Three’s a Crowd

Phelps Dodge's attempt to merge with a pair of other companies — again — shows why such triple plays are rare.

Like Levenson, Bear Stearns & Co. analyst Anthony Rizzuto saw debt as more problematic than complexity, especially when the ability of Phelps/Inco/Falconbridge to repay under favorable conditions reflected market prospects for their metal. “The world is a little more uncertain than it was six months ago, with interest rates, geopolitical instability, and oil prices,” says Rizzuto, who also noticed signs of a deceleration in Chinese demand for copper, which is being challenged by alternatives like plastics and aluminum.

“I did see the strategic rationale for the long term in wanting to put the three companies together,” he says. “But the core asset strength leaned more heavily on the side of Inco and Falconbridge” — the part of the deal that was abandoned. Indeed, $550 million of the projected three-way synergies involved Falconbridge.

Phelps CFO Ramiro G. Peru, who would be Phelps Dodge Inco’s finance chief, notes that Phelps on its own is “significantly undervalued” because of its strong connection to one market, copper. Adding nickel and other metals would bring it “closer to the [global] super majors,” led by BHP Billiton and Rio Tinto. A Phelps/Inco-only merger would combine the world’s number-two producer of nickel and its number-three in copper, but would be much smaller without Falconbridge.

The Second Time Around

For Phelps to win shareholder approval of a combination with Inco sans Falconbridge, the company will have to retool some effusive language about how the triple play would revolutionize metals mining. Phelps executives declined to be interviewed, but in talking to analysts, CEO J. Steven Whisler had claimed that “the stars have aligned, and the marketplace is going to share this excitement.” Asked why Phelps rejected “the alternative of doing nothing” in the thriving copper market, the CEO said, “Sometimes it takes bold moves. If we ran everything by looking backwards, we wouldn’t get anywhere.”

Whisler’s assertion that Phelps would benefit from having previous acquisition-integration experience raised Rizzuto’s eyebrows. As rare as three-way mergers are, points out Rizzuto, Phelps had tried another one in 1999: simultaneous hostile bids for Cyprus Amax Minerals Co. and Asarco Inc., totaling $2.77 billion. Phelps did manage to snare Cyprus Amax, but a bidding war developed for Asarco, and Grupo Mexico SA’s all-cash bid eventually won the day. The Cyprus Amax deal that went through increased Phelps’s leverage sharply, Rizzuto notes. “Now, it’s taking on all this debt again, after it’s worked so hard to pay the debt down,” he said before the Falconbridge deal fell through.

One That’s Working

Another attempt at a three-way deal in recent years involved aluminum makers Alcan, Pechiney, and Algroup, of Canada, France, and Switzerland, respectively. That $19 billion (in assets) deal was blocked by European regulators on antitrust grounds. Antitrust wasn’t the problem for Phelps’s three-way, which cleared such hurdles in both the United States and Canada.

For a three-way to sail smoothly, it helps if it is simple and not complicated by preexisting hostile bids. Within a few days of the Phelps/Inco/Falconbridge proposal, Houston-based Anadarko Petroleum Corp. offered $21.1 billion to buy rival oil and natural-gas producers Kerr-McGee Corp. and Western Gas Resources Inc. in two friendly deals.

Anadarko is paying special attention to explaining its plan for reducing debt from the $24 billion in financing it receives from UBS, Credit Suisse, and Citigroup. Issuing equity and selling assets “will produce a net $15 billion of proceeds to take down the debt,” Anadarko CFO Al Walker told analysts, with other proceeds coming from the “very free, cash-flow-rich situation” involving the two acquisitions.

With the cost of acquisition-related growth these days comparing favorably with exploration growth, it is not surprising that so many natural-resources deals are cropping up. “There will continue to be lots of M&A activity,” says analyst Rizzuto, “from alumina through zinc.”

Roy Harris is a senior editor at CFO.

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