Mining giant Freeport-McMoRan Copper & Gold Inc. (FCX - Analyst Report) has made a major stride to venture into the U.S. energy space. The company has forged definitive merger pacts, under which, it will buy Plains Exploration & Production Company and McMoRan Exploration Co. for roughly $9 billion.
The Phoenix-based company said that it will pay $6.9 billion in cash to acquire Texas-based independent oil and gas company, Plains. Moreover, it will takeover Louisiana-based exploration and production company McMoRan for roughly $2.1 billion (excluding 36% interest currently owned by Freeport and Plains) in cash. The total transaction value is roughly $20 billion taking into account the debt to be assumed by Freeport as part of the deal.
Plains own oil and gas assets in California, Texas, Louisiana and the Gulf of Mexico. McMoRan, an ultra deep-water driller, spun off from Freeport in the 1990’s. The company shares management with Freeport. Plains own a 31.5% stake in McMoRan and holds a couple of seats in the latter’s Board. McMoRan’s shares took a sharp tumble recently as its drilling update showed a delay in the development of a major well (“Davy Jones”) in the Gulf of Mexico.
The transactions are expected to consummate in second-quarter 2013. Following the closure, the combined entity will be based in Phoenix, Arizona, and will have offices in Houston, Texas, and New Orleans, Louisiana.
James Moffett, the incumbent chairman of Freeport and co-chairman and CEO of McMoRan, will remain as chairman in the combined entity. Richard Adkerson, president and CEO of Freeport and co-chairman of McMoRan, will retain his position following the merger. Plains’ chairman and CEO James Flores will become the vice chairman of Freeport and the CEO of its oil and gas business.
Freeport is funding the cash portion of the twin deal with a $9.5 billion financing from JPMorgan Chase Bank, N.A., a unit of JPMorgan Chase & Co. (JPM - Analyst Report) . It will also use the fund to repay Plains' outstanding debt. Credit Suisse Securities (USA) LLC acted as financial advisor to Freeport on both the deals.
The move represents a part of the company’s strategy to diversify away from its bread-and-butter copper mining business. Freeport, which is struggling with declining copper and gold sales, is seeking new avenues for growth. Lower production rates at its Grasberg mine in Indonesia dragged down copper sales and hurt its bottom line in the most recent quarter.
Freeport’s copper business has been hammered by the sluggish global economy. Demand from key end markets, including construction materials and electronics, remain weak due to the overall economic softness. As such, the buyouts are expected to usher in new opportunities for the company.
Investors, however, viewed the move to enter the energy markets as risky and questioned the reunion with troubled McMoRan, and Freeport’s shares slipped 16% following the deal announcement. Shares of Plains and McMoRan rallied 23% and 87%, respectively.
Per the agreement, Freeport is buying Plains for $50 per share in cash and stock. The offer represents a 39% premium to Plains’ closing price on December 4. Plains shareholders will be given an option to receive cash or stock.
For the McMoRan buyout, the company is paying $14.75 per share in cash, representing a 74% premium to McMoRan’s closing price on December 4. McMoRan shareholders will also get 1.15 units of a royalty trust for each share they hold. While the total deal value is $3.4 billion, the actual cash portion of the transaction is $2.1 billion (net of Freeport and Plains stakes). Both transactions are subject to regulatory clearances and approval of the shareholders of the respective companies.
An Emerging Natural Resources Powerhouse?
The merger is expected to make the combined entity a leading natural resource conglomerate in the U.S., leveraging Freeport’s industry-leading mineral assets and the oil and gas resources of Plains and McMoRan. The addition of Plains’ established oil production assets and McMoRan natural gas drilling capabilities and shallow water ultra-deep properties will provide Freeport a significant exposure to energy markets.
Freeport expects the combined entity to generate operating cash flows of roughly $9 billion and EBITDA of around $12 billion in 2013. Roughly 74% of the combined company’s projected EBITDA is expected to derive from mining with the balance coming from oil and gas. The company sees significant synergies from the acquisitions.
Neutral on Freeport
We are optimistic about Freeport’s African operations considering the potential at the Tenke Fungurume minerals district in Democratic Republic of Congo. However, a weak global economy is affecting demand for copper and higher production costs remain a concern.
We are also wary about the dilution associated with the newly announced deals and increased leverage following the merger. Freeport, which had total debt of roughly $3.5 billion at the end of the third quarter, expects its debt to jump to around $20 billion ($16 billion net of cash) following the merger.
Freeport, which competes with Newmont Mining Corp. (NEM - Analyst Report) and Southern Copper Corp. (SCCO - Snapshot Report) , retains a short-term Zacks #3 Rank (Hold). We have a long-term Neutral recommendation on the stock.