Freeport-McMoRan Copper & Gold Inc. (FCX)’s $9 billion bet on Gulf of Mexico oil and gas assets is the latest example of mining companies’ move into energy that ends up hurting investors.
The company, the biggest publicly traded copper producer, slumped 16 percent yesterday, the most in four years, after saying it agreed to buy Plains Exploration & Production Co. (PXP) and McMoRan Exploration Co. (MMR) The stock fell 4.2 percent to $30.81 at the close today in New York.
Freeport, which mines in the U.S., Indonesia and Africa, said the deals will help it to keep expanding and that it couldn’t find a suitable copper acquisition. The move was criticized by BlackRock Inc., one of Freeport’s largest investors, and Dan Rohr, an analyst at Morningstar Investment Service, for failing to create any obvious cost savings.
“In some regards this is a return to an old model that we had seen with the oil majors decades ago, owning significant copper assets like Standard Oil did,” Rohr, who’s based in Chicago, said in an interview. “The market is telling you that the whole may be worth less than the sum of the parts.”
BHP Billiton Ltd., the biggest mining company, took writedowns after spending $20 billion last year on U.S. energy assets. Vedanta Resources Plc, a London-based metals producer, has dropped 49 percent since announcing a $8.67 billion acquisition of Cairn India Ltd. in 2010 to gain access to India’s biggest onshore oil field.
Despite that, there has been an increasing number of mining companies buying energy assets. Including Plains and McMoRan, there have been 19 of such deals with a combined value of $19.6 billion this year, according to data compiled by Bloomberg. There were 13 totaling $20.2 billion in 2011, up from $7.3 billion of transactions in 2010 and just $260 million in 2009, the data show.
Freeport’s return to energy 18 years after it exited that business by spinning off McMoRan illustrates the challenge facing some of the biggest miners. While Freeport’s mines are still profitable, it’s a matter of contention how the Phoenix- based company spends that cash. Large, undeveloped deposits are increasingly scarce and investors have grown unforgiving of dealmaking missteps and construction delays.
The company posted third-quarter net income of $824 million on $4.42 billion in sales. Cash and cash equivalents stood at $3.73 billion on Sept. 30 and the company forecasts copper output will rise by more than 25 percent over the next three years. In contrast, McMoRan and Plains both lost money in the third quarter.
Opportunities for investment in copper are “limited” because mining projects take time to develop and most of the large deposits are already owned by competitors, Freeport Chief Executive Officer Richard Adkerson said yesterday on the company’s conference call.
Freeport said it will pay about $50 a share in cash and stock for Houston-based Plains, representing a takeover premium of about 39 percent based on the companies’ Dec. 4 closing share prices. Holders of McMoRan will get $14.75 in cash and 1.15 units of a royalty trust for each share. McMoRan’s closing price on Dec. 4 was $8.46.
“It’s been a surprise and disappointment to a number of investors who liked that focus” on copper, Dwight Anderson, founder and managing partner of hedge fund Ospraie Management LLC, which holds Freeport and Plains shares, said yesterday on Bloomberg Television’s “Market Makers” with Stephanie Ruhle and Erik Schatzker. “It shows the difficulty in actually being able to put cash flow and capital to work in the space.”
Analysts at Deutsche Bank AG, Macquarie Bank Ltd., Citigroup Inc., RBC Capital Markets, Goldman Sachs Group Inc. and BMO Capital Markets cut their ratings on Freeport shares after the deals were announced. BMO downgraded Freeport to hold from buy “on possible diminished shareholder returns, unwanted diversification and self-inflicted loss of trust,” Tony Robson, co-head of metals and mining, said in a note today.
There are no apparent cost savings to be had from buying Plains or McMoRan, Morningstar’s Rohr said in an interview. A mining deal or returning cash to investors would have been preferable, he said.
“Presuming the market price of Plains was correct, you’d have to believe that the incremental value creation you get from mashing these two sets of assets together would exceed the premium you’re paying to obtain those assets,” Rohr said. “And that beggars belief.”
The strategic justification for the two deals was questioned by BlackRock Inc., which has an 8 percent stake in Freeport, according to a February filing. Evy Hambro, manager of BlackRock’s $12 billion World Mining Fund, said on the conference call that Freeport investors should be allowed to vote on the deal. The Freeport stock used as payment isn’t sufficient to require a vote by shareholders, according to the mining company.
“Congratulations on making one of the worst teleconferences I’ve ever heard to justify a deal,” Hambro told Adkerson. “I haven’t heard anything on this call that in any way justifies why these companies should be put together.”
Investors have the freedom to diversify their own portfolios “and don’t need management teams to do it for them,” Hambro said.
“I hope you’re not going to be jumping to conclusions too quick and look at the history of why we’ve been successful in the past,” Jim Bob Moffett, Freeport’s chairman and also McMoRan’s co-chairman and CEO, said on the call in response to Hambro’s comments.
Freeport’s deals come on the heels of a Nov. 26 announcement by McMoRan that it had once again failed to achieve a flow test that would certify it could produce commercial quantities of natural gas from its Davy Jones No. 1 ultra-deep Gulf of Mexico well.
The news cleaved a third of the value off of McMoRan’s shares and opened the possibility that the much-ballyhooed Davy Jones project, in which the company has sunk almost $1 billion and on which Moffett has staked his wildcatter’s reputation, is a dud.
One industry geologist who has studied the near-shore gulf geological formation tapped by Davy Jones believes the company’s inability to get a conclusive flow test is indicative that the well will never produce.
“They are in a bad deep environment” in which overwhelming pressures and temperatures have squeezed out any commercial quantities of gas while peculiarities of the deep shale geology have produced well logging reports that -- erroneously -- show plentiful hydrocarbons are there, said Donald Timko, an independent Houston-based geological consultant.
Timko says his research indicates there is no commercial potential below 17,400 feet (5,300 meters). Davy Jones has been drilled down to 29,000 feet.
McMoRan has said it hasn’t yet given up on the well and laid some of Davy Jones’ problems to barite, a compound used to thicken drilling mud to keep pressure on the bore hold. At that pressure and temperature, the barite is turning to cement, clogging a flow test. The company has attempted to unclog it with solvents while investigating other possible solutions.
Freeport and McMoRan have maintained ties since their separation. In addition to Moffett they share five other board members. B.M. Rankin, co-founder of McMoRan with Moffett, serves as vice chairman of both boards.
Plains CEO James Flores is on the board of McMoRan because his company owns a 31.5 percent stake. He stands to gain more than $150 million from the deal, including payment in restricted shares, according to a Plains regulatory filing from April.
Under the new structure, Moffett will continue as chairman and Rankin will remain vice chairman. Adkerson will stay as CEO and also be appointed vice chairman. Flores will be vice chairman and head the company’s oil and gas operations.
The transactions announced yesterday promise to boost the value of personal stakes that Freeport’s top executives hold in McMoRan. For Moffett, stock and options worth about $44 million on Nov, 4 are now worth about $89 million, according to a Bloomberg News analysis of his holdings as of Dec. 31.
For Adkerson, McMoRan’s co-chairman, the value of his McMoRan holdings jumps to $14 million from $4.6 million, the analysis shows.
Since 2002, Moffett and Adkerson have taken almost all their compensation for their service at McMoRan in the form of stock options. Most of them were underwater before yesterday’s announcement.
The Bloomberg analysis compares the Dec. 4 closing stock price to its price yesterday, since McMoRan holders get interests in a royalty trust in addition to the $14.75 cash price. It examines their holdings as of Dec. 31 because that is the last date for which the company has disclosed comprehensive information.
Freeport’s biggest deal has been its $26 billion takeover of Phelps Dodge Corp., another U.S. copper miner, in 2007 to expand beyond its Grasberg copper and gold mine in Indonesia.
The Plains acquisition would rank as the second-largest purchase of an oil and gas exploration and production company by a miner, according to data compiled by Bloomberg. The McMoRan deal would be the sixth-biggest.
The Plains and McMoRan deals will reduce Phoenix-based Freeport’s earnings before interest, taxes, deprecation and amortization from mining to 74 percent of the total next year.
“The change in strategy is something that we will question,” Ospraie’s Anderson said.
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