This Deal Looks Like Nonsense, Incestuous Even

This article is part of our real-money portfolio series.

Boy, the market doesn't like this one. Neither do I.

Freeport-McMoRan Copper & Gold (NYSE: FCX  ) announced this morning that it is paying $9 billion to buy two oil and natural gas exploration companies, Plains Exploration & Production (NYSE: PXP  ) and McMoRan Exploration (NYSE: MMR  ) . Buyout premiums are 39% and 74% higher than their respective closing prices last night.

Shares of Freeport, a holding of the real-money portfolio I manage for The Motley Fool, fell 15% when the market opened and have pretty much remained down that amount.

There are two problems with this deal that I see.

The deal looks like a bailout
First, McMoRan appeared to be in trouble last week with shares dropping 31.5% over the course of the week. This happened after it announced further difficulties in obtaining a production flow test from its very deep natural gas well, Davy Jones, in the Gulf of Mexico. According to reports, the well is clogged by a component of the drilling mud and the company's been unable to clear it for months. An analyst at JPMorgan said that if McMoRan cannot get it unclogged, then it "might have to abandon the well."

That would be bad news and could affect the company's ability to obtain additional financing, according to Leo Mariani of RBC Capital Markets. Now, however, it's getting a huge cash infusion from Freeport. Given that James Moffett is the CEO and co-chairman of McMoRan as well as the co-chairman of Freeport, the transaction has the appearance of using one company to bail out the other.

If the Davy Jones well proves to be unworkable, then this could turn out to be a terrible deal for Freeport shareholders.

The deal looks incestuous
Second, the boards and senior executives of the three companies are interlinked. Here's a listing of many of those relationships, both at the board level and the senior executive level:

Name

Serves as...

And as...

James R. Moffett

CEO, President, Co-chairman, McMoRan

Co-chairman, Freeport board

Richard C. Adkerson

CEO, President, Co-chairman, Freeport

Co-chairman, McMoRan board

B.M. Rankin, Jr.

Vice chairman, Freeport board

Vice chairman, McMoRan board

Robert Addison Day

Director and chair of audit committee, Freeport board

Director and chair of audit committee, McMoRan board

H. Devon Graham, Jr.

Director, Freeport board

Director, McMoRan board

Gerald J. Ford

Director, Freeport board

Director, McMoRan board

J. Taylor Wharton

Advisory director, Freeport board

Advisory director, McMoRan board

James C. Flores

CEO, President, Chairman, Plains

Director, McMoRan board

John F. Wombwell

EVP, Secretary, General Counsel, Plains

Director, McMoRan board

Nancy D. Parmelee

CFO, Secretary, McMoRan

Controller of Operations, Freeport

C. Donald Whitmire, Jr.

Principal Accounting Officer, Freeport

Principal Accounting Officer, McMoRan

Dean T. Falgoust

Chief Compliance Officer, Freeport

VP, McMoRan

Source: S&P Capital IQ

There is common history between Freeport and McMoRan. In 1988, the parent company, Freeport-McMoRan, spun of 20% of its operations, creating FCX which started to trade publicly. MMR was spun out of the same parent company in mid-1994. In 1995, the parent company, Freeport-McMoRan, was taken public. Given that, it's not too surprising that they share some board members. At the end of 1997, Freeport-McMoRan disappeared by merging with IMC Global, which is now part of Mosaic.

However, after 17 years of being technically "separate" companies, it's disturbing to see how intertwined they remain. Seven of Freeport's 13 board members sit on McMoRan's board, accounting for half of the 14 seats there. The fact that the two companies do not seem to be fully separate at the highest levels makes me question whether there was enough independent due diligence in reaching the deal between the two companies.

Further, Plains owns 31.5% of McMoRan's outstanding shares and has two board seats as a result (which isn't uncommon for large shareholders). What's odd is that Freeport is buying Plains as well as McMoRan, rather than just buying the McMoRan shares from Plains.

A Lynchian deworsification?
The argument might be made that because of the close ties between McMoRan and Freeport, acquiring an oil drilling company won't "deworsify" Freeport away from its competency as a metal miner. But the fact that McMoRan has not turned a profit since 2002 (and has only done so twice going all the way back to 1995) really makes me think that this acquisition has a strong possibility of harming Freeport.

Maybe that's why Plains is also being purchased. It's been nicely profitable, having lost money in only two of the 13 years spanning1999 through 2011.

In Freeport's third-quarter call in late October, I couldn't find a hint of this acquisition developing. CEO Richard Adkerson's remarks about M&A activity discussed the "base case" of Freeport as "one that's focused on organic growth" and that this base case is "very attractive, and it's one that we're aggressively pursuing." Given that he included discussion of the company's 2007 acquisition of copper miner Phelps Dodge in making those comments, I took them to mean pursuing organic growth -- and possibly acquisitions -- in mining. So this morning's announcement came as a surprise and disappointment to me.

As a shareholder of Freeport (and having purchased shares three different times), I'm going to have to think hard about whether I want to continue holding this copper mining giant. I liked the copper business and thought it was doing quite well, with the likelihood of doing better in the future. But I didn't want to own an oil and gas exploration company when I bought Freeport. Right now, I don't think this is a good deal.

Further, now that the company is making this move, my confidence in the board of directors is shaken, even though I already knew about the intertwined relationship between Freeport and McMoRan.

Should I sell? Should I buy more at this reduced price? Come and discuss this with me on my Messed-Up Expectations discussion board, or follow me on Twitter.

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Read/Post Comments (4) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 05, 2012, at 5:17 PM, duckduffer wrote:

    Perhaps Adkerson and Mofett should've consulted you before risking their careers, their baby (FCX) and their futures before proposing this nonsensical incestuous deal? Or perhaps...just perhaps...they understand the ramifications a little better than a Motley Fool :)

    MMR is a homerun waiting to happen and FCX will be the winner. If you don't think so, sell. Perhaps I'll pickup your shares at a nice discount today.

  • Report this Comment On December 05, 2012, at 8:48 PM, Clint35 wrote:

    I didn't think this deal made any sense when I heard about it today either. Sounds like cronyism and empire building to me. Good article.

  • Report this Comment On December 05, 2012, at 9:22 PM, NOTvuffett wrote:

    I hold shares of FCX and I have done well over the years trading them. Normally, a large decline in the stock price would cause me to pick up some more shares but this deal has left a very sour taste in my mouth. I am down several thousand dollars on my shares in a single day. I hope I am wrong to be upset about this deal but it is hard to see how.

  • Report this Comment On December 05, 2012, at 9:33 PM, ETFsRule wrote:

    .

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