Freeport and Phelps set to become world’s copper giant

If shareholders give the go-ahead, Freeport-McMoRan Copper & Gold‘s (FCX-N) proposed takeover of Phelps Dodge (PD-N) will create the world’s largest publicly traded copper company and the largest North American-based mining company.

The move by Freeport is seen as both a long term bet on copper prices remaining high, and a desire for the New Orleans-based company to diversify its asset portfolio.

The deal which has been unanimously approved by both companies’ boards and is anticipated to be closed in the first quarter of 2007 — will see Freeport dish out a total of roughly US$25.9 billion for the Phoenix-based Phelps in cash and stock.

Freeport is offering US$126.46 a share — a 33% premium on Phelps’ US$95.02 closing price on Nov.17 in New York.

The offer is broken into US$88 in cash plus 0.67 of a Freeport share for each Phelps Dodge share. Freeport says it will finance the roughly US$18 billion cash portion with debt.

But the acquisition comes at a time when many analysts are forecasting lower copper prices. While concerns that supplies were short of demand drove copper up to a peak price of nearly US$3.90 a lb in May of this year, those fears are subsiding, and 28% has come off of copper prices since then. On Nov. 20 copper was trading at US$3.05/lb.

Analysts say while Chinese demand for copper remains strong, an increase in copper substitutes in the construction industry and a slowdown in the American housing market, are making current supplies look sufficient — despite Freeport’s contention that capacity will remain tight going forward.

“If there’s so little new capacity,” says Charles Bradford of Soleil-Bradford Research in New York, “then why is Freeport saying Phelps has a lot of capacity going forward? There’s inconsistency in the data.”

Freeport says it expects copper production for the merged companies to grow roughly 25% over the next three years.

It estimates the combined assets will yield 3.7 billion lb copper, 11.8 million oz gold, and 69 million lb molybdenum. Freeport is currently not a molybdenum producer while Phelps doesn’t currently produce gold.

But while analysts like Bradford have misgivings about the gamble on copper prices, the diversification of Freeport’s asset portfolio is being seen as a shrewd maneuver.

Until now Freeport has been a single asset player with its Grasberg mine in Indonesia. And while Grasberg is the world’s largest copper and gold project in terms of reserves — with roughly 37 billion lb of copper and 40 million oz of gold Indonesia is not considered the pinnacle of political stability.

“Freeport is in one country and it’s not necessarily the place you want to stake 100% of your assets in,” Bradford says.

London-based Control Risk, a business-risk consultancy group, ranks the Papua region of Indonesia — where Grasberg is located — as a high security risk zone, and Indonesia as a medium political risk country.

In acquiring Phelps, Freeport will broaden its asset portfolio to include projects in the United States, Chile, Peru and the Democratic Republic of the Congo (DRC).

With assets spread so far across the globe production synergies are considered unlikely, but Freeport says the takeover will give it the scale it needs to acquire equipment and prospects in an increasingly competitive market.

Alex Gorbansky, an analyst with the Frontier Strategy Group says the deal “creates a company with the financial and operational resources to go head-to-head with the likes of BHP Billiton (BHP-N, BLT-L), Rio Tinto (RTP-N, RIO-L), and Anglo American (AAL-L, AAUK-Q).”

In addition, Gorbansky pointed to Freeport’s operational expertise and history around Grasberg, and said such expertise should be useful at Phelps’ projects like Tenke Fungurume in the DRC.

Freeport says the deal is accretive to both earnings and to cash flow. Using 2006 figures, combined operating cash flow would be US$6.5 billion, the company says.

In New York on November 20 Phelps shares approached the premium being offered, rising nearly 27% or US$25.45 to US$120.47 on close to 30 million shares traded.

Freeport was off slightly, down roughly 3% or US$1.77 to US$55.63 on nearly 23 million shares.

Freeport’s market cap and earnings per share — roughly $11 billion and $7.87 per share respectively are both less than Phelps, which stand at US$24.5 billion and US$9.26 per share respectively.