Freeport-McMoRan Copper & Gold’s (FCX-N) surprise decision to buy two oil and gas companies in a deal involving cash and shares worth nearly US$10 billion has divided analysts on whether the acquisitions make sense.
The world’s largest publicly traded copper company is buying Plains Exploration and Production Company (PXP-N), which has oil and gas interests in California, Texas, Louisiana, and the Deepwater Gulf of Mexico, for US$6.9 billion in cash and stock and is spending about US$3.4 billion in cash on McMoRan Exploration (MMR-N), a company that has natural gas and oil assets in the Gulf of Mexico Shelf and onshore in the Gulf Coast area.
Under the terms of the transactions, Freeport’s effective purchase price of Plains Exploration and Production Company works out to the equivalent of US$50 per share, which represents a premium of 39% to its closing share price on Dec. 4, while the cash consideration of US$14.75 per share for McMoRan Exploration represents a premium of 74%.
Freeport argues the acquisitions will provide exposure to energy markets with positive fundamentals, strong margins and cash flows, exploration leverage and financially attractive long-term investment opportunities. On a pro forma basis in 2013, about 74% of the company’s combined operating income plus depreciation, depletion and amortization will be generated from mining and 26% from oil and gas, with 48% of combined EBITDA from U.S. operations.
The deal puzzles analysts like London-based Tony Robson of BMO Capital Markets. “The company’s presentation on the transaction released this morning contains no compelling rationale to explain the shift in focus,” he writes in a research note to clients. “Arguably existing FCX shareholders hold the stock for its key copper exposure that is now likely to be diluted by the deal.”
Robson also speculates that the purchase “could indicate lack of attractive growth options for the company within the copper space.” Certainly it is becoming harder to find good copper projects in safe jurisdictions. Freeport’s portfolio of assets includes the Grasberg minerals district in Indonesia, the world’s largest copper and gold mine in terms of recoverable reserves; the large-scale Morenci minerals district in North America and the Cerro Verde and El Abra operations in South America; and the Tenke Fungurume minerals district in the Democratic Republic of Congo.
Adrian Day, president of Adrian Day Asset Management in London, describes the transaction as “odd” and notes that it was “badly handled,” which he says is “unlike Freeport.” Day argues that there was no advance indication that the company wanted to expand into oil or any other resources and the deal leaves him wondering what Freeport’s strategy is — “to become a mini-BHP?”
“Markets need some clarity both on rationale and future deals...surely companies have learned from Barrick’s disastrous move into African copper that the market wants explanation and strategy,” he continues. “It seems almost like a ‘trust us’ deal.”
At the same time, however, Day says he does trust Freeport’s management and the company remains the best copper company out there, so he would use the drop in its share price as a buying opportunity.
Some argue that this is the kind of diversification that investors could do for themselves and don’t need a management team to force feed it to them. But not everyone agrees. “While we understand the argument,” Anthony Rizzuto of Dahlman Rose & Co. points out in a research note, “in our opinion Freeport’s shares historically were not given appropriate value as a pure play, especially when compared to diversified producers such as Rio Tinto and BHP Billiton, which on average trade at higher multiples. We believe Freeport paid a reasonable price.”
Patricia Mohr, vice president, economics and commodity market specialist at Scotiabank in Toronto, notes that Freeport “probably recognizes that there are strong opportunities in "light, tight oil," which can be profitably developed with the new multi-fracturing, horizontal drilling technology.”
“The United States is having a remarkable recovery in its oil production based on this technology,” she says in an email response to questions.
Shares of Freeport closed down US$6.11 or 15.96% at US$32.17 on a trading volume of 15.4 million shares. At presstime in New York Freeport was trading at US$32.52 per share within a 52-week range of US$30.54-48.96.
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