MMR Finds a Buyer

Jim Brown
 
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They did not have to look far since the Chairman and CEO of McMoran was still the Chairman of Freeport McMoran. We have expected an acquisition of MMR for several months but I always thought it would be after the Davy Jones well was completed.

The McMoran takeover story started many years ago. McMoran Exploration (MMR) was spun off from Freeport McMoran 18 years ago in 1994. Freeport previously had a large holding of oil and gas assets and divested them to concentrate on the mining sector.

An acquisition was imminent because McMoran Exploration was running out of money. After investing $961 million to date in the ultra-deep science project known as Davy Jones 1 the company did not have enough money to complete other wells which had logged multiple discoveries. The rationalization given was that McMoran was waiting until DJ1 had been completed so they could use what they learned from that well to produce the others. To some extent that was true but I believe the overriding reason was the lack of money.

Freeport (FCX) agreed to buy McMoran for $14.75 in cash and a 5% overriding royalty on existing McMoran ultra-deep discoveries. That 5% royalty may end up being worth more to shareholders than the $14.75 in cash. Each MMR shareholder will receive 1.15 shares in the royalty trust plus the $14.75 in cash.

Plains Exploration (PXP) was also included in the deal with Freeport paying $25 in cash and 0.6531 shares of FCX for each PXP share. Plains was included in the acquisition package because they owned 31% of McMoran. Plains got the shares in an asset swap back in 2010.

Plains was also a very undervalued producer and they had just completed a series of acquisitions and did not have enough cash to adequately fund the exploration. As part of the deal JP Morgan provided $9.5 billion in funding commitments that will allow Freeport to pay off all of the debt held by Plains.

The deal was slightly incestuous since the various players held positions and shares of the other companies. James Moffett Co-Chairman and CEO of MMR is also Chairman of FCX. Mack Rankin, vice chairman of both firms will remain vice chairman of FCX. Richard Anderson, president and CEO of FCX was also co-chairman of MMR. He will continue as president and CEO of FCX. James Flores, Chairman and CEO of PXP will become vice chairman of FCX and CEO of the FCX oil and gas operations. At closing FCX will add Flores and two other members of PXP's board to the FCX board.

I have been expecting an acquisition of McMoran for some time. I thought the acquirer would be Chevron. Chevron has been preaching the benefits of the new ultra-deep discoveries made by McMoran in the shallow waters of the Gulf for over a year. Chevron asked MMR to partner with them on a well onshore but still targeting the same ultra-deep discoveries made by MMR at Davy Jones.

Recently Chevron and McMoran partnered on bidding for six large blocks in the gulf in the same area as the Davy Jones wells. Chevron does not need any partners. They are more than capable of bidding on anything and exploring any asset. They wanted to partner with McMoran because of the very expensive knowledge suite McMoran acquired in pioneering the ultra-deep discoveries.

McMoran acquired the Davy Jones well from Exxon several years ago in a lease purchase. Exxon had abandoned the well after drilling to a shallower depth and finding nothing to produce. McMoran reopened the well with plans on extending the depth to as much as 30,000 feet. They thought it would be cheaper than drilling a new well. That was the worst decision McMoran has ever made. Because the initial DJ well had only been half as deep the diameter of the pipe was only half as big as what was needed to extend the well to near 30,000 feet.

McMoran overcame monumental hurdles in extending the well and found several regions of high pressure gas. The problems came in trying to produce the well. The pipe at the bottom of the well was only four inches across. Because the pipe was so narrow they could not use the heavy duty tools built for extreme depths and temperatures. They continued to run into trouble with the extreme heat over 400 degrees turning the drilling mud into cement. The diameter of the well was not wide enough to maintain adequate circulation of the drilling mud during non drilling operations.

They lost perf guns, bits and pipe in the hole and had to sidetrack after a long section of pipe became lodged in the narrow hole. When they tried to flow test the well in November they found that the heavy duty mud had again turned to cement and had sealed the perforations made to produce the well.

With close to one billion dollars invested in the well and the fate of the entire ultra-deep program resting on a successful well, McMoran could not quit and walk away even though the cash drain continued. They were running out of money and getting additional financing with a two year history of failures on DJ1 would have been difficult. They needed to be acquired.

The key here is that McMoran had a large quantity of high quality assets and a dozen discoveries waiting to be produced.

In a recent MMR presentation they highlighted the various wells underway and acreage under lease. There is no way they are going to zero. MMR Image

Joan Lappin, CEO of Gramercy Capital, contributed an interesting article to Forbes last week stressing the high value of other MMR wells and leases. This is a good read if you own MMR. Forbes Link

McMoran has been quietly accumulating leases onshore from Davy Jones 1. The Chevron well at Lineham Creek, with McMoran as a 50% partner, found an enormous and unexpected discovery at 24,000 feet that corresponds with McMoran's ultra-deep theories. That well is on its way to 29,000 feet and could be there this month.

It was a shame McMoran could not have began production on DJ1 because that would have given them the respect they deserve for the ultra-deep discoveries. Now, as part of Freeport they will at least have enough capital to complete the half dozen wells they have already drilled and complete the exploration on the dozens of leases they have in the portfolio.

As energy investors we will not get the same bang for the buck by investing in Freeport because of the mining component. After the completion of this deal in Q2 Freeport will get 74% of its revenue from mining and 26% from oil and gas.

If you are a shareholder in MMR I would advise you not to sell today. There are numerous reasons why the deal may not get done as scripted. There are several reasons why the eventual price may be higher. Large shareholders in Plains and McMoran are hostile that the deal was done too cheaply. The assets of both companies suggested a higher price.

This was clearly a "get Moffett's butt out of trouble" deal. With Moffett the chairman of both companies there is definitely a reason for the lawyers to attempt to get a higher price.

The number one reason I would not sell the stock today is the royalty trust. A 5% royalty on what McMoran has claimed to be in the neighborhood of 100Tcf of gas is not a small chunk of change. Wait until the deal closes and get your royalty shares. There is almost no chance of the deal falling apart because of the joint history of the two companies. That same joint history could end up forcing them to pay more.

Shares of MMR rallied +87% to close at $15.82 and well over the $14.75 cash price of the deal. It will be interesting to see if the price continues to climb on the royalty hopes and the chance for a revised deal.

There is always the chance for somebody like Chevron, with a wealth of inside knowledge, bidding up the deal. I would not rate that chance high but with Chevron partnering with McMoran in so many ventures there is definitely a possibility.

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Jim Brown

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