Double Acquisition - How Can You Profit?

Mike is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In early December, Freeport McMoRan Copper & Gold (NYSE: FCX) announced its intention to acquire McMoRan Exploration (NYSE: MMR) in a cash-for-stock deal valued at roughly $3.4 billion. Despite a lackluster earnings report from the smaller company, the deal now appears likely to close by the end of the second quarter of 2013. 

At the same time, Freeport McMoRan has also agreed to purchase Plains Exploration & Production (NYSE: PXP) in a two-part deal valued at about $6.9 billion. This deal is also expected to close by the end of the second quarter of 2013. At this point, it appears unlikely that this marriage will threaten the completion of the exploration merger. However, potential shareholder lawsuits threaten to complicate both deals.

About Freeport McMoRan Copper & Gold, McMoRan Exploration and Plains Exploration & Production

Phoenix-based Freeport McMoRan engages in the exploration and production of gold, silver, copper, molybdenum and various heavy metals. The company partially or wholly owns mines in North America, South America, Africa and Asia. With nearly 120 billion pounds of proven reserves, its copper assets are particularly impressive. The two mergers described in this report represent its first major forays into the energy business. Freeport employs over 31,000 people and earned $2.9 billion on $17.7 billion in revenue in 2011.

New Orleans-based McMoRan Exploration is a relatively small oil and natural gas producer. The bulk of its assets are concentrated in shallow Gulf of Mexico properties off the coasts of Louisiana, Mississippi and Texas. It also maintains some onshore holdings in those states. With over 950 operating leases and several proven deep-water holdings, the company's assets are robust for an outfit of its size. McMoRan lost $138.3 million on revenues of $376.9 million in 2011.

Houston-based Plains Exploration & Production boasts over 400 million barrel-equivalents of proven oil reserves in the Gulf of Mexico, California, the Pacific Ocean and the Rocky Mountain region. Whereas the company's offshore assets are comprised primarily of conventional "light" crude, the bulk of its onshore assets reside in difficult-to-extract shale deposits. Plains Exploration & Production employs just under 1,000 people and earned $185.5 million on $2.2 billion in revenue in 2011.

How the deals are structured

Under the terms of the deal between Freeport and McMoRan Exploration, the latter company's shareholders will receive $14.75 in cash for each share of stock that they own. In addition, they will receive 1.15 units of a newly-formed royalty trust. This trust has been designed to tap certain yet-to-be-exploited assets that lie nearly six miles beneath the Gulf of Mexico's floor. 

Despite the risky nature of the deal's trust component, it has been well-received by McMoRan shareholders. Following the deal's announcement, the company's stock nearly doubled in value. Relative to its pre-announcement closing price of $8.46, the deal's cash component provides shareholders with a premium of 74.3 percent. Relative to its current price of $16 per share, the $14.75-per-share offer represents a discount of about 8 percent.

However, the deal's trust component could make up that difference several times over. Depending upon such factors as the price of oil and the exact size of McMoRan's sub-Gulf reserves, the trust's future distributions could provide decades of ongoing revenue for the company's shareholders. Alternatively, the abandonment of the reserves could render the trust worthless within a short period of time.

Under the terms of the second deal, Freeport will pay current Plains Exploration shareholders $25 in cash per share. In addition, Plains Exploration shareholders will receive exactly .6531 share of Freeport for every Plains share that they own. With Freeport currently trading in the neighborhood of $33.50, this increases the value of the deal by about $21.88 per Plains share. 

Accordingly, the total per-share value of the deal currently stands at about $46.88. With Plains Exploration trading at $46.59 per share, this represents a premium of less than 1 percent. 

Complications and legal problems

Lawsuits spearheaded by two activists shareholders threaten to derail both deals. The Exploration deal looks to be jeopardized by a Joel Krieger-led lawsuit. This action claims that the Exploration's $3.4 billion valuation significantly undervalues the company's Gulf of Mexico assets and threatens to cheat its shareholders out of any future returns that arise from the basin's energy assets.

Given the depth of the local fields, it is difficult to value Exploration's Gulf holdings in a rational manner. Further, the deal is structured to provide current Exploration shareholders with a significant amount of the potential production of these assets. As such, the deal's current structure may actually end up overcompensating current Exploration shareholders. In other words, it appears unlikely that the suit will result in the delay or derailment of this deal.

Activist investor Dennis Rice's Plains lawsuit may hold more merit. As it currently stands, the value of Freeport's bid for Plains provides almost no premium for the company. Should the suit move forward, it may fall on Freeport to prove that Plains is not valuable enough to warrant such a premium. Given the potential upside to the current prices for oil and natural gas, this may be a tall order. Many industry observers expect Freeport to withdraw its bid and issue a higher offer in the face of this lawsuit.

Long-Term prospects and outlook

Barring a dramatic change in circumstances, it appears likely that the Freeport-McMoRan Exploration deal will close with little trouble. By contrast, the successful completion of the Freeport-Plains Exploration deal is by no means assured.

In addition, the former deal offers a far better initial return on investment than the latter. It also offers a greater potential long-term reward. Savvy investors would do well to watch McMoRan Exploration for signs of momentary weakness and make targeted purchases that take advantage of these dips. Since the Plains deal remains far from insured, the "smart money" may well remain on the sidelines for the time being. If Freeport is forced to withdraw its bid, a perfect buying opportunity may present itself.

In sum, it is clear that Freeport wishes to embark on a buying spree. Thanks to secular trends like steadily increasing energy prices and a robust boom in North American exploration, its ambitions may be rewarded over the long term. Investors who wish to profit from these trends should watch McMoRan Exploration, Freeport-McMoRan and Plains Exploration carefully.

 


mthiessen has no position in any stocks mentioned. 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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