When I opened up The Wall Street Journal first thing this morning I could hardly believe my eyes.
The front page announced two monster deals: Private equity firm Blackstone’s acquisition of Equity Office Properties (NYSE: EOP) (subscription required), the #1 office building owner in the country, for $20 billion and copper and gold giant Freeport McMoran’s (NYSE: FCX) $25.9 billion acquisition of copper giant Phelps Dodge (NYSE: PD) (subscription required).
The one that interests me most is Top Gun holding Freeport’s acquisition of Phelps Dodge. This will make Freeport McMoran the #1 copper producer in the world. Copper is used for a variety of industrial purposes and demand for it grows along with the world economy.
According to the WSJ, Freeport is offering $88 in cash, which they will pay by borrowing money, and .67 Freeport shares for every Phelps Dodge share. At Freeport’s Friday close of $57.40 that represents about $38.46 in Freeport stock and $88 in cash for every Phelps Dodge share to give you the Wall Street Journal’s figure of $126.46 a share. With 204 million shares outstanding on October 20, 2006 according to Phelps’s latest 10Q this means a total deal value of about $25.8 billion (the WSJ says $25.9 – there are outstanding options and other complications). However, Phelps Dodge had about $3.2 billion in net cash at the end of the 3rd quarter that Freeport will be assuming so they are really paying Phelp’s enterprise value of around $22.2 billion.
Here’s why I think this is a good deal for Freeport. For the $22.2 billion they get Phelp’s Dodges 38.4 billion pounds of proven and probable copper reserves. That amounts to about 58 cents per pound. Copper closed today at $3.08 per pound, according to Bloomberg. Now, it costs some money to mine the stuff out of the ground. But, if you think like me that growth in China and India will mean a huge increase in demand for copper in the coming years, this starts to look like a pretty good deal. The WSJ wrote:
The deal amounts to a huge bet on the long term sustainability of high metals prices.
[Freeport CEO Richard Adkerson] argued copper prices are likely to remain strong because of strong economic development in China and other fast growing countries, and the continued lack of large new mine developments.
When you put it all together, you have a company with 358 million shares outstanding (from 221 million) and $15 billion in net debt for an approximate enterprise value of $35 billion. With about 75 billion pounds in copper reserves, excluding Freeport’s gold and Phelps’s molybdenum reserves, you would be paying about 47 cents a pound. The combined companies should earn about $3.8 billion in free cash flow in 2006 for an enterprise value to free cash flow ratio of about 9.2.
And Freeport’s gold and Phelp’s molybdenum reserves are not negligible. Freeport has 5.5 million ounces of proven and probable gold reserves and Phelps 1.9 billion pounds of molybdenum. That gold is worth at least $2 billion and the molybdenum at least $20 billion.
Therefore, I am adding Freeport McMoran (NYSE: FCX) to Top Gun’s portfolio of recommended stocks at today’s closing price of $55.63.
To round out our base metals exposure to benefit from growth in China and India I am also adding BHP Billiton (NYSE: BHP) at today’s closing price of $40.11. BHP has a variety of base metals such as copper, nickel, aluminum, lead, iron and zinc and looks attractive on a financial basis as well.