According to a report citing unnamed sources, Freeport McMoRan Copper (NYSE:FCX) is scouting for a buyer for its one-third stake in the Luna Energy natural gas power plant that supplies electricity to four of its mines. The plant is supposedly valued at $700 million as a whole but the value of Freeport’s stake is being cited as $200 million rather than around $233 million for unspecified reasons. Wells Fargo has reportedly been appointed to handle the transaction. 
The aim of this sale seems to be to pare down the heavy debt on Freeport’s balance sheet by taking advantage of the strong demand for gas-fired power plants. This seems quite plausible because weak copper prices due to a Chinese economic slowdown and credit squeeze is likely to upset Freeport’s calculations about the expected free cash flow from operations to reduce debt.
- Freeport-McMoRan’s Q4 2016 Earnings Review: Improved Commodity Pricing Environment Boosts Results Amid Regulatory Uncertainty In Indonesia
- Freeport-McMoRan’s Q4 2016 Earnings Preview: Improved Commodity Prices And Production Levels To Boost Earnings
- Why Has Freeport Halted Copper Exports From Indonesia?
- Why Copper Prices Are Likely To Sustain Recent Gains This Year
- The Year 2016 In Review: Successful Debt Reduction Efforts And An Improvement In Commodity Prices Boost Freeport’s Prospects
- Improved Outlook For Copper And Oil Prices Prompts A Revision In Our Price Estimate For Freeport-McMoRan To $15
The Luna Energy facility is a 600 megawatt (MW) power plant. According to Freeport’s 2013 annual report, it supplies power to four of Freeport’s mines- Morenci, Safford, Chino and Tyrone. After the stake sale, Freeport plans to keep buying power from this facility. 
Why Freeport Might Be Looking To Sell Stake In Luna Energy
Copper is the mainstay of Freeport’s business. China is the world’s largest consumer of copper and accounts for nearly 40% of the global annual copper consumption. Copper prices are weak this year due to fears of an economic slowdown in China and expectations of shift to a consumption-led growth model from the investment-led growth so far. In the last couple of weeks, a combination of weak trade data, the country’s first-ever corporate bond default and a partial unwinding of copper-financed loans have rattled copper markets. So far, it had been assumed that corporate bonds had implicit sovereign guarantee of the Chinese government behind them. However, the government now seems ready to let some defaults occur without stepping in to rescue companies. This is causing lenders to re-examine the credit-worthiness of the companies whose bonds they own. As copper prices fall, companies are being asked to put up additional collateral but an inability to do so is causing companies to sell copper in the open market to repay the money. The resulting glut is causing copper prices to spiral downwards.
Freeport McMoran acquired two oil and gas companies last year and borrowed money heavily to finance these deals. Its long term debt stood at $20.4 billion at the end of 2013 which it promised to bring down to $12 billion by the end of 2016. In doing so, it assumed an average copper price realization of $3.25 per pound for 2014 and aimed to generate operating cash flows of $9 billion. The company also stated that a reduction in price realization by 10 cents would decrease operating cash flows by $370 million. So if we assume the average realized price of copper for 2014 to be $3 per pound, that alone will erode Freeport’s expected 2014 cash flows by $925 million, bringing it down to $8.075 billion. While this will still exceed its capital spending target of $7.1 billion, it will leave only $975 million to pay down debt. If this scenario plays out along these lines, we doubt that Freeport will be able to meet its debt reduction target at the end of 2016. ((Freeport McMoran Q4 2013 Earnings Presentation, Freeport Website))
In doing the above calculations we have assumed that Freeport’s estimated copper shipment figures will not be affected. However, the situation in Indonesia makes this doubtful. Freeport’s shipments of copper have been halted after mid-January amid a dispute with the Indonesian government over a new export tax on copper concentrates. The company has said that it may be forced to declare force majeure, which is a legal clause invoked to limit liability when circumstances beyond a supplier’s control causes disruptions in shipments. The shipment figures from Indonesia for the year may not meet the stated targets. In such a case, operating cash flows will take a further hit, leaving even less money to repay the debt. 
Perhaps Freeport recognizes that it is likely to fall behind on its debt repayment targets without generating cash from additional sources. One way to do this would be to sell stakes in non-core assets like Luna Energy. If this reasoning is correct, we may witness further stake sale announcements in the near future.Notes:
- Freeport Said to Seek Buyers for New Mexico Power Plant Stake, Bloomberg Businessweek [↩]
- Freeport 2013 10-K, SEC [↩]
- Freeport says Indonesian unit may need to declare force majeure, Reuters [↩]