Phelps adds three-way twist to four-way battle

Phoenix-based copper giant Phelps Dodge (PD-N) has emerged as a white-knight bidder for both Inco (N-T, N-N) and Falconbridge (FAL-T, FAL-N), with the trio unveiling plans for a three-way merger valued at around US$40 billion.

Under the plan, Phelps would trade 0.672 of one of its own shares plus $17.50 in cash for each of Inco’s outstanding shares. The bid values Inco shares at $80.13 apiece, and represents a premium of 23% over Inco’s closing share price in Toronto on June 23 the last business day before the deal’s announcement. It is also 19% better than a competing bid by Teck Cominco (TEK-B-T, TCKBF-O), which stands at $28 in cash accompanied by 0.6293 of a Teck class B share.

As part of the scheme, Inco would boost the cash portion of its existing pro rationed bid for Falconbridge (FAL-T, FAL-N) to $17.50 from $12.50, with the share exchange ratio climbing to 0.55676 from 0.524 of an Inco share for each Falco share. Falconbridge’s board has unanimously approved the offer, and amended its support agreement with Inco.

Phelps has further agreed to buy up to US$3 billion worth of Inco’s convertible subordinated notes to help it fund its sweetened bid for Falconbridge, and “satisfy related dissent rights, as needed.” The agreement requires that the Inco-Falco deal be completed.

Inco’s revised bid values each Falconbridge share at $53.83, a 2.5% premium over Swiss-based Xstrata‘s (XSRAF-O, XTA-L) all-cash bid of $52.50 per share. Xstrata already owns just shy of 20% of Falconbridge; its bid expires July 7. Phelps says its subsequent acquisition of the enlarged Inco would deliver an 18.3% premium over Xstrata’s bid for Falco shareholders that retain their Inco shares.

Phelps’ proposed acquisition of Inco is not conditional on Inco’s acquisition of Falconbridge. That deal recently got the thumbs-up from the U.S. Department of Justice; it still needs approval from the European Commission. The EC is expected to deliver its verdict by July 12; Inco has extended its bid for a fourth time, this time until July 13.

The three-way deal includes a US$925-million break fee if Inco acquires Falconbridge but fails to consummate the subsequent merger with Phelps. On a stand-alone basis Inco’s break fee comes to US$475 million. Likewise, Phelps has agreed to a US$500-million break fee payable to Inco.

Either way, Phelps plans to close out the transaction by buying back up to US$5 billion worth (less the amount of any convertible notes acquired) of its shares within a year of closing.

The new Phelps Dodge Inco would reign as the world’s largest nickel producer and second-largest copper producer; it will also be a leading producer of molybdenum and cobalt. The behemoth would employ around 40,000 people at operations in more than 40 countries around the world. It would sport a total enterprise value of around US$56 billion.

Combined, the three companies earned US$1.9 billion on revenues of around US$6.3 billion during the first three months of 2006. The trio expects annual synergies of around US$900 million (US$550 million from the Inco-Falconbridge combination) to kick in by 2008.

The combined company would be headquartered in Phoenix, with the nickel division, dubbed Inco Nickel, domiciled in Toronto. Phelp’s chief executive and chairman would continue in his roles at the new entity, with Inco CEO Scott Hand taking a seat as vice chairman and Falco CEO Derek Pannell assuming the role of president. Pannell would head up Inco Nickel, which will house the zinc and aluminum operations. The board will comprise 11 members from Phelps Dodge and four from Inco and Falconbridge.

In the end, existing Phelps Dodge shareholders would own around 40% of Phelps Dodge Inco, with current Inco shareholders holding 31%, and Falconbridge holders owning the remaining 29%.

The deal is expected to close in September, pending approval by regulators and Phelps Dodge and Inco shareholders. Phelps has pledge no significant operational layoffs for three years, and doesn’t anticipate any regulatory hang-ups, as there is very little overlap between its existing copper business and Inco and Falconbridge’s nickel operations. It also said that any copper capacity acquired would have little impact on a very fragmented market.

Phelps plans to fund the acquisition and share buyback via US$22 billion in financing commitments in place from Citigroup and HSBC. Inco has received additional financing commitments from Morgan Stanley, Goldman, Sachs & Co., Royal Bank of Canada, and Bank of Nova Scotia to help fund its revised offer for Falconbridge.

Shares in Inco ended $7.03, or nearly 11%, better at $72.28, with Falconbridge finishing $2.83, or 5%, higher at $58.33 in Toronto following the news on June 26. For its part, Phelps slipped US$6.72, or 8%, to 76.23 on the New York Stock Exchange.