10.
As Mark Twain said, reports of my death are greatly exaggerated.
—ANDREW FORREST
Forrest’s exhilaration at proving the doubters wrong was fleeting. Within a few months of Fortescue’s first shipment of iron ore, the world was gripped by the worst economic downturn since the Great Depression of the 1930s. In one sense, the global financial crisis vindicated Forrest’s uncompromising push to begin exporting iron ore in May 2008, when the iron ore price was still at its peak. A delay of just four months would have meant launching the project as Lehman Brothers filed for bankruptcy in the United States, an event that triggered a severe collapse of economic confidence and a downturn in commodity prices.
When Chinese iron ore demand crashed in late 2008, Fortescue’s share price came back down to earth with a thud. From a spectacular zenith of $12 in June 2008, the shares were trading below $2 by January 2009. Forrest’s paper fortune of $13 billion had slumped to little more than $2 billion in just seven months.
Even in the darkest days of the global downturn, the perennially self-assured Forrest maintained that demand for commodities would bounce back quickly and that the urbanisation and industrialisation taking place in China and other Asian economies still had decades to run. In early 2009, the Australian Financial Review surveyed the nation’s top chief executives for its half-year profit wrap and found they had little hope about the coming year. The only dissenter was Forrest, who said in his folksy style: “If you think everything is crook in Tallarook … think again.” Few knew of the turmoil at the time behind the scenes at Fortescue. Bottlenecks at the Cloudbreak and Christmas Creek mines meant production fell well behind during 2009, just when the company desperately needed to maximise revenue. As well, it was facing huge losses as a result of a disastrous foray into shipping contracts.
Fortescue was burning through cash at a worrying rate and only survived due to a $645 million equity injection from one of its key customers, state-owned Chinese steel-maker Hunan Valin, which bought 16.5 per cent of the company and became the second biggest shareholder after Forrest. After years of wrangling with Beijing, Fortescue had finally done a major funding deal with China Inc. Hunan Valin was the first Chinese steel-maker to take a large stake in an Australian iron ore miner, and Forrest hailed the agreement as an example of the economic cooperation that was needed between the two nations. Valin’s enterprising chairman, Li Xiaowei, also earned a seat on the Fortescue board, although the company agreed not to increase its stake beyond 17.5 per cent, thereby assuaging concerns within the Rudd government about Chinese companies swooping on Australia’s undervalued mining assets. The deal still came as a surprise to many who had long expected China’s biggest steel-maker, Baosteel, to be the logical vehicle for any state-owned investment in Fortescue.
The iron ore price gradually recovered from the shock of the global financial crisis and by 2010 Fortescue’s shares were again trading above $5, making Valin’s purchase at $2.48 per share at the depths of the doom appear prescient. Fortescue’s production problems in the Pilbara were being ironed out and the company managed to export 41 million tonnes of iron ore in 2010 to earn revenues of $3.5 billion, most of which went towards paying down debt. When Fortescue was able to make its first dividend payment to its 52,000 shareholders in 2011, it appeared to have finally arrived as a serious public company. As the biggest shareholder, Forrest received a cheque for $29 million that year and a further $80 million in dividends over the next twelve months.
On 18 July 2011, exactly eight years after founding the company, Forrest stood down as chief executive and handed over to Nev Power, a physically imposing former Thiess executive from Queensland whom Twiggy had recruited after years of searching for the right person to succeed him. Forrest declared he wanted to spend more time on his philanthropy, denying that his decision to resign as chief executive was linked to his ongoing battle with the Australian Securities and Investments Commission over allegations he had misled the market.
Nev Power shared Forrest’s passion for overly ambitious targets, but he also boasted the operational expertise that the company had badly needed ever since it began exporting iron ore. Forrest had proven to be a brilliant fundraiser and a visionary leader, but his time at Anaconda had shown that running an established company was not his speciality. Soon after announcing his retirement as chief executive, Forrest even admitted at a business conference that his day-to-day management skills were lacking: “I think there are some Fortescue Metals people here in the audience that will shake their heads if I say I’m a good manager. I’m not such a great manager.” Despite Forrest’s move into the background, Nev Power was never going to become the sole public face of Fortescue. Forrest stayed on as non-executive chairman and still owned a controlling 32 per cent of the company, ensuring he had the ultimate say on all the big issues.
With iron ore prices creeping back towards $US200 a tonne during 2011, the value of Forrest’s stake was back up around $6 billion for much of the year, ensuring he remained near the apex of the BRW Rich List. But this was when hubris began to creep in. Several months earlier, Forrest had unveiled an extraordinary target to boost Fortescue’s market value to at least $100 billion and to expand annual iron ore production sixfold, to 355 million tonnes by 2017. To put these ambitions into perspective, even Rio Tinto – the biggest iron ore producer in the Pilbara – wasn’t planning to be producing that much iron ore by then. “Forrest only chose that number [355 million] because it was 5 million more tonnes a year than Rio,” says a former Fortescue executive. At the time, Fortescue had not even hit its initial target of producing 55 million tonnes a year. Analysts began to worry that Forrest, who for his whole career had wanted to be the biggest and the best, was getting ahead of himself. “Right now the focus needs to be about delivering the first 55 [million tonnes],” said a sceptical UBS analyst, Glyn Lawcock. “Let’s take it one step at a time.”
By 2012, economic growth in China was beginning to slow down and iron ore prices were retreating from their unsustainable peaks of the previous year. A well-known American hedge fund manager and short-seller, Jim Chanos, began telling his clients that he was “shorting” Fortescue shares, or betting that the price of the stock would fall, because the miner was too highly geared, too exposed to China and was being led by a “promotional management team”. Although Forrest had handed over management to Power by then, the barb about self-promotion was aimed directly at him.
Chanos also predicted that Fortescue would have trouble servicing its huge debt pile if iron ore prices fell below $US100 a tonne. At the time, such a prospect appeared unlikely because iron ore was trading steadily at around $US150 a tonne, allowing Fortescue to meet its interest payments and still deliver a healthy return for shareholders. Moreover, Fortescue’s share price had risen 30 per cent between January and April, despite concerns about the strength of China’s economy. Both Forrest and Power went in hard against Chanos, suggesting Fortescue would always be protected by a natural “floor” in the iron ore price of $US120 a tonne.
Within a few months, however, almost everything Chanos had warned about Fortescue appeared to be coming true. China’s economic growth rate began to slow further and the iron ore price spiralled below the so-called floor of $US120 a tonne. For Fortescue, it was the worst possibletiming: the miner’s revenues collapsed at the same time as its debt load peaked. The debt was funding most of the company’s $US8.4 billion plan to almost triple its production capacity in the Pilbara to 155 million tonnes a year by mid 2013 (Forrest’s previous extravagant target of 355 million tonnes by 2017 had by then been placed on the backburner).
Forrest had long rejected the idea – even when raised by his fellow directors – of raising additional equity rather than taking on even more debt, because this would have diluted his controlling 32 per cent stake in Fortescue. An equity raising now made even less sense for him, given the sudden fall in the share price. Since the early days, when he recruited his inaugural directors, Forrest had ruled the Fortescue board with an iron fist. But tensions developed when Americans Ian Cumming and Joseph Steinberg, the Leucadia bosses who both served stints as non-executive directors of Fortescue, grew critical of what they saw as Forrest’s aggressive growth strategy and his “severe exaggeration”. They told Leucadia shareholders in 2013: “His personality dominated the FMG board and the other directors were more inclined to follow his lead as to the appropriate amount of equity, debt, leverage and the rate at which to expand, as opposed to our more conservative views.”
Ratings agency Moody’s didn’t help matters by putting Fortescue’s credit rating on review for a possible downgrade in August 2012, leading to further share price falls. Forrest tried to outsmart the short-sellers by borrowing money to buy $175 million worth of stock himself. At last, he had some real “skin in the game”, taking a personal financial gamble on the share price improving. But his extraordinary outlay failed to halt the decline. He next embarked on a solo mission to shore up confidence in his company by talking up its prospects to anyone who would listen. “I think it’s a great investment, it’s a multi-generational company, it will be going for many decades and will be one of Australia’s great institutions and I feel privileged to own shares in it,” Forrest said with habitual buoyancy. He added that Fortescue was in “great shape” and could “weather any storm”.
But when the iron ore price dropped like a stone to $US87 a tonne in early September, Forrest had egg on his face. At that price, Fortescue was simply not profitable. The iron ore divisions of BHP and Rio were not facing anything like Fortescue’s conundrum because they had been funding their Pilbara expansions from their own balance sheets rather than by taking on debt. Fortescue’s costs of production were also far higher than either of its Pilbara rivals and its ore was of generally lower quality, meaning its profit margins were much thinner.
Rumours began to swirl through the market that Fortescue might go under. The sceptics who had never trusted Twiggy quickly re-emerged to point out the parallels between Fortescue’s woes and Forrest’s troubled period at Anaconda Nickel – particularly the reliance on big slabs of debt and a deep exposure to a single commodity. The short-sellers, in particular, were triumphant at what they saw as the clear shortcomings of Forrest’s business model. One of them, John Hempton from Bronte Capital in Sydney, summed up the feeling in an interview with Reuters: “He [Forrest] builds iron ore mines on a vast scale. Then he borrows money on a vast scale. And he presumes the iron ore price will deliver him a pile of loot that is also unimaginable to mortals. The world is not complying.”
Faced with a looming disaster, Forrest and Power took drastic action on the morning of Tuesday 4 September 2012. Over the previous weekend, dozens of staff members had been called into head office to work out how they could urgently slash costs. The senior executive team met in the morning and agreed to come back at regular intervals until 8pm to discuss the latest drafts of their cost-cutting plan. Workers munched on sandwiches from a nearby Subway outlet as well as sweets left over from the eighteenth birthday party of chief financial officer Stephen Pearce’s daughter the previous evening. Forrest, Power and Pearce decided that their debt-funded expansion plan – which they had repeatedly promised would be unaffected by any iron ore price collapse – would need to be radically scaled back, and that 1000 employees and contractors would have be axed if the company was to survive.
By that afternoon, hundreds of vacant desks at Fortescue’s head office provided vivid evidence of the carnage. Entire teams, including the environmental, heritage, legal, IT and exploration divisions, were cleaned out. Many of those working in the company’s indigenous relations group were also sacked, in spite of Forrest’s commitment to improving living conditions for Aboriginal people. Fortescue said the retrenchments would save $300 million in operating costs that year.
After all of Forrest’s preaching over the years about the love he felt for his “Fortescue family”, the company’s actions that day confirmed that the quest for profits would always come before any sense of loyalty. One worker posted a note on Facebook claiming his email account and phone were disabled as he was being escorted from the Fortescue building. “I couldn’t even say goodbye to those I wanted to in the office,” he wrote.
The biggest shocks were still to come, however, when several of Fortescue’s most respected and longest-serving senior executives were culled in the following days. Years of loyalty to Forrest and his dream suddenly counted for nothing. Those sacked included government relations chief Julian Tapp, the key strategist behind Fortescue’s lengthy efforts to gain access to BHP’s railways and a major figure behind Forrest’s campaign against the federal government’s mining tax. Also axed was investor relations chief Rod Campbell, who had been sent out the previous day to brief analysts on Fortescue’s pared-back expansion plans.
Tapp and Campbell, who both joined Fortescue in 2004, were blindsided by their sackings. Campbell and his wife had enjoyed a close relationship with Andrew and Nicola Forrest over the years. Like others, they struggled to understand how the decision to remove them and pay them up to six months’ salary in redundancy packages could benefit a company facing a short-term cash squeeze.
Another senior executive, Ann Marie Lowry, had accompanied Forrest to Sydney on 4 September as he made an impassioned speech at a Philanthropy Australia conference about the evils of child labour. Lowry, the company’s senior legal counsel, was known as the “chief cheerleader” for Fortescue and had grown personally close to both Andrew and Nicola. In an in-house publication in 2008, she said: “Of all our assets, the ones we value most and see as most powerful are our people and our culture.” But by the end of the day, even as she travelled with the Forrests, Lowry was sacked.
Geologist Barry Knight, who had performed a variety of senior roles since joining Fortescue in 2003, when it was still housed in Forrest’s lounge room, was also retrenched. Eamon Hannon, the once-fêted exploration boss whom Forrest treated as a son, was so disgusted at the way some of his staff were retrenched that he brought forward his own planned resignation date and walked out the door. One long-serving former executive says there is still anger towards Forrest and Power over the sackings, which he believes were badly handled. “Like at other companies, it should have been last in, first out,” he says. “It was a very sad day for Fortescue.”
While many saw the purge as an example of Power trying to step out of Forrest’s shadow and put his stamp on the company, Forrest admitted later that he had personally endorsed all of the sackings. But he did not personally deliver the bad news to anyone; that grim task was handled by Power and Stephen Pearce. When asked about the sacking of some of his most loyal executives, Forrest said he could not countenance a situation in which those with close links to him were excluded from redundancies that were needed to keep the company afloat.
Just a few days later, he said he was confident that Fortescue would emerge from its scrape with death in stronger shape. “I can’t tell you how well I am sleeping at night,” he said. “The share price thing, it really matters nought to me. But my heart breaks for the people we have had to let go. They are paying a high personal price for something that is necessary because we have to emerge from this with a company that is fitter and stronger to make sure we really have built a multi-generational business.”
Under the scaled-back growth plan, Fortescue’s new annual production target would be cut to 115 million tonnes – a move that would save $1.6 billion for the year. Power also announced a fire sale of some of the company’s “non-core” assets. He managed to sell a power station to a Canadian utility for $300 million and a 25 per cent interest in an iron ore joint venture with fellow miner BC Iron for $190 million. In late 2012, Fortescue also started talks aimed at selling a stake in its Pilbara rail and port assets, a move that could raise billions of dollars.
But the bean counters at Fortescue’s head office in Perth had even further cost-cutting in mind. On 5 September, an internal memo announced that staff barbecues would be axed in Port Hedland. The memo also said the company would no longer buy tomato sauce or other condiments for staff, who would also have to bring their own cutlery from home in future. And for good measure, employees were warned that the stationery cupboard in the administration office would from now on be locked. Morale among Fortescue staff hit rock bottom.
Largely unbeknown to the market, Fortescue was facing a separate financial problem that posed a much bigger threat than a few bottles of ketchup. The collapse in the iron ore price had rendered Fortescue unprofitable, but it also meant the company would likely be in breach of its loan covenants before the year was out. The conditions on the loans required Fortescue’s pre-tax earnings to remain at more than two and a half times the annual interest bill on its $US10-billion debt. On 13 September, the Australian Financial Review published a story on its website that revealed Fortescue was in talks with its bankers about a possible refinancing. The story triggered a 14 per cent plunge in the share price to just $2.99 and yet another round of speculation that the company was facing collapse.
In Perth, where Forrest is a household name, even taxi drivers were suggesting the tycoon’s luck had finally run out. The main story on the front page of the West Australian the next day suggested Fortescue was in danger of going under. Like Icarus, Forrest appeared to have flown too close to the sun and was now crashing back to earth. The website Crikey ran a story gleefully reminding Forrest how he had ignored Jim Chanos’ warning about the twin dangers of Fortescue’s high gearing levels and the falling iron ore prices. “The disaster unfolding at Fortescue, and the desperate attempt by billionaire Andrew ‘Twiggy’ Forrest to cling on to his fortune, prove again that when Jim Chanos says something, it’s worth listening,” wrote business reporter Adam Schwab.
Mere hours after those words were published, Fortescue announced it had raised $US4.5 billion in fresh debt to shore up its sickly balance sheet. Power and Pearce endured sleepless nights to complete the deal, while Forrest travelled to China, the United States, the Middle East and Europe, talking to shareholders and financiers. The new facility would refinance all of Fortescue’s existing bank debt and remove the restrictive covenants that would otherwise have been breached within months. In short, Fortescue had taken on more debt to solve its debt crisis, but the freshloans came with less onerous conditions and no principal repayments for three years. The company had bought more time in the hope the iron ore price would recover. It was a sign that credit markets still had a taste for risk and continued to believe in Forrest’s vision. Just a few days after many had written him off, Twiggy had pulled a rabbit from his hat.
In raising the money, Fortescue was also able to walk away from its 2006 loan deal with Leucadia, which had ended up costing the miner more than $1 billion in royalty payments. In 2010, Forrest hired prominent Melbourne investment banker John Wylie and former Labor prime minister Paul Keating, an adviser to Wylie’s firm Lazard, to lobby Leucadia to extinguish the loan. Over the years, Leucadia boss Ian Cumming had revelled in the brilliance of his loan deal with Forrest, once describing it as “succulent”. Because the royalty payments under the loan were linked to Fortescue’s iron ore revenues, the deal had proven far more profitable for Leucadia than even the most bullish forecaster could have predicted at the time.
On their initial mission to New York in 2010, Wylie and Keating failed to convince Cumming, a 71-year-old billionaire, to give up the loan. It didn’t help matters that Leucadia was also suing Forrest in the WA Supreme Court, alleging he had engaged in “misleading and deceptive behaviour” in attempting to dilute the hedge fund’s share of future profits from the convertible note. Leucadia sold down most of its shareholding in Fortescue in 2011, but Cumming’s anger with Forrest was doubtless assuaged by the fact that his original equity investment had delivered a profit of more than $1 billion.
By September 2012, with the iron ore price in freefall, Wylie went back to Forrest and said he believed it was an ideal time to negotiate with Leucadia to buy it out of the loan, which was not due to expire until 2019. According to the Australian Financial Review, Wylie met Cumming inthe United States and said Fortescue was willing to pay $US715 million for the note if Leucadia dropped its legal action in Australia. He warned that Fortescue was about to unveil a huge secured debt facility that would put Leucadia towards the bottom of the list of creditors in the event of the company being wound up – a scenario that wasn’t unrealistic at the time. Cumming accepted the offer. What neither Wylie nor Forrest knew at the time was that Leucadia urgently needed cash to fund a major acquisition it was planning. Just as the Leucadia deal had proved to be brilliant timing for Fortescue back in 2006, its ability to extract itself from the expensive loan seven years early was also something of a masterstroke.
In the space of one wild month, Fortescue had appeared close to financial ruin, only to emerge with a new financing package and free from the Leucadia loan. But in reflecting on the drama, the Australian’s respected business commentator John Durie pinned the blame for the near-death experience on Forrest’s hubris in pushing to expand Fortescue at such a rapid pace. “Andrew Forrest is financially secure once more, but questions remain whether he has at last learned the perils of too much debt in a commodities play,” Durie wrote. “The way Forrest saw the world, the iron price would stay high forever and the quicker he expanded the quicker he could lower the costs of production and hence make more money.”
Of course, Forrest’s expand-at-all-costs mentality and his penchant for risk were not new. He had done the same thing, with varying degrees of success, in deal-making circles in Perth and Sydney in the 1980s and 1990s. Similarly, his grandiose ambition to dominate the nickel industry at Anaconda in the 2000s had proved unrealistic. But Forrest thrives on dealing in high stakes and proving people wrong. As his executives scrambled to refinance Fortescue’s debt in the darkest days of the price plunge in September, a photograph of a beaming Forrest appeared on the front page of the Australian Financial Review, accompanied by a story in which he declared that suggestions of his imminent failure were not credible. “As Mark Twain said, reports of my death are greatly exaggerated,” he said.
Forrest’s blind optimism underscores legendary British economist John Maynard Keynes’s theory that business decisions are often driven by “animal spirits” rather than a careful assessment of the numbers or the facts. Keynes suggested that without “animal spirits”, or entrepreneurs investing spontaneously, there would be no economic progress. “It is safe to say that enterprise which depends on hopes stretching into the future benefits the community as a whole,” he wrote. “But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death.”
There is a big difference, though, between animal spirits and recklessness, which is how some have viewed elements of Forrest’s career. The 2012 debt crisis exposed Fortescue’s core weakness: it is entirely reliant on strong iron ore prices and it is entirely funded with other people’s money. Forrest has also failed to diversify Fortescue beyond iron ore, despite promises over the years to push into coal and other minerals. Philip Kirchlechner, who served as Fortescue’s head of marketing between 2003 and 2006, believes Forrest made a critical error in failing to encourage the Japanese or Korean steel industries to buy his iron ore. “Forrest is hugely exposed to a single market in China,” he says. “BHP and Rio are very, very jealously guarding their sales into Japan and Korea – those markets are important to them in terms of diversification. But Forrest always had trouble in dealing with Japan because the Japanese couldn’t deal with his aggression. It was okay for China but not in Japan.”
When the debt refinancing deal was announced, the Fortescue share price surged 17 per cent in a single day. But analysts warned that Fortescue remained too highly geared and exposed to the highly volatile iron ore price. They wondered whether Forrest’s great gamble would survive the next crisis. Many also cautioned that the iron ore market would suffer from a significant oversupply after 2014, by which time prices could be back down below $US90 a tonne. The analysts, of course, had been proven wrong before. And in Forrest’s world, they would be wrong again.
Proving that life at Fortescue was indeed a roller-coaster ride, the iron ore price climbed back to $US135 a tonne by December 2012 and the company was able to reactivate the $1.1 billion development of its Kings deposit, which would deliver an extra 40 million tonnes a year of iron ore. The production target of 155 million tonnes a year was back on the agenda just a few months after it had been shelved. Fortescue appeared to be back on track, albeit with a $12.8 billion debt pile, which was higher than the company’s market value.
Despite this semblance of stability, Power was adamant that there was no place for the 1000 people axed in September, conceding that Fortescue had grown fat in the good times and would have to remain a lean organisation. It was a very different message to the one Forrest had delivered in Fortescue’s 2012 annual report, when he declared that all former servants of the company would “always be welcome back” when the opportunity arose.