Freeport-McMoRan Deal: Not So Fast!

McMoRan Exploration (NYSE:MMR) must have been on Santa’s nice list this year.

Though I don’t see how.

Just a week after the oil and gas producer announced it was again having difficulties with its ultra-deepwater Davy Jones well, its white knight in shining armor appeared.

MMR received a life-saving big bid from former parent Freeport-McMoRan Copper & Gold (NYSE:FCX) for assets, and FCX also made a bid for MMR partner Plains Exploration & Production (NYSE:PXP).

There’s a lot to like about the deal, as InvestorPlace‘s Dan Burrows points out. Freeport now will be on par with natural resource giants like BHP Billiton (NYSE:BHP) and Teck Cominco (NYSE:TCK) as it expands beyond just metals and mining.

But not everyone is as enthused as Dan. In fact, most investors — including Freeport’s biggest shareholders — hate it. That could put a big wrench in the buyout plans and send McMoRan Exploration back down to a watery grave.

Too Close for Comfort

While the buyout certainly is affirmation of the current high-price oil & gas environment and is a win for MMR shareholders, plenty of investors felt like they just got burned.

Freeport stock plunged more than 13% to reach $33.28 on Wednesday after announcing the deal for PXP and MMR — a low not seen since summer. During a conference call to discuss the deal, analysts and shareholders questioned the wisdom of one of the world’s largest metals miners moving back into a business it left behind years ago.

McMoRan Exploration was spun off of Freeport back in 1994. Leading that charge was BlackRock (NYSE:BLK), FCX’s largest shareholder at 3.1% through its various mutual funds, ETFs and private equity funds. Evy Hambro, manager of the firm’s $12 billion World Mining Fund, questioned management’s sanity and rationale for buying two energy firms, said Freeport management had “broken shareholder trust,” and said shareholders should get a vote on the pending deal because it completely changes FCX’s business model.

The money quote:

“I haven’t heard anything on this call that in any way justifies why these companies should be put together.”

Freeport management countered, saying the amount of stock used as payment isn’t sufficient enough to require a vote by shareholders, and over the long-term, the merger would work just fine.

Yet there is some validity to Hambro’s claims.

Freeport is one of the largest mining companies in the world. Its holdings stretch across Indonesia, the Democratic Republic of Congo and Arizona — home to one of the biggest copper mines in the world. As such, investors typically use FCX as a proxy for metal since its revenues are so heavily tied to it. Moving into the energy world will throw that thesis out of whack.

And many FCX investors are concerned the deal will be a huge distraction from a mining operation that has been performing well since the original spinoff, which many investors fought hard for in the first place.

Then there are the potential corporate governance issues to consider.

First, the deals are expensive, especially considering some analysts expected MMR to go bankrupt. Those high prices may be explained by the strange interlocking of the three company’s boards. Freeport Chairman James Moffett and CEO Richard C. Adkerson are also the co-chairmen of McMoRan’s board. Plains chairman and CEO, James C. Flores, is also a McMoRan director. Other board members share various roles across the three firms. This interlocking has some analysts and investors worried that Freeport purposely overpaid to save its struggling “friends.”

At the same time, McMoRan and Plains shareholders are worried they aren’t getting a fair deal, as other bidders could have offered potentially more for shares.

Some investors have even claimed that McMoRan Exploration purposely strung investors along with its ambitious Davy Jones field — knowing full well it was in trouble with the site a full year ago — to decline far enough for Freeport to buy MMR “cheap.” The same can be said for Plains over-reaching itself to buy assets from BP (NYSE:BP) a few months back, knowing it would be soon bought out from a stronger firm.

I’m not sure I buy the conspiracy theory, but the way the three companies are linked certainly entertains the idea.

Bring on the Lawsuits

Despite the potential positives, there’s still a host of issues relating to the deal — namely, the corporate governance problems. I suspect BlackRock and few other major institutional investors will be making a call to their lawyers soon. There’s a big possibility the deal saga could go on for a while before there’s a result, either way.

In the meantime, I still don’t think I’d want to own McMoRan Exploration. Most of the money has been made, so most of the risk is to the downside, in the event the deal falls through. Plus, I’m not sure if the company can survive on its own if that happens.

As for Freeport, investors have everything to gain and really nothing to lose. FCX is dirt-cheap (though it rebounded a bit Friday). By buying shares now, investors can get access to one of the world’s premier miners — and if the deal goes through, they get some juicy oil and gas assets, too.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

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