Freeport to swallow Phelps

If shareholders give the go-ahead, Freeport-McMoRan Copper & Gold’s (FCX-N) proposed takeover of Phelps Dodge (PD-N) will create the world’s largest publicly traded copper company and the largest North American-based mining company.

The move by Freeport is seen as both a long-term bet on copper prices remaining high, and a desire for the New Orleans, La.-based company to diversify its asset portfolio.

The deal — which has been unanimously approved by the boards of both companies and is anticipated to close in the first quarter of 2007 — would see Freeport dish out roughly US$25.9 billion for Phoenix, Ariz.-based Phelps in cash and stock.

Freeport is offering US$126.46 a share — a 33% premium over Phelps Dodge’s US$95.02 closing price before the deal was announced.

The offer consists of US$88.00 in cash plus 0.67 of a Freeport share for each Phelps share. Freeport says it will finance the roughly US$18-billion cash portion with debt.

But the acquisition comes at a time when many analysts are forecasting lower copper prices. Concerns over supply shortages drove copper up to a peak price of nearly US$3.90 per lb. in May, but those fears are subsiding, and copper prices have declined by 28% since then. At presstime, copper was trading at around US$3.12 per lb.

Analysts say that while Chinese demand for copper remains strong, an increase in copper substitutes in the construction industry and a slowdown in the American housing market are easing the supply crunch — despite Freeport’s contention that capacity will remain tight going forward.

“If there’s so little new capacity,” says Charles Bradford of Soleil-Bradford Research in New York, “then why is Freeport saying Phelps has a lot of capacity going forward? There’s inconsistency in the data.”

Freeport says it expects copper production for the merged companies to grow roughly 25% over the next three years.

It estimates the combined assets will annually yield 3.7 billion lbs. copper, 11.8 million oz. gold, and 69 million lbs. molybdenum. Freeport is currently not a molybdenum producer while Phelps does not produce gold.

Although analysts like Bradford have misgivings about the gamble on copper prices, the diversification of Freeport’s asset portfolio is being seen as a shrewd manoeuvre.

Until now, Freeport has been a single-asset player with its Grasberg copper-gold mine in Indonesia. And while Grasberg is the world’s largest copper and gold project in terms of reserves, with roughly 37 billion lbs. copper and 40 million oz. gold, Indonesia is not the most politically stable country.

“Freeport is in one country and it’s not necessarily the place you want to stake one hundred per cent of your assets in,” Bradford says.

London-based Control Risk, a business-risk consultancy group, ranks the Papua region of Indonesia — where Grasberg is located — a high security risk zone, and Indonesia a medium-risk country in terms of politics.

In acquiring Phelps, Freeport will broaden its asset portfolio to include projects in the United States, Chile, Peru and the Democratic Republic of the Congo (DRC).

With assets spread so far across the globe, production synergies are considered unlikely, but Freeport says the takeover will give it the scale it needs to acquire equipment and prospects in an increasingly competitive market.

Alex Gorbansky, an analyst with Frontier Strategy Group says the deal “creates a company with the financial and operational resources to go head-to-head with the likes of BHP Billiton, Rio Tinto, and Anglo American.”

In addition, Gorbansky points to Freeport’s operational expertise and history around Grasberg, and said such expertise should be useful at some Phelps projects, such as the Tenke Fungurume copper-cobalt project in the DRC.

Freeport says the deal is accretive to both earnings and cash flow. Using 2006 figures, combined operating cash flow would be US$6.5 billion, the company says.

In New York on the news, Phelps shares approached the premium being offered, rising nearly 27% or US$25.45 to US$120.47 on nearly 30 million shares traded.

Freeport was off slightly, down roughly 3% or US$1.77 to US$55.63 on roughly 23 million shares.

Freeport’s market capitalization and earnings per share stand at roughly $11 billion and $7.87, respectively; that’s less than Phelps Dodge’s numbers, which stand at US$24.5 billion and US$9.26, respectively.