It looks like Freeport-McMoRan Copper & Gold (NYSE:FCX) wants a piece of the Great American Oil Rush.
The mining giant is returning to its energy roots, announcing a deal Wednesday to buy oil and natural gas companies McMoRan Exploration (NYSE:MMR) and Plains Exploration & Production (NYSE:PXP) for about $9 billion plus the assumption of debt.
The market responded to the news with something resembling sticker shock, causing Freeport’s shares to tumble more than 17% at one point early in the session. But the strategic thinking behind the acquisitions — as well as the assets themselves — appear more than solid, making the market’s knee-jerk reaction look overdone.
There appears to be two major secular themes behind the deals.
For one, new extraction techniques, such as deepwater drilling and hydraulic fracturing, have unleashed a torrent of oil and natural gas in the American heartland and its offshore waters. Indeed, the International Energy Agency recently said the U.S. could surpass Saudi Arabia in oil production as early as 2017.
At the same time, the great commodity supercycle — boosting prices for everything from gold to copper to iron ore — might be nearing its end. Goldman Sachs (NYSE:GS) analysts just slashed their 2013 gold price forecast by more than 7%. Meanwhile, the days of China’s economy growing at a double-digit rate — the great tailwind of the commodity supercycle — are over.
That has put downward pressure on commodity prices. Gold prices are off more than 2% year-over-year, while copper has slumped about 1.5%. Yes, prices for the metals are hardly in freefall, but FCX’s costs for getting the commodities out of the ground are going up, pressuring margins and profitability.
So, it’s only prudent for Freeport to diversify its revenue stream.
By bringing McMoRan and Plains into the corporate fold, FCX goes from being a mining giant with operations largely overseas (South America, Africa and Indonesia), to a sprawling mining, oil and gas conglomerate with a big footprint in the U.S., too, since McMoRan and Plains have energy plays mostly in California, Texas and the Gulf of Mexico.
True, the cost savings in attaching energy companies to a mining giant might not seem readily apparent, but then, the potential synergies touted by mergers and acquisitions are usually overstated anyway. (Besides, after coughing up about $6 billion in market cap Wednesday morning, we’d like to think the risks have been adequately discounted in FCX’s share price at this point.)
It’s also not as if these companies are strangers to one another. Freeport spun off McMoRan Exploration in 1994 and its CEO, James Moffett, is chairman of Freeport. B.M. Rankin Jr., who co-founded McMoRan with Moffett, sits on FCX’s board.
And if that weren’t incestuous enough, Plains already owned more than 31% of McMoRan, while Freeport held about a 5% stake prior to the deal.
Those existing corporate and personal ties might just help FCX avoid many of the pitfalls most mergers hit, from culture clashes to operational integrations to savings that never materialize.
Freeport expects the new company to generate more than a quarter of its 2013 pro-forma operating earnings from oil and gas. That’s the sort of diversification that could go a long way toward cushioning any further weakness in gold and copper prices.
Wednesday’s drubbing has given FCX a forward price-to-earnings ratio of 7 — or 46% below its own five-year average — and a dividend yield of 3.8%. With shares now off nearly 30% from a 52-week high notched back in early February, FCX looks like a bargain worth buying on the big dip.
As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.