In early December 2012, Freeport-McMoRan (NYSE:FCX) unveiled a bold move to buy not one but two oil and gas businesses, agreeing to pay roughly $20 billion in a combination of cash, stock, and the assumption of debt for Plains Exploration & Production and McMoRan Exploration. Doing so would give the copper and gold miner a diverse set of long-life assets that were generating robust cash flow and had attractive growth prospects.
But the real driving force behind Freeport-McMoRan's acquisition was a desire to take advantage of low borrowing rates so it could capture the upside it saw ahead for commodity prices. That's evident from the following comments from CEO Richard Adkerson in the press release announcing the deal: "We anticipate that attractive debt financing markets and our strong balance sheet will allow us to finance a significant portion of the transaction using low-cost debt and enable FCX shareholders to retain the significant value we see in our existing asset base, while enhancing future value-generation opportunities."
In fact, Freeport-McMoRan had already lined up $9.5 billion in financing to complete the transaction, which would saddle the pro forma company with $20 billion of debt. However, it was comfortable with that level of leverage because the combined business would generate $9 billion of operating cash flow given where commodity prices were at the time, enabling it to quickly de-lever. Or so it thought.
It all came crashing down so quickly
When Freeport-McMoRan announced the deal, oil was over $100 a barrel and natural gas was at $4.50 per million British thermal units. Meanwhile, both copper and gold were riding high at $3.50 per pound and $1,500 per ounce, respectively. However, those prices started crashing within a year of the mid-2013 close of these transactions, which unraveled the company's plans to de-lever the balance sheet.
By early 2015, the company started taking aggressive actions to defer or delay capital spending and other costs so it could maintain its financial strength and flexibility in the face of the sharp drop in oil prices. In fact, the company initiated efforts to raise third-party funding to help finance a portion of its oil and gas drilling budget. Those efforts, however, proved unsuccessful, leading the company to explore an IPO of its oil and gas unit in mid-2015 as it searched for ways to raise cash for capex. Before the end of that year, the company would sell $2 billion of its equity at the parent-company level in a highly dilutive offering, suspend its dividend, and cut spending to the bare bones so it could stay afloat.
Unwinding the damage
By the beginning of last year, the company stated that its "clear and immediate objective is to restore FCX's balance sheet." That would lead the company to complete a series of asset sales to shore up its financial situation, including gutting its oil and gas business.
The biggest sale was its properties in the Gulf of Mexico, which it unloaded in a deal with Anadarko Petroleum (NYSE:APC) for $2 billion in cash and up to $150 million in future contingent payments. To put that price into perspective, just two years prior, Freeport-McMoRan spent $1.4 billion to acquire additional oil and gas assets in the Gulf from Apache (NYSE:APA). That's on top of the $321 million it spent to acquire more leases from the government in 2014 and the billions more it invested in capex to develop its assets in the Gulf, not to mention what it paid for its initial position in the Gulf. That's a sickening amount of shareholder value going up in flames, while Anadarko got a steal of a deal at Freeport's expense.
Freeport-McMoRan has realized some additional value from the business over the years outside the declining cash flow it generated. For example, in 2014 it sold its Eagle Ford Shale assets to Encana (NYSE:ECA) for $3.1 billion. The company would use half of the proceeds from the Encana deal to pay down debt while using the other half to buy those GOM assets from Apache. Meanwhile, the company recently jettisoned its onshore oil and gas properties in California to a private buyer for $720 million.
Still, even when adding in those sales, Freeport-McMoRan has brought in only about $4.4 billion for assets it was so keen on acquiring in 2012. While it still has some properties left, the company has basically incinerated most of the roughly $20 billion it paid for these businesses in 2012. Meanwhile, despite all the asset sales, equity issuances, and other efforts to shore up its balance sheet, the company still had $15.4 billion of debt on its balance sheet at the end of the first quarter.
Don't always believe the M&A hype
It's hard to believe that Freeport-McMoRan would make such a poor decision and take on an enormous pile of debt to acquire companies with direct exposure to volatile commodity prices. It's a gamble that had a high probability of failing, since it would have only paid off if prices remained high. This debacle should serve as a reminder to investors that they should remain skeptical when companies with exposure to commodity prices pile on debt to make a large transaction. More often than not, these purchases incinerate shareholder value rather than creating more.