Monday, November 20, 2006

What the Phelps Dodge Acquisition Means

So, there is little doubt that I am a bear when it comes to asset prices. Many other commentators agree with me with regards to copper. This is reassuring, since I do not study commodity markets.

People who live this business, however, are suggesting that I am wrong. Had I listened to my friend Jason Tilberg, I could have made some nice dough in Southern Copper. But as I noted above, I don't follow commodity markets, so I ignored it (trying to stay in my zone of comfort). Plus, as noted above, I am an asset price bear, so in my mind, commodities, and companies tied to them, are things to avoid.

However, there is increasing evidence that I have erred. The Freeport acquisition of PD is such evidence. Freeport clearly believes that copper prices will remain high enough, long enough for it to basically pay down the new debt it is issuing to acquire Phelps before prices fall. The transaction is actually accreditive to earnings in the first year. This is rare in an acquisition, since the premium paid is usually too high, and new shares issued for the acquisition, plus other acquisition costs usually put a dent in earnings for at least 12 months, before cost cutting synergies and pricing power take root.

Now, even if copper prices fall, Freeport may have gotten a good deal, since as the largest manufacturer, they should also be the low cost supplier to the market (higher market share leads almost inevitably to lower relative cost), and in an oversupplied market, it is the low cost provider (whic can still reduce prices and make money) that wins.

Even so, this is a bet on higher copper prices going forward, because the increased fixed charges have to be paid by cash coming from operations. If copper can remain at elevated prices for another year or two, however, and Freeport is disciplined at deleveraging, they have the opportunity to reduce those fixed charges by the time prices begin dropping.


  1. 2 things.

    1. i think you've erred by ignoring commodities. read 'hot commodities' by jim rogers

    2. i'm not sure copper prices are going up in the short term, infact they might go down. the US market's housing sector is reducing the blding of new homes[a major consumer of copper]. i own FCX and would've sold at 59 on monday morning, 'cept i didn't read the news till noon and FCX was under 56. but i bought it for the divis [they give nice special divis in addition to the regular ones] and in the next 5 years it should do well. but i doubt it'll shoot up in the next 6 months. maybe a good covered call selling play!
    [but your stock knowledge is far superior to mine!]

  2. Empty Spaces, thanks for the complement and the advice. I am sure that you have forgotten more about real estate investing than I know!

    What are the major points in Rogers' book?

    Although I have attempted to read Adventure Capitalist (where Jim drives around the world in a specially modified Mercedes-Benz), I couldn't finish it. He's too full of himself. I am always looking for insight, though, so based on your recommendation, I will pick it up.

    I agree with you that copper prices should fall. Higher commodity prices are leading to greater supply, and prices will moderate. Plus, globally we are moving away from easy money. The reason I wrote about the PD acquisition is because despite the fact that I think prices are headed lower, its obvious that Freeport doesn't think so. Or maybe more accurately, they don't see prices falling as far as the markets do. As long as prices stay at more elevated levels than the market expects, the acquisition will be a major success.

    Do you think Freeport will come to regret their decision?