Shares of mining giant Freeport McMoRan (FCX: Charts, News) dived over 17% at the end of last week, after the company announced its planned acquisition of oil and natural gas producers Plains Exploration (PXP: Charts, News) and McMoRan Exploration (MMR: Charts, News) for $10.3 billion in a cash and stock. The debt inherited from these two companies will push the cost of the deal up to approximately $20 billion. Analysts and investors appear to be at a consensus that Freeport overpaid for the two companies, which dilutes the value of the company.
To acquire Plains Exploration, Freeport paid a 39% premium for a company that just took on $8 billion of new debt to finance the acquisition of BP’s (BP: Charts, News) Gulf of Mexico deepwater assets. To most investors, this offsets Plains Exploration’s increased production rate at its Eagle Ford and Haynesville operations – its most profitable assets.
Freeport’s acquisition of McMoRan Exploration, for a stunning premium of 74%, has puzzled analysts as well. Freeport McMoRan spun off McMoRan Exploration 18 years ago, but the two companies still share six board members. These overlapping board members, including McMoRan Exploration CEO Jim Bob Moffett and co-founder B.M. Rankin, stand to gain handsomely from the hefty acquisition premium paid on McMoRan Exploration, which had plunged 32% in November after doubts were raised by problematic flow tests at its Davy Jones site in the Gulf of Mexico. McMoRan, which had posted declining revenue over the past few quarters, has struggled to convince Wall Street that Davy Jones could be the biggest deepwater oil discovery in the past decade.
After the Freeport deal was announced, McMoRan shares now trade above $15 – a new 52-week high, erasing all losses for shareholders. Despite the plunge in Freeport McMoRan stock, insiders invested in both companies were able to recoup those losses because they hold stock and options in both companies.
According to Bloomberg estimates, Jim Bob Moffett’s stock and options, worth $44 million on November 4, doubled to $89 million after Freeport announced the acquisition. During the conference call last week, Moffett failed to offer any cost-saving synergies that would justify a 74% premium for his company, only stating that it was “cheap” and would help Freeport McMoRan benefit from low natural gas prices. However, after acquiring Plains Exploration’s BP assets, 89% of Freeport’s production will be liquids rather than natural gas. Both Plains and McMoRan are oil heavy companies with little focus on natural gas.
The sudden, simultaneous acquisition of both Plains and McMoRan is also suspected of insider deals, since James Flores, the CEO of Plains Exploration, also has a seat on the board of McMoRan Exploration, allowing him to take advantage of both acquisition premiums.
Freeport estimates that it needs crude to stay above $100 per barrel and natural gas to reach $4.50 in the coming year for the deal to become earnings accretive. Citigroup (C: Charts, News) notably disagrees, and has stated that Freeport’s deal will dilute its 2013 earnings by 3.2%. Standard & Poor’s also cut Freeport’s BBB debt rating from stable to negative due to Freeport’s new debt. To make matters worse, the apparent conflict of interest has already triggered a wave of legal investigations, which could hit Freeport with hefty legal fees from dissatisfied investors.
Most damaging of all, Freeport’s decision to heavily pursue deepwater oil drilling has discouraged investors from investing in the company for its copper assets – its core competency. Many investors had expected improvement in the U.S. housing sector and industrial growth in China would cause copper and metal prices to surge in the coming year, and Freeport was once seen as the best pure-play copper stock in the market.
Freeport pays a quarterly dividend of 31 cents per share – a 3.92% yield at current prices. It trades at 6.9 times forward earnings with a 5-year PEG ratio of 2.6.
Other News About FCX
Plains CEO Stands to Earn as Much as Freeport Top Brass
Did Freeport make these controversial acquisitions to benefit top insiders?
After 20% Slide, Freeport-McMoRan Bouncing Back
Is the pain ebbing for Freeport shareholders?
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