Institutional Investor's Alpha Magazine - June 2008 - (Page 16)

Pay Dirt in Iron Ore J UPDATE The Ratings Game n a wide-ranging set of proposed reforms, the Securities and Exchange Commission is following through on its promise to clamp down on the credit rating agencies. The agencies — and the SEC, which is supposed to be the industry watchdog — have come under intense congressional criticism over their role in the subprime mortgage crisis. During a series of Capitol Hill appearances in the spring, SEC chairman Christopher Cox pledged immediate action (see “When Sentinels Go Astray,” May 2008). The new rules, formally proposed on June 11 and likely to be implemented this summer, would bar rating agencies from consulting with clients on how to structure a security to get a good rating. Suggested changes in the disclosure requirements would make the agencies reveal what information goes into ratings so that investors can better evaluate the scores. The credit rating agencies, which include Moody’s, Standard & Poor’s and Fitch Ratings, have come under ﬁre in recent months for their failure to accurately assess certain subprime debt, much of which, in hindsight, received far better ratings than it deserved. A broad variety of investors — including pension funds, endowments, hedge funds and individuals — have historically relied on the agencies for insight into the underlying value of securities. The most controversial of the proposed reforms would require the agencies to use a new, separate set of symbols or modifiers for rating struc- I tured investment vehicles like collateralized debt obligations, some of the very investments that are at the root of the credit crunch. The Securities Industry and Financial Markets Association, a major trade group, warns that such a change would set off a ﬁre sale of securities in an already difﬁcult market and impair credit for student loans, auto loans, credit cards, mortgages and so on. “When you pull on a string, it is usually a good idea to consider what might unravel,” says Deborah Cunningham, chief investment officer of Bostonbased investment management firm Federated Investors and co-chair of an association task force on credit rating agencies. “The possible consequences for our markets if rating modiﬁ ers are adopted could be disturbing.” The SEC is obliged to weigh public comment before reaching a decision. But given the level of public interest in the issue, it seems poised to implement the changes as proposed, perhaps within weeks. Cox says the goal is to get at conﬂicts of interest that are “hardwired” into the rating agency business model. “We have learned that the ratings of structured products in the subprime area made those conflicts of interest even more acute,” Cox said at an open SEC meeting in June, adding that one practice in particular had been especially egregious. “Selling consulting services to entities that purchased ratings became a triple-A conﬂict of interest,” he said. — Darrell Delamaide Fortescue CEO Andrew Forrest sees a windfall in Australian mining. a Perth-based mining entrepreneur, took over a moribund company worth A$9 million ($6 million), renamed it Fortescue and declared it would be a “third force” in Australian ore production, challenging the domination of BHP Billiton and Rio Tinto. But when Australian institutional investors wouldn’t put money into Fortescue because Forrest had presided over a notorious failed nickel venture, he went offshore, to Harbinger and Leucadia. Harbinger paid A$400 million for 16 percent of the company in 2006. With Fortescue stock topping A$10 a share in mid-June, Falcone is sitting on a paper proﬁt of about A$4.4 billion. Leucadia’s 9.9 percent stake (a different combination of debt and equity) has also generated a A$4.4 billion paper proﬁt. Fortescue’s A$30 billion market value makes CEO Forrest, with his one-third share, Australia’s richest man. Harbinger and Leucadia are the next-biggest shareholders. “People just saw him as a promoter,” John Veldhuizen, a Melbourne-based analyst at Australian investment bank BBY, says of Forrest. From late 2004 to 2007, Veldhuizen was the only analyst to cover the stock, putting a buy recommendation on it from the get-go. Veldhuizen has a hold rating on Fortescue now, however, with a target price of A$7.50 a share. “I’m just putting my cautious hat on,” he says. Falcone may have a similar view: Press reports in Australia suggest he may sell his stake to Chinese steel producers, which have been snapping up Australian mining assets. (Meantime, BHP Billiton is pursuing an unsolicited takeover bid for Rio Tinto.) Early faith in Fortescue began to pay off this spring, when the company made its ﬁ rst delivery to China, its biggest potential market by far. Chris Catlow, the company’s CFO, says skeptics “don’t understand the compound nature of GDP growth in China. It’s a wave that is not go- 16 • INSTITUTIONAL INVESTOR’S ALPHA • JUNE 2008 NELSON CHING/BLOOMBERG NEWS oseph Steinberg, founder and CEO of Leucadia National, a Utah-based holding company, calls Fortescue Metals Group the world’s biggest Tinkertoy set, and New York–based Philip Falcone, senior managing director of hedge fund ﬁrm Harbinger Capital, hasn’t even set his eyes on it. Together, though, they own more than a quarter of the company, Australia’s newest iron-ore producer. And they’ve both made billions from that investment. The story begins ﬁve years ago, when Andrew Forrest,

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - June 2008

Investor's Alpha Magazine - June 2008 Contents Letter From the Editor Longs & Shorts Cover Story: Alpha Hall of Fame Bruce Kovner Michael Steinhardt Kenneth Griffin Louis Bacon Steven Cohen George Soros James Simons Seth Klarman Julian Robertson Jr. Jack Nash Leon Levy Paul Tudor Jones II Alfred Winslow Jones David Swensen Looking Ahead: Back to the Future Research Center: Europe Hedge Fund 50 Unhedged: Let the Sunshine In

Institutional Investor's Alpha Magazine - June 2008

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