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Freeport-McMoRan Faces Tough Choices In Strategic Review Of Oil & Gas Business

Freeport-McMoRan Inc. has announced a strategic review of its oil and gas business, as it looks for the best response to the prevailing weakness in oil prices.

However, the conundrum facing Freeport is not just the weakness in oil prices, but also that copper, the other major commodity that the company produces, is currently characterized by a subdued pricing environment, as well. Given that neither copper nor oil prices are likely to rise significantly in the near term, we feel that the company must take decisive action to protect its interests, though there are no easy choices before the company management. Freeport’s credit rating remains under threat due to its heavy indebtedness against the backdrop of weak commodity prices. In addition, with noted activist investor Carl Icahn recently acquiring a stake in Freeport, the company management has added incentive to take action in order to protect shareholder interests. In this article, we will evaluate the latest developments at Freeport.

Brent Crude Oil Prices Over Last Twelve Months, Source: Y Charts

Strategic Review of Oil and Gas Operations

As per the company’s press release, the strategic review is being undertaken with the objective of improving the company’s financial position and enhancing long-term shareholder value. The various options under consideration to accomplish these objective are the potential public offering of a minority stake in the oil and gas business, a potential spinoff of the oil and gas business, joint venture arrangements, and further spending reductions.

In addition to the announcement of a strategic review of the company’s operations, Freeport has reshuffled its board of directors, an item that was on Mr. Icahn’s agenda when he acquired an 8.5% stake in the company. Freeport has announced the retirement of two board members. Additionally, five other members from the Freeport-McMoRan board of directors have joined the board of the company’s oil and gas subsidiary, Freeport-McMoran Oil & Gas, a move that would facilitate the potential spinoff of the oil and gas business. Close on the heels of this announcement, two nominees of Carl Icahn have joined the Freeport-McMoRan board of directors. Mr. Icahn’s representatives are also present on the board of the oil and gas subsidiary.

We will now evaluate the various options under consideration by Freeport as a part of its strategic review. Given Freeport’s boardroom reshuffle, a spinoff of the oil and gas business remains a distinct possibility. This move would separate the company’s mining from the oil and gas businesses. However, in the absence of more information from the company, a number of questions remain, the most important of which is the proposed capital structure of the two entities. Freeport’s credit rating was downgraded by S&P earlier in the year, citing weak commodity prices and the company’s debt burden. In order for either of the two entities (the mining business or the oil and gas business) to benefit in terms of an improved financial position, a favorable allocation of the company’s existing debt burden is needed. If Freeport intends to favorably capitalize its mining business, it would imply a correspondingly heavier debt burden on the oil and gas business, which would hamper its prospects. Interestingly, the majority of Freeport’s debt burden pertains to the acquisition of the oil and gas business in 2013. Thus, in the event of a spinoff, the company has to decide which business it intends to focus upon and fund favorably. The unfavorably funded business could be a candidate for a potential sale in the future. Given that the mining business accounts for the majority of the company’s revenues, it is likely to get favorable treatment in case of a spinoff, though no comment to this effect has been made by the company.

Decline In FCX’s Stock Price over Last Twelve Months, Source: Google Finance

Now, we will consider the other options before the company. Freeport has already made the relevant SEC filings for a potential IPO of a minority stake in the oil and gas business. However, shareholders would benefit from such a move only if oil prices and the company’s stock price improves. Under current market conditions, Freeport is unlikely to realize much value from the sale of a minority stake in the oil and gas business. The same logic applies to a joint venture arrangement, where Freeport may not realize the best value for the sale of a stake in the company to a joint venture partner. The sale of a minority stake in the oil and gas business and joint venture arrangements should be made under current market conditions only if the company is unable to sufficiently boost cash flows through other means. One of these other means are proposed spending cuts. The company has already sharply reduced its capital spending plans earlier in the year. Further spending cuts could be in order, given weak market conditions for both oil and copper.

In conclusion, improving its financial position under current market conditions, while preserving shareholder value, is an extremely challenging task for Freeport-McMoRan. The company may have to prioritize one of its businesses over the other. In a choice between its mining and oil and gas businesses, the company is likely to favor the mining business. Such an outcome would certainly negatively impact the prospects of the oil and gas business.

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