Freeport-McMoRan adds oil and gas to the mix

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$10.3 billion has divided analysts on whether the acquisitions make sense. 

The world’s largest publicly traded copper company is buying Plains Exploration & 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. It is spending another 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.

Freeport’s purchase price of Plains Exploration and Production Co. works out to US$50 per share — a 39% premium to its closing share price on Dec. 4 — while the cash consideration of US$14.75 per share for McMoRan Exploration represents a 74% premium.

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 would be generated from mining and 26% from oil and gas, with 48% of combined earnings before interest, tax, deductions and amortization from U.S. operations.

But the deal puzzles analysts like London-based Tony Robson of BMO Capital Markets. “The company’s presentation on the transaction . . . contains no compelling rationale to explain the shift in focus,” he writes in a research note to clients, adding that “existing FCX shareholders hold the stock for its key copper exposure that is now likely to be diluted by the deal.”

Robson also notes that the purchase “suggests management sees a lack of attractive growth opportunities within the copper sector.” 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 mineral district in North America and the Cerro Verde and El Abra operations in South America; and the Tenke Fungurume mineral district in the Democratic Republic of the Congo.

What Robson finds “most perturbing” about the deal, however, “is the lack of opportunity for shareholders to vote on a transaction that is two-thirds the market capitalization of Freeport, especially given management’s financial interest in one of the targets.”

“Shareholders may seek to lobby the board for a vote on this transaction, or if not listened to, possibly remove the board,” he adds. “The bids may well be accretive, but recent history suggests otherwise, and Freeport does not have the management to assess petroleum ventures.”

Adrian Day, president of Adrian Day Asset Management in London, described the transaction as “odd” and noted that it was “badly handled,” which he says is “unlike Freeport.” Day argued that there was no advance indication that the company wanted to expand into oil or any other resources, and the deal leaves him wondering whether Freeport’s strategy is “to become a mini-BHP.”

He added that “markets need some clarity both on rational and future deals . . . surely companies have learned from Barrick’s disastrous move into African copper that the market wants explanation and strategy . . . it seems almost like a ‘trust us’ deal.”

But Day says he does trust Freeport’s management. He describes it as the best copper company out there — and would use the drop in its share price as a buying opportunity.

Some argue that investors could do this kind of diversification 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 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 of 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 U.S. 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 press time in New York, Freeport was trading at US$32.52 per share within a 52-week range of US$30.54 to US$48.96.