Should Freeport Pursue Lundin Mining?

Freeport McMoran Copper (NYSE:FCX) is a miner of copper, gold and molybdenum. It has operations in North and South America, Indonesia and Africa, and competes with other miners such as the Southern Copper (NYSE:PCU), Codelco and Newmont Mining (NYSE:NEM).

The market is currently speculating the entry of Freeport in the ongoing bidding war for the acquisition of the Toronto-based Lundin Mining Corp (TSX:LUN). But does this acquisition make sense for Freeport? Here we ty to pinpoint what Freeport stands to gain if it decides to go ahead with the deal, specifically looking at the upside from our base price estimate of $63.42 for Freeport’s stock. We argue that the potential upside to profits is evident, but this upside could be more than offset by the cost of the acquisition. Our price estimate currently stands about 20% ahead of market price.

The Lundin Mining Story

Lundin produces copper and zinc through its operations in Sweden, Ireland, Spain, Portugal, Congo and Russia. During late January of this year, the company accepted a takeover bid from Inmet Mining Corp (TSX:IMN). The two companies were to be merged under a new entity, Symterra. But last week, Equinox Minerals (ASX:EQN) made a counter offer of C$4.6 billion ($4.7 billion) for Lundin, raising Inmet’s bid by 14%. ^[1] Equinox owns and operates Africa’s largest copper mine at Lumwana, Zambia.

Freeport is strongly expected to take part in the contest for Lundin, as both the companies jointly own a significant stake in a copper mine in south Congo. Freeport’s share of the $2 billion mining project is 56%, with Lundin contributing 24%. The remaining 20% rests with Congo’s state-owned mining company Gecamines.

Where Freeport Fits In

Freeport previously announced its intention to aggressively increase its copper production capacity to match the expected increase in demand in the years to come. ^[2] It also acknowledged that, although acquisitions have not been a part of its strategy, it would definitely look into any opportunity that comes its way. ^[3]

Lundin produced about 110,000 tonnes (about 240 million pounds) of copper in 2010, including its share of the Tenke mine in Congo. ^[4] Besides this, it also produces and sells considerable amounts of zinc and lead.

While Lundin’s copper sales figure is dwarfed by Freeport’s 3.85 billion pounds of copper for 2011, the increased output would have a significant positive impact on Freeport’s revenue.

See our full analysis and $63.42 price estimate for Freeport’s stock

Upside Exists…

To simplify the upside case, we consider the scenario in which an acquisition is completed this year and Lundin’s entire production is added to Freeport’s operations in Africa. This would mean the company’s African division would sell almost double the amount of copper predicted in our current base case – close to 500 million pounds. Moreover, the capacity increase over the years could increase our estimated sales figure to more than 1,200 million pounds by the end of our forecast period. This represents a 5% upside to our $63.42 base price estimate for Freeport’s stock, pushing our estimate past the $66 mark.

… But at What Cost?

But if the acquisition is done on an all-cash basis, then Freeport would have to shell out at least $5 billion in cash, including the C$120 million (about $123 million) breakup fee to Inmet, which would in itself reduce about 7% of Freeport’s value.

In our opinion, as there are not many synergies to be obtained from the acquisition, it would make sense for Freeport to go ahead only if the cash component can be kept below $3 billion, with the rest of the compensation being in shares.

1. Freeport-McMoran Lured in Equinox Lowball Bid for Lundin Mining: Real M&A, Bloomberg, March 3 2011 [↩]
2. Freeport-McMoRan ‘aggressively’ looking to boost copper output, Mining Weekly, Oct 21 2010 [↩]
3. Freeport Says Opportunities for ‘Big’ Acquisitions Are Limited, Bloomberg, Feb 28 2011 [↩]
4. Lundin Mining Earnings Announcement for 2010, Lundin Investor News, Feb 23 2011 [↩]