Freeport-McMoRan: New Twist At Grasberg

| About: Freeport-McMoRan Inc. (FCX)
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Summary

The Indonesian government wants to take a majority stake in Freeport Indonesia in 2 years.

Papua administration also wants its piece of the pie.

Freeport-McMoRan should find a way to completely exit Indonesia with minimal damage.

The flow of news from Indonesia, where Freeport-McMoRan (NYSE:FCX) fights for its contractual rights with the local government, intensifies. This is typically a sign that we may hear some concrete information soon. Volatility in Freeport-McMoRan's shares may increase, providing opportunities for both longer-term investing and trading.

I previously covered this story, so in case you did not see it, you may find it useful to read previous articles (here and here) to learn more about the context. Without further ado, let's evaluate the recent news from Indonesia and what they might mean for the company and for the stock.

Bloomberg reported that the Indonesian government wanted to take a majority stake in Freeport Indonesia in two years. Preparations for this action have already begun by turning aluminium producer PT Indonesia Asahan Aluminium into a holding company.

At the same time, the administration of Papua, where Grasberg is situated, expressed its desire to get a 10% share of divested shares of Freeport Indonesia. Papua officials commented that Indonesian president "completely agreed with our stance on Freeport" and that Papua and Jakarta were fighting for the same thing.

As I previously commented, this time Indonesia is serious about getting its hands on Grasberg. In this light, all that Freeport-McMoRan can do is to maximize the value of its exit from Indonesia.

When the new part of the Indonesia story began, I was thinking that Freeport-McMoRan should find a way to minimize the damage and to continue operations at Grasberg. Now, it looks like the exit from Grasberg is almost inevitable and the only question is the price.

The reason for this is that Freeport-McMoRan cannot stay with a minority stake in the project as this will be a strategic suicide. The Indonesian government has already shown its inclination to change rules on the fly.

Grasberg open pit mining is coming to an end, and Freeport-McMoRan should be investing significant amount of capital to further develop the mine and continue production. Also, the Indonesian government wants Freeport to build a new smelter in the company. Without those investments, Freeport-McMoRan won't be able to profit from the remaining stake in Grasberg (in case it agrees to divest it).

However, Indonesia is basically non-investable for Freeport-McMoRan if it loses the protection of the current Contract of Work. You can only imagine what other requirements for Freeport may arise if the company is under such pressure during the term of the existing Contract of Work, which is now mostly ignored by the Indonesian government.

In the comments section of my previous article on Freeport, some readers argued that the resolution of the problem through arbitration was unlikely. Arbitration takes time. In addition, going to arbitration could bring additional problems to the already troubled operation.

However, I do not see how Freeport-McMoRan can get out of Indonesia without losing much value. The terms of the Indonesian government are unacceptable because Freeport will have to put more money into operation without any guarantee of the safety of its investment.

Therefore, the company must find a buyer which will step in and buy Freeport-McMoRan's remaining stake right after the company divests the majority stake to the Indonesian government. Finding such a buyer takes time and arbitration will offer this time to Freeport-McMoRan.

Let's now look at what this all means for Freeport-McMoRan's shares. I'm a bit puzzled by the fact that trading in the company's shares has been rather calm in recent days, despite signs of increased activity in Indonesia. Most likely, the market wants to see additional news on this front before committing to positions.

In the absence of definitive news, the existing local downtrend may continue, ultimately providing an opportunity for a long entry at an attractive price. At the same time, any sign that Freeport-McMoRan was able to orchestrate a decent exit from Indonesia might send its shares closer to the highs seen at the beginning of this year. Judging by the density of the news flow, we will know more information on the negotiation process soon.

Some readers suggested that my hold rating of Freeport-McMoRan was a bit optimistic, but I believe that it is appropriate at this point. Freeport-McMoRan's shares are not a screaming buy at these levels, given the risks of prolonged fight in Indonesia, but the upside from the potential exit from Indonesia is also a real possibility.

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.