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Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) shares plunged in a very short period of time in December 2012. Shares declined 16% on the day the company said it would spend $9 billion to acquire McMoRan Exploration (NYSE:MMR) and Plains Exploration (NYSE:PXP) for $3.4 billion and $6.9 billion, respectively. This would expose the company to the oil and gas markets, increasing risks for investors. On its balance sheet, Freeport-McMoRan is increasing its liabilities as it loses its focus from its core business. When shares finally bottomed on December 6, 2012, at $30.81, speculators could be betting that greater diversification in its business would compensate for short-term integration uncertainties. Freeport recently closed at $35.49 and is rapidly approaching its pre-selloff level. The company is currently valued at a P/E of 11.5 times and a forward P/E of 8.

Is it time to buy Freeport? There are 3 things to consider.

1. Balance Sheet Analysis

Freeport had $3.7 billion in cash at the end of its last quarter (September 30, 2012). Its cash levels declined from the previous quarter after cash from investments and property, plant and equipment declined by $1 billion each:

12/31/2011

3/31/2012

6/30/2012

9/30/2012

Cash

4,822.00

4,496.00

4,508.00

3,727.00

Values in millions USD ($) - Data Source: Kapitall.com

The company's debt was steady for the last four quarters. Freeport-McMoRan decreased its debt steadily over the last four fiscal years.

12/31/2011

3/31/2012

6/30/2012

9/30/2012

Long-Term Debt

3,533.00

3,517.00

3,519.00

3,521.00

Other Long-Term Liabilities

3,789.00

3,752.00

3,788.00

3,725.00

Values in millions USD ($) - Data Source: Kapitall.com

12/31/2008

12/31/2009

12/31/2010

12/31/2011

Long-Term Debt

7,284.00

6,330.00

4,660.00

3,533.00

Values in millions USD ($) - Data Source: Kapitall.com

Freeport-McMoRan wants a $4 billion term loan and a $5.5 billion bridge to bonds. The company also wants to refinance a $1.5 billion, 5-year revolver facility. Raising additional debt of this size is puzzling. The company could use its existing cash balance and raise a smaller level of debt. Its leverage (total liabilities / total assets) is currently at 39.9%. The additional debt would raise its total debt to $20 billion. The debt/EBITDA ratio will be 1.7 times.

2. Shareholder Vote Circumvented

The acquisition was not vetted with shareholder voting. By circumventing the scrutiny of shareholders, investors should assume that the best value was not obtained from this deal.

3. Operational Risks Expected

Entering the exploration and production business runs counter to Freeport-McMoRan's existing strategy. In addition, after suffering massive losses in 2008, the company became more responsible in improving its balance sheet. This acquisition will likely hurt earnings. McMoRan Exploration Co. lost $116 million last year, or negative $0.72 per share. Conversely, Plains Exploration earned $185.5 million, or $1.44 per share.

Comparison

Freeport-McMoRan is still valued much less than comparable investments on a forward P/E measure: Southern Copper Corp. (NYSE:SCCO), Newmont Mining (NYSE:NEM), and Cliffs Natural Resources (NYSE:CLF).

(Chart Source: Kapitall.com)

Conclusion

Investors should not expect the recent bounce in Freeport-McMoRan shares to be sustainable. Shares are adjusting for excessive undervaluation, as suggested by the forward P/E relative to its peers. An improving economic outlook for global economies could negate this view, but other investment opportunities will not have the same integration risks faced by Freeport-McMoRan.

Source: 3 Reasons To Avoid Freeport-McMoRan