When a merger fell through last autumn, mining company Freeport-McMoRan was undeterred. It has just bought a rival and issued the world’s biggest junk bond to pay for it. Edward Russell-Walling explains.
When it bought its rival, Phelps Dodge, Freeport-McMoRan Copper & Gold struck a rich seam of superlatives. Not only did it become the world’s largest publicly traded copper company, but it also went on to part-finance it with the world’s biggest-ever junk bond issue. And those were not the only new records it set.
The mining industry has been in a state of corporate ferment, fuelled by record commodity prices, and the result has been consolidation on an unparallelled scale.
Headquartered in Phoenix, Arizona, copper and molybdenum miner Phelps Dodge had been out on a limb after its proposed three-way merger with Canadian miners Inco and Falconbridge collapsed last September (Xstrata snatched Falconbridge and Companhia Vale do Rio Doce made off with Inco). At the same time, New Orleans-based Freeport had been looking for ways to reduce its heavy dependence on Indonesian gold and copper interests.
The $26bn takeover, agreed in November, was the largest acquisition in mining history. Although Freeport is acquiring Phelps Dodge, whose chief executive will retire, it has agreed to move its headquarters to Phoenix.
Better access
The combined company will be a major producer of copper and gold and the world’s largest producer of molybdenum, with interests in Indonesia, North and South America, Africa and Europe. Freeport CEO Richard Adkerson said that enlarged scale would give the company better access to resources, suppliers and project opportunities.
Freeport’s original hope was to settle half in cash and half in shares. But Phelps Dodge insisted on a higher proportion of cash and by the time negotiations had ended, this had increased to about 70% – $18bn.
“We wanted to get more stock into the transaction than we were finally able to negotiate,” says Kathleen Quirk, Freeport’s chief financial officer. “We used cash on hand of about $2.5bn and debt finance of $16bn, structured via the bank market, term loan markets and high yield markets.”
JPMorgan and Merrill Lynch were joint bookrunners on the bond issues and advised Freeport that a large high yield transaction would execute well in the market. At the same time, they pointed to considerable capacity in the institutional term loan market.
Second largest
The final package was the second-largest non-investment grade acquisition financing ever (after the one assembled by Kohlberg Kravis Roberts and others to pay for last year’s acquisition of HCA). It included a $1.5bn senior secured revolving credit facility and two senior secured term loans. Labelled A and B, these were for $2.5bn over five years at Libor plus 150 basis points (bp) and $7.5bn over seven years with a Libor margin of 175bp respectively. Term loan B generated more than $11bn in demand from more than 250 institutional loan investors.
The high yield element, offered in mid-March, was split into three tranches. The first was a $1.5bn, eight-year issue priced at par with an 8.25% coupon. Another $3.5bn in 10-year paper yielded 8.375% at par. A further $1bn in floating rate bonds paid six-month Libor plus 325bp.
“We were always planning to raise $6bn,” says Ms Quirk. “But there was significant demand for a floating rate note, so that was added to the eight-year and 10-year fixed rate tranches.”
The high yield market was, in her words, “a little choppy” when the issue priced, as investors reacted to bad news from the US subprime mortgage industry, and the coupons were tweaked a little higher than initial guidance.
This was judicious, because investor demand for the junk deal was very strong, with $15bn in orders from more than 250 investors. “They liked the story,” says Ms Quirk. “They liked the fact that this is the largest traded copper company, and that the acquisition was the largest in mining history. And they like the outlook for the copper business.”
Size means index weight, and investors like that, too. The bonds have since traded very well.
De-leveraging policy
Freeport has always enjoyed strong cash generation and has a firm policy of de-leveraging to the utmost. It could not issue new equity until it had completed the debt transactions but, once it had, wasted no time in setting more records with an equity issue. It raised a gross $5.8bn through the largest ever dual tranche equity issue – of common stock plus (the largest ever) mandatory convertible preferred offering.
“We originally launched a $3bn equity offering, but upsized significantly because of strong investor interest,” says Ms Quirk.
Because the equity proceeds are being used to pay down debt, Moody’s and Standard & Poor’s subsequently raised their credit ratings on Freeport itself and, by two notches, on the junk bonds. It pays to think big.
