Billion Merger Between Freeport Mcmoran

¶ … billion merger between Freeport McMoran and Phelps Dodge (NYSE: PD) created the world's largest publicly held copper mining firm. The deal was announced on Sunday November 19, 2006 and was completed on March 19, 2007, five months later. After the merger, Freeport McMoran moved its headquarters from New Orleans to the Phoenix headquarters of Phelps Dodge. The company is now a significant producer of both gold and copper. Revenues are $16.9 billion and profit $2.7 billion. Much of this was supplied by Phelps Dodge which, despite being taken over, was the bigger of the two firms. This paper is going to examine the impact of the merger on the stock price of Freeport McMoran (NYSE: FCX).

The Offer

The offer was announced on Sunday November 19, 2006. Freeport McMoran offered to buy Phelps Dodge for a value of $126.46, which was comprised of $88 cash and 0.67 shares of FCX. The deal was announced on a Sunday, so there were no direct ramifications to either company's stock until the opening bell Monday morning. The deal was based on the closing prices for the stock on Friday November 17, 2006. The closing price for FCX on November 17th was $57.40. The closing price for Phelps Dodge was $95.08.

The fact that the deal was announced on a Sunday evening gives us a clear break for which to study this merger. There is no doubt when trading stopped and when in recommenced. However, it should be known that there were rumors of a deal before the actual announcement. The industry in general was going through a consolidation phase at the time, and Phelps Dodge in particular was rumored to be on the block. One of its lead shareholders, Atticus Capital, was reportedly disgruntled and shopping its near 10% share. PD had also been involved in a failed bid for Inco. Another company that failed in that bid, Teck Cominco, was rumored to still be in asset acquisition mode. All of this speculation and activity had resulted in the price of mining assets, in particular those of Phelps Dodge up the months prior to the takeover announcement by Freeport McMoran (Trounson, 2006).

Despite all of the rumors, there was little indication that Freeport McMoran, a company smaller than PD, was in the running. One analyst noted that there were only two firms large enough to acquire Phelps Dodge, Australian giants Rio Tinto and BHP (Schneiderman, 2006). Indeed, a complicating factor in our calculation was a surge in FCX a few days after the merger, when BHP was rumored to be interested in the combined entity (Mandaro, 2006).

Stock Price Data

For this project, we shall study the impact of the deal based on weekly stock prices of FCX through past the date of deal closure, finishing on June 29, 2007. This will allow us to study not only the interim period between the announcement and the closing, but also the impacts of the merger once the operational integration process was underway. Closing prices for each week will be used in this study.

Market Data

The benchmark index used will be the S&P 500. Unfortunately the S&P/TSX Global Mining Index did not exist during this period, as it would otherwise be the best index to use, as it reflects the global nature of the mining industry and the fact that New York does not specialize in mining. However, given this, the broader S&P 500 is the next best choice. The Dow Jones Mining Index is weak, due to the fact that most serious mining money is in either Toronto or Sydney. Thus, a broad market index is the best available comparison for the time period studies.

CAPM

The capital asset pricing model is appropriate for this particular event study. The event is an acquisition by Freeport McMoran of an asset, Phelps Dodge. Many mergers are made for operating synergies, but in this case the move was made for different strategic reasons. Phelps Dodge knew Atticus was going to sell their stake and wanted to make a pre-emptive strike against that. For Freeport, the move was made to more than double their size. They went from being a medium-sized mining firm to being a major world player. In the process, they removed themselves from the position of being a takeover target (the BHP rumors never amounted to anything). The merger was therefore done for long-term reasons more than anything else. Thus, its effectiveness cannot truly be measured until long-term returns have been realized, preferably through an entire business cycle (mining being a cyclical industry).

The best proxy for the risk free rate in the market is treasury securities. We will examine the rate of return on 1-year treasuries at the time of the purchase. In November 2006, the yield curve was inverted, and 2-year treasury notes were yielding 4.718%. This is the risk free rate used in the CAPM calculation. The beta was calculated to be 1.068. The market return in the period was calculated to 7.29%. Thus, the expected rate of return on this investment is 4.718 + 1.068 (7.29 -- 4.178) = 8.04%.

Abnormal Returns

The returns were generally abnormal. The actual returns on Freeport McMoran stock were considerably higher than the returns on the market over the study period. There was significant week-over-week variance, showing that on a week-to-week basis there is little if any correlation to the market.

Analysis of Results

Over the study period, Freeport McMoran's stock increased 44.28%, versus an expected increase of 8.04%. The stock should have finished the period at slightly above $62 per share. However, the acquisition appears to have boosted the fortunes of Freeport stock significantly in the first several months after the purchase announcement. The cyclical nature of the industry can explain some of the movements as commodity prices increased substantially over the study period. Copper prices rose 25% between November 2006 and June 2007. This increase was less than the increase on Freeport's stock, however.