On December 5, 2012 Freeport McMoRan Copper & Gold (FCX) announced that it would acquire Plains Exploration & Production (PXP) and McMoRan Exploration (MMR) for $10.3 billion in cash and stock that priced PXP at what then was a 73% premium. The deal was unpopular with Freeport shareholders and many analysts for several reasons: it was done secretively, it smudged Freeport's value as a barometer of global copper prices and growth, and it provided $130 million in bonuses and stock for Chairman Dr. James Moffett and James Flores CEO of Plains who also is on the Board of McMoRan, which FSC spun off in 1994. Jim Cramer said the deal "failed the smell test." The plan has prompted lawsuits from shareholders at all three companies. See here for a pdf sampling.
Upon news of the deal, Freeport's price plunged from $38 to $30 a share before recovering to about $33. The collapse of prices for precious metals and the entire mining sector in the past two weeks has dropped Freeport further. FCX closed Thursday at $27.24, down from $43.65 in September 2012. Thursday's bottom was a 43-month low going back to 3Q 2009. The price of copper, Freeport's major product, has been weak since January 2011 as copper's ETF (JJC) shows, and during this 28-month period, Freeport's market cap has plunged 54% to $26.6 billion.
Via the acquisitions, Freeport aims to reduce its country risk and diversify into a major mixed commodity producer by making oil and natural gas 25% of its production. The plan has as many merits as it has moving parts, one of which has arrived. News Thursday evening from Plains Exploration complicates and may negate the acquisition. Some may applaud this, but it would initiate a period of price volatility, especially if there is a period of extended re-negotiation.
PXP's Phobos deep water project in the Gulf of Mexico looks promising. Plains Exploration shares have risen while FCX is down 25% since the acquisitions were announced. The analysts Bloomberg quotes (see link in previous paragraph) believe that PXP shareholders may demand more compensation from FCX given that the portion of the purchase secured by FCX shares are now worth less and PXP $6/share more. Freeport shareholders will not like this as its share price already has been pounded by slipping copper prices and a massive collapse in the gold price in April, especially since Goldman Sachs called on shareholders to short gold, as I have discussed here.
The purchase of PXP was for $50/share and for Freeport stock totaling $6.9 billion. To finance the sale, FCX would use its massive cash reserves plus a series of bond issues requiring payment from 2016-2030. The deferral of much of the debt service seems like a good plan given the ongoing decline in the dollar and general fiscal and economic uncertainty. But the deal, lawsuits and results from PXP's drilling are heading for turbulent convergence. Many big players are watching: Anadarko (APC) owns 30% of the Phobos site, while Exxon (XOM) owns the remaining 20%. Plains Exploration shareholders are scheduled to vote on the deal May 20.
Phobos "could be a life-altering find," Steve Gerbel, founder and president of Chicago Capital Management LP, a Chicago-based hedge fund focused on merger arbitrage, said in a phone interview quoted by Bloomberg. If "you were Freeport, you'd try everything you could to get this deal done before that well comes in." Spokesmen for Plains and Freeport had no comment on the status of the acquisition or pending lawsuits. Results from the Phobos well are not a sure thing, so that is another level of uncertainty to the situation. FCX shares are down to $27.76 as of this writing, midday April 19.
In this climate, no one can accurately estimate profitability, share price, cash flow or debt service for FCX in the next year or two and only speculators should add to or initiate positions. There now are major wild cards in this deck.
McMoRan Exploration would be acquired for $14.75/share per the deal. MMR currently is trading at $16.44. It is mainly an exploration company at this point with no net EPS or dividend. Still, its prospects put it at a trading premium to the deal. All these complications do not sweeten the outlook for Freeport shareholders. Rick de los Reyes, an analyst for T. Rowe Price quoted by Bloomberg, summed up the situation by saying "it would not be prudent" for FCX to increase its purchase price "given the decline in its own shares and ongoing weakness in the price of copper, its major product, which is tied to declining prospects for global growth" including in China, the primary buyer for the commodity.
Meanwhile, developments in Africa indicate how rapidly the outlook for commodity companies may change and change again. On April 5, the Mining Minister of the Democratic Republic of the Congo (DRC), Martin Kabwelulu banned export of copper and cobalt ore unless it had "value added" to it before shipping. However, Moise Katumbi, Governor of Katanga, the southernmost province in the DRC said his province will not implement the ban because Katanga does not have the electricity to support the process and that "when you have partners you consult with them" before implementing such decrees. "They will continue to export concentrates until there's enough electricity," he concluded. Freeport and other companies in the region are dealing not simply with "resource nationalism" but the interface of civil strife, geopolitics and international finance that goes back many decades.
Students of history may know that the turbulent wars in the Congo in the 1960s included the secession of Katanga province under the leadership of Patrice Lumumba. His opposition to the central government eventually was crushed amid jockeying by major players in the cold war and a problematic "peace-keeping" mission by United Nations armed forces. There has been sporadic fighting between separatist groups and DRC forces for years. In the past 10 weeks, the conflict has spiked. The Congo is the source of more than half the world's cobalt and 4% of its copper. There also are abundant tin resources. In 2012, Freeport exported 160k tons of copper from its mine at Tenke Fungurume. The DRC exported 650k tons in all, most of it from Katanga.
I discussed the dynamics of this growing, world-girdling storm of commodity jockeying and impoverishment in my piece "Barrick Gold Hits Glacier." The DRC's brief ban on exports was just one example of the turbulence that hurt the production outlook and share price of copper companies Glencore International (GLEN) and Lundin Mining (OTCPK:LUNMF) before news of Katanga's opt-out. These issues are essential to discussion of the prospects of Freeport McMoRan and indicate some of the motives driving it to diversify into American energy production.
The threat to copper and cobalt miners (for example at Tenke Fungurume) now seems allayed, though the discussions between the Mining Minister and provincial governor Katumbi may be sharp: the long-standing conflict between Katanga and the central government in Leopoldville far to the northwest highlight another wrinkle in the tension between growth, production, nationalism, business and geopolitics. The high stakes and formless wars ruffle expectations for development, peace and prices. Freeport McMoRan has a stake in this situation, which interfaces with the contentions and uncertainty shadowing its pending and now imperiled acquisitions of Plains and McMoRan. It is ironic since overseas difficulties in the Congo and at its huge Grasberg Minerals complex in Indonesia helped drive the deal. Yet the difficulties in all these areas now are converging.
Vladimir Zirnov has offered on SA a cogent assessment of the case for buying FCX. However, political and armed conflict in Katanga, the positive news about drilling at Phobos and the consequent rise in PXP share prices raise questions about Freeport McMoRan's acquisition of PXP and MMR. Unless one has deep pockets and a taste for a good bet, it might be better to see how the lawsuits and shareholder votes play out before adding to or initiating a position in Freeport McMoRan.