Corporate strategy goes through fads: one minute the key is stripping down to “core businesses” — which really says very little because what is core is endlessly redefined — and the next diversification is paramount. Both can be considered corporate speak for: “we’re bored,” or “we haven’t done a big deal in awhile, so let’s remind the market that we can.” But in the case of Freeport-McMoRan (NYSE:FCX), which made an acquisition deal worth $20 billion last week, the story may relate more to personal relationships — and a rescue mission.
While companies may optically grow through acquisitions, more executives than not say that only on the rarest occasions do acquisitions translate into increased shareholder value.
And Freeport’s shareholders have not held back about how they feel regarding the world’s largest publicly traded copper producer buying McMoRan Exploration (NYSE:MMR), its former sister company, and Plains Exploration & Production (NYSE:PXP).
They went into sell-off mode and the stock took a 16-percent nosedive.
First to the rescue-mission theory. Seeking Alpha contributor Devon Shire wrote last week that he took a close look at McMoRan’s balance sheet and found that the company’s “liquidity is starting to get pretty tight.” His conclusion: “[t]he truth is that this transaction looks an awful lot like a bailout of McMoRan.”
But why would any company that is beholden to shareholders want to bail out another? Shire and Benzinga’s Matthew Kanterman have both pointed out the close relationship between the three companies. “[T]here are 20 cases of board members from all three companies being intertwined through the boards,” Kanterman said. Part of that has to do with the fact that Freeport and McMoRan were spun off from the same mother company; further, Plains owns nearly a third of McMoRan. “[This] is another example of companies with intertwined boards making acquisitions that may not be the most beneficial to shareholders in the near term but may further the collective boards’ interests,” Kanterman noted.
Bloomberg noted that Plains’ CEO, James Flores, stands to gain more than $150 million from the deal; co-chairman and CEO of McMoRan, James Moffett, who is also the chairman of Freeport, holds stock and options now worth about $89 million — more than double their value before the deal; and Freeport’s CEO, Richard Adkerson, also co-chairman of McMoRan, saw his holdings’ value jump more than three-fold, to $14 million.
It may not be fair to say that personal gain was the primary motive for this deal, but the glaring interconnectedness of the three companies’ boards has given law firms — ever ready to contest the terms of big deals — an easy hook with which to attract investors to join a class-action lawsuit. Levi & Korsinsky and Newman Ferrara are just two that plan to “investigate” the deal.
But let’s for a minute take the executives at their word that this will be a good deal. Moffett mentioned that the new company will be “world-class” and will focus on “value creation,” while Adkerson used phrases such as “strong current cash flows” and “complementary exposure.” Flores cited “meaningful returns.”
Those returns might materialize around the end of 2013, “[g]iven China’s recent growth figures and the increasing demand for copper, oil and gas,” another Seeking Alpha contributor said. Moreover, Forbes noted that there has been concern about growth opportunities in copper mining due to difficulty finding reserves that are easy to tap, declining ore grades and rising costs. On a similar note, an OilPrice.com contributor said China’s “soaring energy demand” is an impetus to get back in the oil industry, commenting that “[t]hese acquisitions give them skin in the game.”
Adkerson said the problem the company is facing isn’t the price of copper, but a lack of high-quality mines to dig. He said the oil and gas investments are “large-scale assets with long lives, low cost and geologic potential to support growth through exploration and development,” The Wall Street Journal reported. He was sure to make clear that this does not mean Freeport thinks any less of copper’s outlook.
With this deal, Freeport is starting to resemble BHP Billiton (ASX:BHP,NYSE:BHP,LSE:BLT), which also has a large oil and gas business. For that reason, it’s perhaps unsurprising that investors were reluctant to get on board. BHP took a $2.84-billion write-down after spending $20 billion last year on US energy assets, and in 2010, Vedanta Resources (LSE:VED) lost half of its value after gaining access to India’s biggest onshore oil field by acquiring Cairn India for nearly $9 billion.
Evy Hambro, manager of the $12-billion World Mining Fund at BlackRock (NYSE:BLK), which owns an 8-percent stake in Freeport, put it this way: “[i]nvestors obviously have the freedom to diversify their own portfolios” and “don’t need management teams to do it for them.” He also criticized the deal structure, which means it doesn’t require Freeport shareholders’ approval.
BlackRock’s sentiment was echoed in a slew of downgrades and price-target cuts of Freeport stock by firms including Goldman Sachs (NYSE:GS), Deutsche Bank (NYSE:DB), Citigroup (NYSE:C), UBS (NYSE:UBS), Macquarie (ASX:MQG) and the Bank of Montreal (TSX:BMO). It hasn’t helped that Adkerson cited “attractive financing markets” as a reason for making a deal now. Moody’s Investor Service currently rates Freeport’s credit at Baa3, one notch away from junk bond status. Standard & Poor’s cut its rating to negative from stable.
“We believe that Freeport stock will remain in the penalty box for the foreseeable future and multiples will remain depressed on the back of these acquisition announcements, given investor uncertainty on the strategic merit,” Goldman Sachs said, according to Reuters.
Whether the deal was driven by a bona fide desire to diversify or not, the personal relationships; the seemingly untroubled decision to take on $20 billion in debt even as managers said nothing about cost or revenue synergies; and the whopping 74-percent premium for McMoRan, which before the deal had lost 41 percent of its value this year, are all factors that have left investors with a bad feeling about the deal. Perhaps the only way managers can regain investors’ trust will be to let them vote. Otherwise, the company may see them in court.
Securities Disclosure: I, Ragnhild Kjetland, hold no investment interest in any company mentioned in this article.
| Updated December 2015
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