Despite a U.S. jobs report that proved to be favorable for a mining company like Freeport-McMoRan (FCX 2.40%), it is difficult to determine if the stock's 2.9% advance during Friday's session was a dead cat bounce from the previous two days' 19.5% collapse or a positive reaction to the data. For that matter, after the announced acquisitions of both Plains Exploration and Production (NYSE: PXP) and McMoRan Exploration (NYSE: MMR) for $9 billion, it is difficult to determine if Freeport can be rightly called a mining company at all.
The stock has received blanket downgrades from several major Wall Street firms, and the transaction has been criticized as being more about benefiting upper management than shareholders. Many of the three companies' top spots are held by overlapping players, each of which will receive significant financial benefits from the deal that was able to be structured so as to not need shareholder approval. Still, with shares down so dramatically, some are wondering if the large sell-off represents a solid buying opportunity. Ultimately, the deal is best described as muddled and lacking in clear direction, making the stock better to avoid until a more defined path is available.
The transaction
Under the terms of the deal, Freeport will pay $6.9 billion in cash and stock for Plains and an additional $2.1 billion for McMoRan; McMoRan was spun out of Freeport in 1994 and it and Plains already own a combined 36% of McMoRan's outstanding shares. A significant concern for investors is the debt structure that will be created within the new, combined entity when the deal is consummated. The transaction is being financed with an additional $9.5 billion in debt instruments that will take the company's total debt burden to roughly $20 billion. Reflecting the market's increased concern as to the company's ability to service its debt, credit default swaps traded sharply higher on the news.
Based on last Tuesday's closing prices, the deal represents a premium of 39% for shares of Plains and an inexplicable 74% premium for the price of McMoRan shares. The fact that McMoRan shares had been trading down by over 40% year to date prior to the announcement was but one of the reasons that investors, including a fund manager at BlackRock, questioned the sensibility of the deal. Christopher Swann pointed out in a recent New York Times article: "While other shareholders in Freeport nursed paper losses on Friday morning, [CEO Jim Bob Moffet's] gains on his McMoRan holding trumped his losses on Freeport stock to the tune of some $15 million."
Can we say management conflict?
To truly understand the incestuous nature of these three management teams gives us some insight into why so many investors have questioned the motives for the deal. The skepticism with which you may view the deal will only be bolstered when the financial ramifications are added to the mix. As the team at Trefis spells out: "McMoran Chairman Moffett could collect $73 million cash for his shares while Plains Chief Executive Jim Flores stands to get $65.4 million for his. Flores could also receive a change-in-control payout of as much as $150 million."
The few arguments in favor
In order to give the deal thorough consideration, it will be useful to evaluate it with an eye for finding it reasonable. Along these lines, while the strength of copper has been a solid argument in favor of owning Freeport, growth potential is lacking. Production costs across the mining industry are on the rise and ready sources of additional copper production are limited.
But the prospects for the oil and gas industry are a bit more positive. The two targets in this deal have solid assets that will give Freeport access to shale operations in Louisiana and Texas, as well as to offshore operations in the Gulf. While the position of U.S. policymakers has been mixed on the export of natural gas, there is little doubt that with the excess gas created by shale operations, the potential for significant profits is there.
If the acquisitions are viewed as a long-term diversification play, the deal looks marginally tolerable. Even if you accept that this was the strategic vision behind the deal, the simple answer is that investors can get diversification by owning different stocks – management need not do it for us. Friday's bounce may have been a case of the stock trading higher with most of the major commodity plays on the jobs report, or it could have been Freeport taking a breather from its decline. While the sell-off has been significant and may create a tempting entry point, the apparent competing interests in the deal make Freeport a company to avoid while things get sorted out. There are simply better plays out there that require less of a leap of faith.
