Freeport-McMoRan (FCX) announced the sale of its oil and gas business in California, just weeks after it sold oil and gas activities in the Gulf of Mexico. This latest divestiture almost marks the end of the painful diversification adventure into the energy business.
Freeport's debt load continues to come down following these divestments, as the company is left with a core mining operation which has been shrinking following some divestments. At the same time, the balance sheet remains leveraged as equity holders have suffered quite some dilution. As copper prices have not rebounded in any big way, it is not a given that equity holders will gain handsomely from these prudent moves in the years ahead.
Given the uncertainty involved and poor decisions made in the past, I would still be very cautious on the outlook for equity holders. While long-term investors might see handsome returns, it requires a big rebound in copper prices, as the company continues to operate in a challenging environment until that point in time.
The Deal - Getting Almost Entirely Out Of Energy
Following the $2-billion sale of Deepwater Gulf of Mexico properties to Anadarko Petroleum (APC) a few weeks ago, Freeport has now agreed to sell its onshore activities in California to privately owned Sentinel Peak Resources.
Freeport will receive $592 million in cash for the properties which produce about 28,600 barrels of oil equivalent per day. The good news is that it will receive $50 million for each year in the period 2018-2020, if Brent crude prices average at $70 per barrel or more. Including the assumption of abandonment obligations with a value of $100 million, the deal tag could increase towards $842 million.
Freeport's remaining energy assets include the onshore fields in South Louisiana and the Shelf of the Gulf of Mexico, as well as offshore activities in California, among others. The production of these remaining fields is very modest at 8,600 barrel of oil equivalent per day. if sold, Freeport might be able to fetch a couple of hundreds of million dollars for these assets.
Keeping An Overview On Leverage Reduction
Freeport has been very busy to deleverage this year as multiple deals and different closing times make it hard to keep an overview. The company ended the second quarter with net debt of $19 billion, while it has $4 billion in environmental and abandonment liabilities being present on its books as well.
Many divestments still have to close and they are not going all smoothly. The company expects $1.4 billion in net cash proceeds from the deepwater Gulf of Mexico assets, $2.65 billion for its 56% stake in the Tenke mine, as well as a $90 million consideration for some smaller Haynesville shale assets.
That means that net debt will fall towards $15 billion if all the deals close, as some contingency payments could reduce net debt a little further. The latest deal will reduce net debt by another $600-750 million, as net debt realistically comes in at $14-14.5 billion. If all the remaining energy segments are sold, net debt could fall towards $14 billion as environmental liabilities are coming down as well.
Becoming A Pure Play On Copper
Freeport is returning to something which it once was, a pure play on copper and related byproducts. In this recent article, I gave a brief overview of the remaining copper assets and their potential valuation, which is a hard thing to do of course.
After selling a 13% stake in the Morenci mine for $1 billion in May of this year, the remaining 72% stake could be valued at $5.5 billion. That furthermore suggests that the entire mine is valued at $7.2 billion, for operations which produce 1.2 billion pounds of copper each year. That suggests that production is valued at $6 per pound.
Based on the $2.65 billion sale price of the 56% stake in the Tenke mine, that mine is valued at a total of $4.5 billion, equivalent to $9 per pound being produced each year.
If we exclude production from the Morenci, Tenke and non-controlling interests, copper production from the remaining mines comes in around 2.2-2.4 billion pounds a year. If we would award this production a $6-9 per pound multiple, copper producing assets could be valued at roughly $14-21 billion. Including the remaining 72% stake in Morenci at a $5.5 billion valuation, all remaining copper assets could be valued at roughly $20 to $27 billion.
I would like to stress that it is a daunting task to value all these mines as production and transportation costs differ. It should furthermore be said that some other mines, notably the Grasberg mine in Indonesia, yield lucrative byproducts, making them more valuable. That said, the Grasberg mine, in particular, faces higher political risks as well, reducing the value to any commercial buyer.
Debt Becomes Rapidly More Manageable
While it is the energy adventure which nearly bankrupted Freeport and is now causing the painful dilution, copper is not doing great as well. Mining operating profits totaled $400 million in the second quarter of 2016, as copper prices remain stuck at around $2 per pound.
With net capital expenditures being flat for the mining business and depreciation charges running at $400 million a quarter, EBITDA for Freeport runs at little over $3 billion a year. If we assume that net debt indeed falls below $14 billion following the announced divestitures, leverage ratios remain high at 4.5 times EBITDA.
While this remains elevated, debt is somewhat manageable as Freeport benefits from very long duration of its debt, as well as relatively low interest rates. This gives it a key advantage versus some other challenged players.
Worth Owning If Management Executes
The $13-14 billion remaining leverage position remains high, but Freeport could always sell more assets or stakes in its mining operations to reduce leverage further, if needed. The question is what is left for equity holders.
Mining assets are valued at $20-27 billion based on the copper production, but these are rough estimates and do not take into account revenues from byproducts such as gold and molybdenum.
It is hard to come up with a realistic value as these assets are often unique. One gauge is to look at the balance sheet, on which all the mining assets are valued at roughly $37 billion. That is nearly double the low end of the $20-27 billion range calculated above, although that number does not include value of byproducts.
The issue is of course that the first $13-14 billion of this valuation will have to go towards debt holders. If mining assets are realistically worth $27-37 billion, equity might be worth anywhere between $13.5 and $23.5 billion. That is a huge range of course, equivalent to $10-18 per share with nearly 1.3 billion shares outstanding at this point in time.
You can see that leverage still has a huge impact for equity holders, as relative modest swings in the valuation of the underlying assets create much greater swings for equity holders. Note that the valuation remains uncertain as the calculated range does not provision for other obligations such as environmental clean-up costs, large transaction costs as well as any ongoing issues.
Deleveraging, Locking In The Losses
The round-trip in oil & gas has been very painful, but that is a thing of the past as these divestitures lock in the losses. The good thing is that leverage is coming down and given the duration and cheap cost of debt, Freeport has the potential to operate with higher leverage ratios.
As a result, bankruptcy fears have alleviated in a rapid way, but the question for equity holders is what their future can look like. One thing is for sure, they have suffered large capital losses, the business is a lot smaller, large dilution has been incurred and Freeport still carries a lot of debt, all resulting from mismanagement in the past.
To create any real opportunities Freeport would of course be helped by high copper prices, although that is outside of the direct control of management. All that management can do now is slash costs, defer capital spending, close previously announced deals and avoid making stupid capital allocation decisions.
I will continue to watch the story with great interest, but still see few fundamental reasons to buy the shares given the discussed circumstances, as earnings power of the mining business is none to very limited with current prices.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.