Last week, Freeport-McMoRan Copper & Gold Inc. (FCX) announced monumental mergers that sent the stock plunging 20% over the next two trading days. While the deals appear attractively priced compared to the assets obtained, the market clearly doesn't appreciate complex investments in the current environment.
For those investors living under a rock, the company agreed to purchase both Plains Exploration & Production Company (PXP) and McMoRan Exploration (MMR). Since both of these companies focus on oil and gas exploration, the purity of being a strictly copper focused producer attracted plenty of investors that might disappear now.
Another major issue is that investors actually don't understand the McMoRan Exploration potential. Too many investors focus squarely on the failures of the exploratory Davey Jones No. 1 well and miss all the other wells under drilling programs. These wells are drilled with the benefits learned from the failures of the original Ultra-Deep Swallow Water well.
While investors also overly obsess on the co-mingled management teams, it also highlights the value potential realized. Freeport buying McMoRan could potentially be seen as an insider purchase considering the overlap. Instead, the market frets that numerous insiders would risk careers, reputations, and financial gains on the silly premium in the McMoRan deal. In reality, maybe everybody involved finally realized that the only thing holding McMoRan back was the lack of the deep pockets provided by a major firm such as Freeport. The unlimited potential of the ultra-deep plays in shallow water just went from a question of 'if' to 'when'.
Plains Exploration Deal Details
In a slightly surprising move, the company acquired Plains Exploration in addition to McMoRan. The deal originally valued Plains Exploration at roughly $6.9B though the stock portion has lost considerable value already.
A major reason for this purchase was the 36% net interest it owned in McMoRan.
Freeport lists the major assets as strong oil production in California, growing production in the Eagle Ford trend in Texas, large onshore resources in the Haynesville Shale in Louisiana, and significant production facilities and growth potential in the deepwater Gulf of Mexico.
Part of the allure of the Plains Exploration deal was the recent $6B purchase of BP p.l.c. (BP) and Royal Dutch Shell pl (RYDAF.PK) assets in the Gulf of Mexico. The company acquired 100% of BP's interest in Holstein, Horn Mountain, Ram Powell, Diana-Hoover oil fields and 100% of Shell's interest in the Holstein oil field. The company expects the ability for significant production increases and cumulative excess cash flows for the next four years of $4-5B that equivalently pays for the deal.
As the below page from a recent presentation highlights, Plains Exploration has significant reserve potential after these acquisitions.
The deal consists of 0.6531 shares of FCX common stock and $25.00 in cash. The original intent was for total consideration of $50.00 per PXP share, but now the value has diminished to $45.70 based on the substantial decline of FCX.
The company will issue 91M shares for this deal and approximately $3.4B in cash.
McMoRan Deal Details
In a not very surprising deal, Freeport agreed to acquire McMoRan. Considering the overlap of management teams and the previous investment by Freeport, a move was almost inevitable. The company owns substantial ultra-deepwater assets that only needed capital in order to develop the potential trillions in natural gas reserves.
The real surprise was the offer of a 74% premium to the McMoRan closing price on December 4th. The market was clearly caught off guard as a few analysts even forecasted the equity as possibly worthless after the recent Davey Jones failures.
The previous article, McMoRan: Investment Remains Intact Despite Mechanical Issues, highlighted all the potential resource plays besides the much-maligned Davey Jones well. Investors that are negative on the premium or even the deal in general need to research further on what McMoRan has to offer. The media obsesses on just one of up to ten deepwater wells in progress. The company isn't the one trick pony as typically presented.
The deal consists of $14.75 in cash and 1.15 units of a royalty trust, which will hold a 5% overriding royalty interest in future production from McMoRan's existing ultra-deep exploration properties.
The cash portion of the transaction only totals $2.1B considering the substantial ownership interests already held by FCX and PXP. More importantly maybe was the cash premium that so concerned investors only amounted to $900M. The amount is rather insignificant when considering the potential value once these natural gas assets are tapped.
As mentioned prior, the investment community continues to be narrowly focused in making investment decisions. If a fund wants a copper play, it previously bought Freeport. Now that fund might be looking at Southern Copper (SCCO) or iPath DJ-UBS Copper ETN (JJC) instead. Unfortunately, the vast majority of investors live in this narrow band and hence the stock plunged. Not to mention, recent research has suggested that companies with a simple focus have performed better in 2012. SandRidge Energy (SD) and Carrizo Oil & Gas (CRZO) both have hit recent lows based as much on the confusing joint venture deals rather than value potential.
Read through the Freeport headlines on Yahoo! Finance and one will see numerous analyst opinions against the deal or questioning whether the company overpaid. The New York Times wrote that the Freeport deals were too cozy for comfort. Yet the article never addressed whether shareholders got the deal at attractive prices regardless.
As the article also mentioned, a Blackrock fund manager also brought up the conflicting issues on the earnings call yet didn't explain why a cash flow accretive deal was so bad no matter what price paid.
Value - EBITDA Machine
The market appears concerned about a copper company moving into oil and gas yet the valuation is extremely compelling. The pro forma company will have an estimated EBITDA of $12B and operating cash flows of $9B.
While this estimate assumes $4.50 per MMbtu for natural gas, it assumes limited production increases from the ultra-deepwater projects that remain in doubt by the market.
Considering the deal involves the limited issuance of 91M shares and cheap debt, the company will have a market cap of roughly $33B and an enterprise value of $50B. At these levels, one should be able to see the extremely attractive valuations. The EV/EBITDA would only hit 4.
At completion of the deal, the company will have approximately $20B in total debt with around $3.7B in cash. JPMorgan Chase (JPM) has agreed to provide $9.5B in financing to pay the cash for the deal and assume the Plains Exploration debt. While a large amount of debt, the company will quickly use cash flow to reduce the debt load to more conservative levels.
The deal offers a very compelling valuation with a proven management team. Investors need to quit fretting over the nature of the deal and focus on the value creation history of Jim Moffett and Richard Adkerson.
While the stock might need a month or so for the investor base to turn over from copper focused funds to mega mineral and mining stocks, investors also need to be prepared that the stock could remain at these extreme valuations for a lengthy time. Until more positive details regarding the McMoRan wells start flowing, investors are likely to stay away fearing Freeport might face massive write-downs.
Additional disclosure: Please consult your financial advisor before making any investment decisions.