Twiggy (17 page)

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 fresh
loans 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 in
the 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.

Sometimes you’ve got to do things to survive that you would have preferred not to do.

—RODNEY ADLER

From the moment Forrest burst back on to the scene in 2003, the nation’s corporate cops began to keep an abnormally close eye on him. The regulators at the Australian Securities and Investments Commission (ASIC) and the Australian Securities
Exchange (ASX) – the two bodies tasked with protecting investors – were wary of Forrest, who was intent on winning publicity for his new venture. They also knew investors had lost plenty of money at Anaconda Nickel when Forrest had promised the world but failed to deliver. And besides, they had a long-standing mistrust of big-talking mining entrepreneurs from Perth.

Ultimately, these suspicions
would lead to an eight-year legal battle over Forrest’s conduct that would jeopardise his ability to remain in charge of Fortescue, cast a pall over his reputation and cause untold stress to him and his family.

The regulators’ scrutiny of Forrest’s grand vision for Fortescue began within days of his election as chairman in July 2003. Perhaps the ASX was uneasy that Fortescue’s share price
had risen rapidly from 10 cents in April to 26.5 cents on the day of the July shareholders’ meeting, even though there had been no official announcements about Forrest’s planned takeover of the company.

At the meeting at the Celtic Club in West Perth, Forrest could hardly have been accused of talking down his prospects of success in building an iron ore mine in record time. He announced he
was seeking a partnership with mining heiress Gina Rinehart’s planned Hope Downs iron ore project in a bid to establish new rail and port facilities in the Pilbara. But a Hope Downs source was quoted in the
West Australian
three days later as saying Forrest’s infrastructure plan was “not something we are spending a lot of time thinking about at this stage”.

Fortescue quickly released what
it termed an “explanatory statement” to Forrest’s speech in an attempt “to ensure there is no confusion in the market”. The statement confirmed Fortescue had no agreement with Rinehart’s Hope Downs project. It went on to “clarify” to the ASX that Fortescue’s proposed iron ore project had no definitive reserves, no definitive budget, no definitive timetable and no definitive funding strategy.

On the same day, the ASX sent Fortescue a “please explain” letter over another report, which said the company was in talks to form an iron ore joint venture with fellow Perth company Consolidated Minerals, a move that would boost Fortescue’s chances of being able to raise the money it needed for a railway line and a port. The ASX clearly wasn’t happy that it was reading about the talks in
a newspaper before the market had been informed. Later that day, Fortescue confirmed the joint venture with Consolidated Minerals had been finalised.

These early misunderstandings would seem trivial compared to the stoushes that followed. In December 2003, a team of Fortescue executives, including Forrest, Graeme Rowley, Alan Watling, Chris Catlow, Barry Knight and Philip Kirchlechner, embarked
on a crucial trip to the Chinese industrial city of Maanshan to spruik their vision to thirty of the country’s steel mills. As a result of the trip, Fortescue announced on 9 December it had secured “memoranda of intent” with steel mills to buy 25 million tonnes a year of iron ore, declaring it was confident it had established a market for its product. But the ASX put a dampener on the news
when it asked Fortescue why its share price had suddenly run up from 48.5 cents to 66 cents in the four trading days before the announcement of the MOIs.

Among the buyers during that period was Graeme Rowley, the Fortescue executive director who was also Forrest’s right-hand man. On 3 December, before the Maanshan trip, Rowley had paid $170,000 to buy 350,000 Fortescue shares at 48.5 cents
each. By 9 December, when the Maanshan deals were announced to the market, Rowley’s $170,000 outlay was suddenly worth $230,000. ASIC wanted answers and summoned all of the Fortescue executives who went to Maanshan in an attempt to discover what Rowley had known about the status of the MOIs when he bought his shares.

ASIC told Fortescue it was investigating Rowley under section 1043A of
the Corporations Act, otherwise known as the insider trading provision. The Fortescue executives, including Forrest, gave sworn evidence at ASIC’s Perth office and were told to hand over all relevant documents. “Graeme was stupid to buy shares at that time,” says a former Fortescue executive. “I think it was an honest mistake, but I still thought it was stupid.”

ASIC dropped its insider
trading investigation into Rowley several months later and the probe was never made public, but the episode illustrated that the corporate regulator had Fortescue firmly in its sights from the early days. Later, ASIC also questioned Fortescue over the nature of some of the “binding” sales contracts it had signed with Chinese steel mills in late 2004 and early 2005. In the end, that investigation was
also dropped.

But the regulators stayed on Forrest’s case. In April, the ASX sent an extraordinary four-page letter to Fortescue, demanding answers to a series of questions about the company’s project cost estimates, its timelines and the extent and quality of the mineral resources it had announced to investors. This was a rare kind of rebuke, and it proved that Fortescue was being scrutinised
more closely than just about any other stock on the market.

The questioning led Fortescue to admit that its project was indeed facing a significant cost blowout beyond the budget of $1.85 billion and a six-month delay until the second quarter of 2007. It was also forced to back down on the bullish way it had been describing its resources to the market over the previous eight months. The ASX
said Fortescue’s reporting did not comply with the Joint Ore Reserves Committee (JORC) code, which is the official measure by which miners must evaluate their deposits. It pointed out that Fortescue should not be using the term “ore” to describe its mineral resources because that implied it had a “reserve” that was viable for mining. The company’s response shocked the geologists at other mining
companies, who viewed the industry’s JORC code as sacred. “It was not Fortescue’s intention to use the term ‘ore’ in the context of suggesting that it was at ‘reserve’ grade status,” Fortescue said, “but rather the term was being used in its colloquial or natural meaning within the ‘iron ore’ industry.”

Within a few days, there was more to come. The perennially bullish Forrest, his popularity
in mining circles clearly rising, gave a sold-out address to the Sydney Mining Club in May 2005, in which he said Fortescue would be able to sell its lower-quality ore for 95 per cent of the prices being obtained by BHP Billiton and Rio Tinto for their premium products – a claim that raised eyebrows when reported in the
Sydney Morning Herald
the next day. Forrest also told his audience that the
capital cost of the project “would start with a two, not a one” but he would be working hard to ensure it did not blow out to anywhere near $3 billion.

The ASX jumped on the statements, demanding the company explain what Forrest had meant. Fortescue responded that everything Forrest had said was correct. This may have been true, but to many observers it appeared as if Fortescue had a real
problem in complying with Australia’s system of continuous disclosure, which requires companies to announce all price-sensitive information to the market in a timely manner.

It was in March 2006, however, that Forrest felt the full weight of the nation’s regulators. After a twelve-month investigation that arose from an ASX referral, ASIC’s then chairman, Jeff Lucy, announced the watchdog
was suing Forrest and Fortescue in the Federal Court. ASIC alleged Forrest had breached his duties as a director by referring to a series of construction deals with Chinese companies as “binding contracts” when they were, in fact, merely loose framework agreements. It also claimed Forrest had failed to correct his misleading statements even when it became obvious that the deals were not binding. In
essence, ASIC was saying Forrest had exaggerated the nature of the deals and then deliberately kept the market misinformed while Fortescue’s share price soared. It wanted Forrest to be fined $4 million and, more importantly, disqualified from serving as a director over what it regarded as a serious breach of the Corporations Act. Experts said the ban would likely last for between three and five
years if he were found guilty.

For Forrest, the stakes had never been higher. To his critics, the civil charges were confirmation of what they believed all along: the Forrest spin machine had finally gone too far and he would be brought to account by a judicial system that had already found him to be dishonest several times in the past. But to Forrest’s growing band of supporters, ASIC’s
pursuit was evidence of Australia’s “tall poppy syndrome” and the regulator’s desperate need to claim the scalp of a high-profile businessman. Forrest himself responded by saying he had done nothing wrong, the contracts were indeed “binding” and he was confident the courts would find in his favour.

Another school of thought contended that even if Forrest had overstated the nature of the
deals to generate some excitement and boost his share price, a protracted courtroom brawl involving arcane legal argument over the precise definition of a “binding contract” might not be the best way to remedy the breach.

Forrest suspected that the ASIC charges had arisen as a result of lobbying by his enemies at BHP and Rio. There was no direct evidence to support this. But the damage to
Forrest’s reputation was immediate and it allowed his rivals in the industry to privately gloat over the whole affair. In the
Australian,
business columnist Matthew Stevens called on Forrest to resign from Fortescue, arguing that the charges could jeopardise the company’s ability to secure contracts with financiers and customers.

The trouble had begun in August 2004, when Fortescue had told
the market it had entered into a “binding contract” with the state-owned China Railway Engineering Corporation (CREC) to finance and build its railway line in the Pilbara. At a press conference, a journalist had asked Forrest: “You talk about a $1.85 billion project, how much of that is the railway line?” Forrest had replied: “The price of the railway line and the rolling stock is confidential
but we are pleased to say it’s competitive.” To the average investor, it sounded as if Fortescue had already negotiated a price for the works. But Forrest was too busy celebrating to worry about such semantics; that evening he was marking the deal by downing cocktails at a lavish party at the Australian Embassy in Beijing, surrounded by a throng of senior Chinese government officials and businessmen.
Ten weeks later, Forrest had even more good news to trumpet: Fortescue had signed “binding contracts” with two other Chinese state-owned entities, China Harbour Engineering Company (CHEC) and China Metallurgical Construction Corporation (MCC), to finance and build its port and mine.

The mining industry had gasped in astonishment at these announcements. It seemed as if Forrest might really
have a viable project. Forrest claimed the deals had removed the risk of the project. “These commitments by Chinese interests now cover the financing and construction risk for the total project,” he said after a signing ceremony with CHEC and MCC in Beijing. “Our approach has been to ensure the construction risk is carried by the contractors and that project payment by Fortescue Metals only follows
practical completion.” In the
Weekend Australian
, resources writer Robin Bromby had summed up the mood among observers by declaring: “Andrew Forrest has pulled off what must be one of the most breathtaking deals in our mining history – he has talked the Chinese government into almost fully financing his $1.85 billion Pilbara iron ore dream. And he has done it without giving away a single share
in his Fortescue Metals Group.”

Investors clearly thought the same thing. Fortescue shares were trading at just 55 cents when the CREC announcement was made on 23 August. By the time the latter two “binding contracts” were announced in November, the share price had risen to $1.66. From there, the shares continued to soar, rising above $5 in February 2006 and catapulting the company into
the ASX top 300. Fortescue had arrived as a glamour stock.

But as investors rushed to get behind Forrest’s vision, his so-called binding contracts were beginning to unravel behind the scenes. In the early weeks of 2005, the Chinese companies began to demand a big equity stake in the project as a condition of going ahead with the financing deals. But Forrest was not prepared to give away
majority control of his company or the project.

According to evidence given in the Federal Court, Forrest embarked on a desperate campaign during early 2005 to get the Chinese to commit to the contracts. “We have no money. We might have to think about a joint venture,” Forrest was claimed to have said. He was even apparently prepared to invoke his friendship with prime minister John Howard
in an attempt to force the Chinese to honour the contracts.

In mid January, Forrest met MCC vice chairman Ma Yanli, who told him he was reluctant to commit to the project before Fortescue had proven it had sufficient iron ore reserves. A Fortescue translator and executive assistant, Wei Fisher, told the court that Forrest had said to Ma during the meeting: “This is a very important project
and MCC is a large company. I have been to see the prime minister, and he knows that there is a signed agreement. If MCC pulls out now, the ability of the Chinese to carry out international work will be doubtful and it would damage our relationship.”

On 3 February, as his net worth soared on the back of the Fortescue share price frenzy, Forrest was handed a fax that had just arrived from
Ma. According to evidence given in court (but which was ultimately rejected by the judge), the fax said the deal MCC had signed three months earlier to build Fortescue’s mine was off. Wei Fisher, who was standing near the fax machine at the time, told the Federal Court: “I recall that when Andrew Forrest saw this fax, I heard him say words to the effect that ‘This is ridiculous. If anyone tells the
press, we have had it.’ I recall seeing Forrest walking about the office waving the fax, and raising his voice, he was very upset.”