McMoRan Investors Focus Too Much on Davey Jones

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Last week, McMoRan Exploration (NYSE: MMR) announced Q4 earnings that provided more of same regarding failures at the high profile Davey Jones #1 well. Considering the potential of the Davey Jones well and the famous pedigree (member of the musical group the Monkees), it can be understandable that investors ignore the other ultra-deep wells.

Back in December, the leading ultra-deep Gulf of Mexico explorer accepted a buyout along with Plains Exploration & Production (NYSE: PXP) from Freeport-McMoRan Copper & Gold (NYSE: FCX). The company focuses on drilling depths of greater than 25,000 feet in the shallow water of the gulf. Besides the upfront cash, the deal with Freeport offers an interesting royalty trust that provides intriguing upside potential if the ultra-deep plays are successful.

Besides the infamous Davey Jones well, the company has several wells under completion or in the process of being drilled that offer enormous natural gas potential. The company forecasts an incredible gross unrisked potential of approximately 130 Tcfe between the offshore and onshore prospects.

Q4 2012 Results

The company provided the following highlights for Q4:

  • Production averaged 119 million cubic feet of natural gas equivalents per day (MMcfe/d) net to McMoRan, and 137 MMcfe/d for the twelve months ended December 31, 2012.
  • Operating cash flows totaled $(28.9) million for the fourth quarter of 2012, including $31.0 million in working capital uses and $28.4 million in abandonment expenditures, and $33.7 million for the twelve months of 2012.
  • Capital expenditures totaled $89.5 million in the fourth quarter of 2012 and $505.1 million for the twelve months of 2012.
  • Cash at December 31, 2012 totaled $114.9 million and total Debt was $557M.

While the stock is more about the Freeport deal and the drilling prospects, some key points are that the company already has a massive producing well in the Flatrock and the net debt position of $442M is very manageable considering the prospects.

Ultra-Deep Prospects

While the Davey Jones #1 well gets all the media attention due to the massive failures, McMoRan actually has numerous promising ultra-deep prospects under development.

  • Lineham Creek prospect – Encountered positive results above 24,000 feet in November 2012; currently drilling below 26,500 feet to proposed total depth of 29,000 feet to evaluate primary targets.
  • Lomond North prospect in Highlander area – Currently drilling below 13,500 feet with a proposed total depth of 30,000 feet.
  • Blackbeard West No. 2 reached total depth of 25,584 feet in January 2013. Initial completion efforts are expected to focus on the development of laminated sands in the Middle Miocene located at approximately 24,000 feet.
  • Operations to flow test Davy Jones No. 1 are ongoing. Completion and testing of Davy Jones No. 2 expected to commence following review of results from Davy Jones No. 1.
  • Development plans for Blackbeard East and Lafitte are pending approval by the Bureau of Safety and Environmental Enforcement (BSEE).

While the company has spent over $1B on the Davey Jones prospects including the #2 well that has already been drilled, it has spent nearly $500M on the combined Blackbeard East and Lafitte wells.

As the slide below from the Q4 earnings presentation highlights, the above are only the plays currently in development. It doesn’t include all of the prospects such as Calico Jack, England, Davy Jones West, or any of the numerous other plays highlighted in the slide.

<img height="500" src="/media/images/user_15227/screen-shot-2013-01-22-at-115757-am_large.png" width="660" />

Royalty Trust

The stock currently trades above the $14.75 cash offer price by over $1 due to the royalty trust potential. McMoRan shareholders get 1.15 units of the trust that holds a 5 percent overriding royalty interest in future production from McMoRan’s existing ultra-deep exploration prospects.

The big question remains whether this trust has any real value. The answer came in the earnings call when legendary investor Leon Cooperman of Omega Advisors postulated that the trust could hold the same value as the existing stock price. The CEO didn’t disagree suggesting the trust has a potential value around the $15 level if the prospects work out as expected.

At this point, investors are paying around $1.25 for the 1.15 units of the trust, which amounts to a call option on the ultra-deep prospects accumulated by McMoRan.

Conclusion

The merger hasn’t gotten much in the way of bullish commentary yet the prospects remain incredible for Freeport, McMoRan, and Plains Exploration shareholders. In the end, all investors might benefit from the deal. Without the capital provided by Freeport, McMoRan and Plains Exploration might never be able to achieve the tremendous potential of the ultra-deep prospects. Without paying up for the McMoRan stock, Freeport shareholders might not be able to gain from the almost unlimited potential of the prospects.

Investors wanting a large cap with limited downside risk might want to go with Freeport. As mentioned in a previous article, the stock has plenty of upside in the primary copper market with a rebounding domestic real estate market and a return to fast growth in China. Investors wanting the high risk/reward play might go for McMoRan. Either way, both stocks offer strong potential for investors.


Mark Holder and Stone Fox Capital Advisors, LLC own positions in Freeport-McMoRan Copper & Gold. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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