster than you could say goodbye expansion plans, to below $90 a tonne so did Fortescue share price. Famously Jim Chanos, who shorted Enron before it’s implosion, and made his name and his fortune by shorting vulnerable companies looks to have done his homework on Fortescue Their big problem is unlike RIO and BHP they are a bit ‘Johnny come lately’ as the third force in Iron Ore. As a result they carry too much debt, too many layers of debt and their cost base is this far higher than the incumbents in the business, BHP and RIO. They have moved decisively to cut costs and also their much mooted expansion plans and have even sold a power station for $300m to head off the inevitable equity raising. This prospect seems to be an ‘over my dead body’ event as far as 30% shareholder Twiggy is concerned. But more importantly in a episode reminiscent of ‘Night of the Long Knives’ there has been a purging of some of the FMG family with the company secretary and other long term family members biting the corporate dust. This coupled with the layoffs from their contractor base is starting to either smell like full blown panic or for the optimists amongst us very prudent and decisive action. Time will tell, but it has not been a good look and a back flip even our current Government would be proud of.

So the big question is where to from here for our intrepid entrepreneurs? Well, the bounce today is welcome that’s for sure and they were looking a little oversold but the hedge funds which hunt in packs will now have them firmly in their sights. The standard operating procedure for these sorts of trades is aggressively short the stock, spread the word to the press why you are doing so, get as many negative stories in the press as you can and keep the pressure on the stock and management until they are forced into the dilutive equity issue, where the hedge funds use that capital raising as their short covering opportunity and walk off into the sunset with a big bag of money.

Of course the Iron Ore price itself holds the key to the stock price as much as the hedge funds. Whilst it hovers around $90 a tonne it will be hard to contemplate a sustained rally and some analysts have looked into their crystal balls and suggested that $50 is where the price is heading. If that happens Chanos and his buddies will be laughing all the way to the bank and Twiggy will be up ‘Christmas Creek’ without a Paddle. Equally important, the recession dodging ability of the Australian economy owes much to success of our Iron Ore business, so this has implications for us all. I believe that we will see a new impetus in the Chinese market after their impending leadership change and with it a rise in the Iron Ore price. Let’s hope I am right. Events today are promising with increased spending on roads and subways. It’s a start. Twiggy can breathe easier this weekend.

Fortescue call themselves ‘the new force in Iron Ore’; let’s just hope it’s not a spent force!

Clarence

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