Phelps Dodge adds twist to four-way battle

Phoenix, Ariz.-based copper giant Phelps Dodge (Pd-N) has emerged as a white-knight bidder for both Inco (N-T, N-N) and Falconbridge (Fal-T, Fal-N), with the trio unveiling plans for a three-way merger valued at around US$40 billion.

“The transaction we have announced this morning is clearly transformational, certainly for our three companies and perhaps for our industry — it creates a new global industry leader,” Phelps Dodge CEO Steven Whisler told analysts during a recent conference call to discuss the deal.

Whisler says the three-way combination would vault Phelps Dodge Inco into super-major status, giving greater access to capital markets and the size and scale to develop world-class projects on a global basis.

“There’s really no question in my mind that we will create tremendous shareholder value by bringing our companies under one banner,” added Inco chief executive Scott Hand. “I’m very excited for what it means for our shareholders, customers, all of our employees, and very importantly, the communities in which we do business.”

Falconbridge CEO Derek Pannell said the union would create a North American-based world leader in copper, nickel, and molybdenum, with strong portfolios in other base metals, including zinc and aluminum.

“We will have what I see as the best portfolio of growth projects in the global mining industry, and the financial strength and expertise to capitalize on this tremendous potential,” he added.

Under the plan, Phelps would trade 0.672 of one of its own shares plus $17.50 in cash for each of Inco’s outstanding shares. The bid values Inco shares at $80.13 apiece, and represents a premium of 23% over Inco’s closing share price in Toronto on June 23 — the last business day before the deal’s announcement. It is also 19% better than a competing bid by Teck Cominco (TEK.B-T, TCKBF-O), which stands at $28.00 in cash accompanied by 0.6293 of a Teck class B share. Teck’s bid officially expires on July 24.

As part of the scheme, Inco would boost the cash portion of its existing pro-rationed bid for Falconbridge to $17.50 from $12.50, with the share exchange ratio climbing to 0.55676 from 0.524 of an Inco share for each Falco share. Falconbridge’s board has unanimously approved the offer, and has amended its support agreement with Inco.

Inco’s revised bid values each Falconbridge share at $53.83, a 2.5% premium over Swiss-based Xstrata’s (XSRAF-O, XTA-L) all-cash bid of $52.50 per share. Xstrata already owns just shy of 20% of Falconbridge; its bid expires July 7. Phelps says its subsequent acquisition of the enlarged Inco would deliver an 18.3% premium over Xstrata’s bid for Falco shareholders that retain their Inco shares.

Phelps has also agreed to buy up to US$3 billion worth of Inco’s convertible subordinated notes to help Inco with its sweetened bid, and “satisfy related dissent rights, as needed.” The agreement requires that the Inco-Falco deal be completed.

Meanwhile, Phelps’ proposed acquisition of Inco does not require the Inco-Falconbridge merger to go through. The latter transaction recently got the thumbs-up from the U.S. Department of Justice; it still needs the approval of the European Commission. The EC is expected to deliver its verdict by July 12; Inco has extended its bid for a fourth time, this time until July 13.

Major hurdle

Placing a major hurdle in front of any competing offers, the three-way deal includes a US$925-million break fee if Inco acquires Falconbridge, but fails to consummate the subsequent merger with Phelps. On a standalone basis, Inco’s break fee comes to US$475 million. Likewise, Phelps has agreed to a US$500-million break fee payable to Inco.

Either way, Phelps plans to close out either transaction by buying back up to US$5 billion worth (less the amount of any convertible notes acquired) of its shares within a year of closing. It intends to fund the acquisition and share buyback via US$22 billion in financing commitments from Citigroup and HSBC. Inco has received additional financing commitments from Morgan Stanley, Goldman, Sachs & Co., Royal Bank of Canada, and Bank of Nova Scotia to help fund its revised offer for Falconbridge.

The new Phelps Dodge Inco would reign as the world’s largest nickel producer and second-largest copper producer; it would also be the second-largest molybdenum producer and third-largest producer of cobalt. The behemoth would employ around 40,000 people at operations in more than 40 countries around the world. It would sport a total enterprise value of around US$56 billion. Combined, the three companies earned US$1.9 billion on revenues of around US$6.3 billion during the first three months of 2006.

Whisler told analysts that the key driver behind the proposed transaction is the potential for “significant synergies” even beyond those already tabled by Inco and Falconbridge. The trio expects annual synergies of around US$900 million (US$550 million from the Inco-Falconbridge combination) to kick in by 2008.

“Together, Inco and Falconbridge were able to unleash significant synergies on the nickel side,” Pannell added.” The entrance of Phelps Dodge brings similar opportunities on the copper and molybdenum side when combined with Falconbridge’s copper and molybdenum operations in North and South America.”

The combined company would be headquartered in Phoenix, with the nickel division, dubbed Inco Nickel, domiciled in Toronto. Whisler would remain as chief executive and chairman of the new Phelps, with Hand taking a seat as vice-chairman and Pannell assuming the role of president. Pannell would head up Inco Nickel, which would also house the zinc and aluminum operations. The board would comprise 11 members from Phelps Dodge and four from Inco and Falconbridge.

In the end, existing Phelps Dodge shareholders would own around 40% of Phelps Dodge Inco, with current Inco shareholders holding 31%, and Falconbridge shareholders owning the remaining 29%.

September close

The deal is expected to close in September, pending approval by regulators and Phelps Dodge and Inco shareholders. Phelps has pledged no significant operational layoffs for three years, and doesn’t anticipate any regulatory hang-ups, as there is very little overlap between its existing copper business and Inco and Falconbridge’s nickel operations. It also said that the additional copper capacity of the enlarged company would have little impact on a very fragmented market.

“This combination will be good for Canada,” Hand said. “We’ll be a stronger company, with the headquarters of our nickel operations located here in Toronto. The increased strength will give us greater control over our destiny, which will mean greater stability and good jobs that will stay right here in Canada.”

Phelps plans to apply to have its shares listed for trade on the Toronto Stock Exchange.

Shares in Inco ended $7.03 or nearly 11% better at $72.28, with Falconbridge gaining $2.83, or 5%, to make $58.33 in Toronto following the news on June 26. For its part, Phelps slipped US$6.72, or 8%, to $76.23 on the New York Stock Exchange.

There really was a Phelps . . . and a Dodge

Phelps Dodge (PD-N) began in 1834 as a New York City-based mercantile company, trading American products to England in exchange for copper, iron, tin and other metals. The company derives its name from founding partners Anson Phelps, a one-time saddle maker, and his son-in-law, William Dodge, a dry goods merchant.

The company entered mining in 1881, when it invested in the Detroit Copper Mining Co. in Morenci, Ariz. Phelps Dodge quit the import-export business in 1906.

When the American West was still wild, Phelps Dodge was developing copper deposits in Arizona, New Mexico and Mexico. Phelps Dodge also has operations in Chile and Peru.

Phelps Dodge was among the first companies in the industry to convert to open-pit mining from the firmly established underground method. After nearly four decades of und
erground mining at Bisbee, Ariz., the company switched to open-pit mining in 1917. Morenci, situated about 240 km east of Phoenix, Ariz., converted to open-pit mining in 1937 and remains one of the largest open-pit copper mines in the world.

In the face of the Great Depression in the 1930s, Phelps entered the copper refining and manufacturing business. Phelps still owns cable and specialty conductor operations, which use copper and other metals produced from the company’s mines.

Phelps Dodge expanded its copper mining operations internationally in 1984 when it acquired the Ojos del Salado mine in Chile and then developed Candelaria, a sizable copper deposit located beneath the Atacama Desert in Chile.

With the company’s acquisition of Cyprus Amax Minerals Co. in 1999, Phelps Dodge further diversified its copper mining portfolio by adding El Abra in Chile, Cerro Verde in Peru, and Sierrita, Bagdad and Miami in Arizona. In the Cyprus deal, the company also obtained Climax Molybdenum Co. with its molybdenum mine and processing facilities in Colorado, as well as others in Iowa, the U.K. and the Netherlands.