A deep-pocketed miningconglomerate has just anted up $9 billion
to make a high-stakes wager on energy.
Freeport McMoRan (
is best known for its massive metals hoard, most notably the
Grasberg complex in Indonesia, which is the largest gold mine and
third biggest copper mine on the planet. With operations on four
continents, the company holds 102 billion pounds of copper
reserves, 40 million ounces of gold, 266 million ounces of silver,
2.5 billion pounds of molybdenum, and 700 million pounds of
Starting soon, this world-classasset portfoliowill be joined by
millions of barrels of crude oil and trillions of cubic feet of
On Dec. 5, Freeport McMoRan extended a bold $9 billionbuyout
offer ($20 billion including the assumption of debt) for two
mid-tier exploration and production (E&P) firms.
The first target is
McMoRan Exploration (
, which, as you might guess, once belonged to Freeport McMoRan. MMR
gained its independence via spin-off in the mid-1990s. After
amassing 255 billion cubic feet of proved oil and gas reserves, MMR
is now reuniting with its former parent.
The second prize in this mega-deal involves
Plains Exploration (
, which incidentally owns a sizeable stake in MMR. Plains itself is
still digesting a $6 billionacquisition of offshore properties
Shell (NYSE: RDS)
that are currently generating 67,000 barrels of oil per day
After the deal closes in the second quarter of 2013, the
Freeport McMoRan natural resource empire will dramatically expand
Opportunity in the Gulf
The common thread that binds these dual transactions is offshore
production in the Gulf of Mexico. Freeport is paying $2.1 billion
for McMoRan Exploration (net of what it already owns) to gain
control of what could potentially be one of the largest discoveries
on the Gulf of Mexico shelf in decades.
Prior to the buyout, MMR was a portfolio holding in my
Exploration & Paydirt
newsletter. So I'm well acquainted with the firm's shallow-water,
ultra-deep drilling targets, which are brimming with eight trillion
cubic feet of natural gas resources, perhaps more.
A precise reserve figure can't be nailed down just yet because
the company has been stymied by a series of flow test delays.
McMoRan is anxiously waiting to test its highly promising Davy
Jones well, but progress has been hampered by drilling mud blockage
and other setbacks. Of course, that happens when you're working
30,000 feet below the surface under pressures that exceed 25,000
pounds per square inch.
Now, it's up to Freeport to finish the job and get Davy Jones
and other nearby wells flowing.
McMoRan Exploration is situated in the middle of a 200-mile band
of offshore drilling targets. And to bolster its position, the
company recently outbid its neighbors for 14 new lease blocks that
will add 65,000 acres in the heart of its territory.
Given the potential for blowout production, I can see why
Freeport McMoRan was anxious to bring these assets back under its
roof. In fact, the company was so optimistic that it offered a
buyout premium of nearly 80%.
And this was the smaller of the two purchases.
Freeport is also writing a $6.9 billion check for Plains
Exploration, which is already reporting record oil sales. Most of
thecredit goes to the Eagle Ford Shale in Texas, where the firm's
output has surged six-fold over the past year, to 30,400 barrels
per day from 5,200 barrels per day.
But that's nothing compared to what lies ahead.
On Nov. 30, 2012, Plains finalized a deal with
Shell (NYSE: RDS-A)
to acquire $6 billion of deep-water assets in the Gulf of Mexico.
The purchase included wells that are currently spitting out 67,000
barrels of oil per day -- along with enough exploration and
development acreage to last into the next decade.
How I Plan toProfit
Had Freeport McMoRan not beaten me to the punch, Plains Exploration
would likely have been one of my next portfolio candidates.
Fortunately, Freeport is in my
Scarcity & Real Wealth
portfolio, which by extension means I'll soon own Plains as
Some investors wanted Freeport to remain a metals pure-play and
would rather get their energy exposure elsewhere. But pairing the
two diversifies the firm's asset base with resources that are vital
to global economic stability and growth.
And the bigger question is whether this is an efficient use of
shareholder capital. I would say unreservedly yes. Following the
acquisition, Freeport will generate about $9 billion in annualcash
flow , assuming conservative commodities prices. Based on a
pro-formamarket cap of $44 billion, the firm's operations will be
a cash flowyield of 20%
And that's just based on today's production, without any regard
to future success on the exploration front.
Better still, Freeport didn't have to break the bank to make
this deal happen. With interest rates near record lows, the company
was able to take advantage of cheap financing to acquire long-lived
assets that will grow increasingly valuable in the years to
Action to Take -->
With more financial resources, Freeport will be able to milk the
vast tracts of prospective oil-bearing land held by Plains and
bring McMoRan's ultra-deep plays to the finish line.
The timing of this deal was opportunistic, considering both
companies' market values had been beaten down because of unforeseen
mishaps that had nothing to do with the value of their oil and gas
The influx ofcash will allow Freeport to deleverage, raise
dividends, and plowmoney into new mines and expansion projects.
In a world where currencies are depreciating and paper assets
could blow away, I find Freeport's world-class mines and energy
reserves highly reassuring.
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