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Freeport-McMoRan Shifts Into Overdrive

Stocks in this article: FCX PXP MMR BHP RIO

NEW YORK ( TheStreet) -- Other investor's pain may very well translate into our gain. On Dec. 5 Freeport-McMoRan (FCX), the world's second largest copper producer, announced a pair of game-changing acquisitions.

Freeport decided to diversify its business away from mining (copper, gold, molybdenum, cobalt hydroxide, silver and other metals) as it agreed to purchase to oil and gas exploration and production companies. The proposed acquisitions do change the face of the company, and shareholders face a company that is quite a different beast from what they had already invested in.

Pre-deal, Freeport was predominately a copper producer and now energy will make up approximately 25% of its earnings before interest, taxes, depreciation and amortization. Needless to say, investor reaction was harsh and the stock tumbled 16% from its pre-deal price the day of the announcement.

As newcomers to the name, we have no emotional baggage or pre-existing notions of what the investment was. We can base our decision on what the investment is and, best of all, we get to purchase the stock on sale while the investor base is in transition.

We get high-quality copper assets at an attractive price. Management has the lowest finding and development costs in copper, which gives the company a competitive advantage and we expect them to deploy this know-how into the energy business.

To be sure, this is a buy-and-hold name, maybe even be the archetype for buy-and-hold investing, as the merits of the acquisition will take time to prove out. Nonetheless, we recommend investors purchase the shares which were recently trading at $33.50.

The game did change for existing Freeport investors, and we are thankful we didn't have to endure their pain. Freeport decided to significantly lever up its balance sheet when it agreed to purchase Plains Exploration and Production (PXP) and McMoRan Exploration (MMR) for $6.9 billion and $3.4 billion respectively, with a combined assumption of $11 billion in debt.

The rationale is to diversify Freeport into a global diversified natural resource play. Though there are no business synergies here (all the companies dig for commodities and remove them from the earth but otherwise have no overlap), there are financial synergies as Freeport will use its lower cost of debt and significant cash flows to retire its acquirees' expensive debt, thus creating some accretion.

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