Digging in mountainous terrain comes naturally to Phelps Dodge Corp. So after launching twin tender offers last August for two smaller copper producers -- Asarco and Cyprus Amax -- intent on merging with each other, Phelps was accustomed to rocky footing. When Asarco capitulated on October 6, one week after Cyprus Amax agreed to terms, Phelps appeared to emerge from the three-way hostile takeover as the world's premier copper producer. But as matters stood a day later, the celebration had to wait.
"A two-way deal is tough enough; a three-way is even more difficult," says Phelps Dodge CFO Ramey Peru. Besides convincing its own shareholders that a three-way scenario made sense, Phelps had to persuade two separate groups of shareholders to merge with Phelps and, consequently, not to proceed with alternatives. "None of us was able to come up with a precedent for a three-way hostile," says Peru.
Even when the parties are not hostile, successful three-way mergers are relatively rare. One of this small group is the recent $9.1 billion deal that joined three struggling British cable companies: Mercury Communications, a subsidiary of Cable and Wireless Plc; Bell Cablemedia, a British subsidiary of Bell Canada; and Nynex Cablecom, a British subsidiary of Nynex Corp.
"When we suggested a three-way merger, people started rolling their eyes," claims managing director Terence Kawaja of Salomon Smith Barney, which proposed the deal. The new company, Cable & Wireless Communications, is battling against British Telecom, and also challenges Rupert Murdoch's lock on the satellite TV busi-ness through a company called BskyB.
Another amicable three-way merger was completed this year. Even as Phelps Dodge was slugging it out, Alusuisse-Lonza Group AG, of Zurich, signed a definitive merger pact on friendly terms with two rivals in the aluminum business, Pechiney SA, of France, and Alcan Aluminum Ltd., of Quebec, Canada. The $22 billion merger formed APA, to be headquartered in Montreal.
But this year also witnessed the failure of two hostile attempts at three-way mergers. Banque Nationale de Paris SA stepped in after Paribas SA proposed a merger with another French bank, Société Generale SA. In this case, Banque Nationale de Paris gained control of Paribas, but Société Generale slipped away.
In similar fashion, General Dynamics sought to uncouple a friendly deal between two smaller shipping companies, Newport News Shipbuilding and Avondale Industries Inc. Regulators blocked the three-way deal, however, fearing too much concentration of the U.S. Navy's shipbuilding program under one roof. In May, Litton Industries Inc. tried to pick up the pieces with its own dual bid for Newport News and Avondale. This time, the navy scuttled the deal on grounds that it would stifle competition among shipbuilders. Nevertheless, Litton managed to snare Avondale with a $529 million all-cash bid, versus the $470 million stock swap that Newport News had proposed.
Against this checkered backdrop, Phelps Dodge hoped to set a precedent. But Asarco and Cyprus Amax had other ideas. They countered by adding $545 million to their price tag in the form of $5-per-share cash payments to shareholders of the new Cyprus Asarco. In reply, Phelps raised the ante on September 22, with a $2.8 billion bid. Two days later, just to make matters more interesting, Grupo Mexico leaped into the fray with an all-cash $1.1 billion bid for Asarco.
All four companies are players in the depressed copper mining and smelting industry, where prices in later spring were hovering near a 12-year low. Since then, they have risen 30 percent and are expected to rise further next year, as demand increases from a recovering world economy. The mining assets of all three U.S. firms are concentrated in New Mexico and Arizona.
Concern about resulting debt load raised flags with credit analysts. Duff & Phelps LLC put the copper producer on rating watch in late September.
"We're looking probably at a debt-to-cap ratio of 50 percent," Peru says, versus 31 percent pre-deal. "Clearly, it is a much bigger burden on our balance sheet than we expected," he admits. Thus, Phelps Dodge wants to get its debt-to-capital ratio below 35 percent, and will do so with asset sales of noncore businesses. "With any luck in the copper market, hopefully in the next two or three years we'll be down at levels we're more comfortable with," he says.
Unfazed by additional debt, equity analysts sound more bullish than the debt analysts. "Phelps Dodge had everything to gain and nothing to lose," says John Tumazos, metals analyst at Sanford C. Bernstein & Co., in New York, who faulted the initial bid as too low. Cost control alone holds a lot of promise. "This is a once-in-a-lifetime opportunity to get discipline in the marketplace," says Anthony Rizzuto Jr., equity analyst at Bear, Stearns & Co. Rizzuto believes the three-way combo could eventually bring $300 million to $350 million in cost savings.
Observers note that added size creates an even more compelling advantage. Typically, the industry engages in a self-defeating cycle. Just as prices start to rise, new capacity undercuts them. With fewer competitors, that is less likely. "Stabilizing prices, that's really the thrust of it," says S&P equity analyst Leo Larkin. "Certainly at that level they can thwart overexpansion of capacity in the industry."
The combination of Phelps Dodge, Asarco, and Cyprus Amax would represent about 15 percent of the world's copper-producing capacity, according to Thomas McNamara, an equity analyst at CIBC World Markets, in New York. "It would not be an OPEC, but it should have an influence on the copper market," he says. The three companies have a capacity of 800,000 metric tons. Since the world market now has excess capacity of 200,000, the three companies, if combined, "could take the world market from surplus to deficit" by cutting its capacity, McNamara says. This, in turn, would stabilize prices, he adds.
Attracted to new mining assets, Phelps Dodge had been eyeing Asarco and Cyprus Amax some time before making the bid, according to Peru. He insists that Phelps Dodge does a better job than others in the industry of managing its assets by avoiding over-investment at the peak of the cycle, thereby keeping the company profitable for shareholders throughout the volatile copper cycle. The same expertise could be applied to the assets of Asarco and Cyprus Amax, Peru says.
"We're one of the few mining companies that has earned our cost of capital for the last 10 years," he says. Over 15 years, claims Peru, Phelps Dodge has delivered total returns to shareholders of 1,024 percent, in contrast to 25 percent for Asarco and 102 percent for Cyprus Amax.
Resistance centered on the question of valuation. Phelps proposed to pay a 30 percent premium over the share prices that existed prior to the agreement between Asarco and Cyprus Amax. Critics carped that the offer was inherently unfair owing to the market's treatment of low-cap stocks. In the current climate, small companies are out of favor. Although the copper assets in the ground are similar, investors pay higher multiples for Phelps than for its smaller competitors. Some explanation undoubtedly rests in a market leader's efficiencies and clout, but that would become moot once Phelps owned the new assets.
As a consequence of this valuation, Phelps Dodge was "twice as expensive" as its two targets, says Tumazos. Several standard indicators underscored this point, namely share price to book value, share price to cash flow, and share price to earnings.
This differential worked brilliantly for Phelps Dodge, according to analyst Tumazos. Cyprus Amax either held or would soon hold around $1.6 billion in cash for assets sold or being sold, or $17.67 per share. Thus, a $20.54-per- share final price tag would give Phelps mining assets for a mere $2.87 per share. From the outset, this looked like a no- lose strategy.
Public bidding began on August 20, and then followed a dramatic script. On August 25, Asarco and Cyprus Amax spurned the Phelps Dodge bid. Their counteroffer included a $5 a share payout for each new share of the proposed Cyprus Amax company, or about $545 million.
Many analysts had expected Phelps Dodge's offer to prevail over the merger proposal between Asarco and Cyprus Amax. Even so, on September 22, an eager Phelps Dodge raised its offer and threw in $1 billion in cash, offering $25.47 a share for Asarco (including $9 a share) and $19.49 a share for Cyprus Amax, including $6.89 in cash. That translated into $1.01 billion for Asarco and $1.76 billion for Cyprus Amax, for a total of $2.77 billion.
This bid prompted Asarco CEO Francis R. McAllister and Cyprus Amax CEO Milton Ward to agree to meet with Phelps Dodge CEO Douglas Yearley in New York on September 24 . McAllister and Ward lowered their asking price for a three-way merger from the $3.3 billion of a month earlier to $3.1 billion, according to a source familiar with the meeting. Phelps offered a higher undisclosed price above his previous $2.77 billion, but the three parties were unable to close the gap on exchange ratios, the source says.
Next, McAllister and Ward met and decided to seek potential white knights to acquire the two companies, and they divided up a list of potential suitors. According to sources familiar with the meeting, Grupo Mexico, which already owned 10 percent of Asarco, was on McAllister's list of potential merger partners to call.
At McAllister's request, an agent of Asarco placed a call to Grupo Mexico "to see if there would be a time for Asarco's chief executive to talk to their chief executive." Later that day, McAllister received a faxed letter from Grupo Mexico offering an all-cash offer at $26 a share for Asarco. That would place Asarco's valuation at $1.03 billion, just $20 million higher than Phelps Dodge's offer of $1.01 billion.
Phelps was surprised but not blindsided by Grupo Mexico. "We were always aware that there were others who might step in," Peru says. "Grupo Mexico clearly came to the top of that list. So there was no surprise on our part. It did come kind of late in the game, but we were prepared."
Cyprus Amax, left out of the Grupo Mexico offer and unable to find a white knight of its own, turned to Phelps Dodge to continue negotiations. The two companies reached agreement on September 30. A week later, Asarco accepted a sweetened offer from Phelps Dodge. On October 8, however, Grupo Mexico reopened the bidding and Asarco elected to consider it. Phelps Dodge chose to stand firm, pending an earnings release on October 13. When earnings came in ahead of schedule, a resulting 3.4 percent rise in the price of Phelps Dodge shares revived the bid for Asarco
----------------------------------------------- --------------------------------- Meetings of the Mines?
Trying to snare two targets at once, Phelps Dodge gropes for a foothold.
Asarco and Cyprus Amax agree to a merger of equals. The deal is valued at $2.02 billion based on the prices of the shares of the two companies on July 14. In the deal, Cyprus Amax shareholders would receive 0.765 shares of the proposed Asarco Cyprus for each share of Cyprus Amax. Asarco shareholders would receive one share of the proposed Asarco Cyprus for each share of Asarco.
Asarco and Cyprus Amax reject Phelps Dodge's offer of $18.44 per share for Asarco and $14.50 a share for Cyprus Amax. Phelps Dodge bids to acquire Asarco shares at an exchange ratio of 0.4098 Phelps Dodge shares for each Asarco share and 0.3135 Phelps Dodge shares for each Cyprus Amax share. This represents a bid of $955 million for Asarco and $1.66 billion for Cyprus Amax, for a total of $2.62 billion.
Asarco and Cyprus Amax sweeten their own two- way merger terms with a $5 a share payout, which is worth an estimated $545 million. Based on share prices on August 25, this pushes the value of their merger bid to $3.06 billion. At the same time, they say they would agree to a three-way merger with Phelps Dodge, if Phelps Dodge would raise the exchange rate for Asarco holders to .5300 shares of Phelps Dodge, and improve it for Cyprus Amax holders to .4055 shares of Phelps Dodge. Based on share prices the previous day, this would value the counteroffer at $3.3 billion. Phelps Dodge rejects this bid as "totally unreasonable."
Phelps Dodge sweetens its bid to $25.47 per share of Asarco, including $9 in cash and 0.288 shares of Phelps Dodge and $19.49 per share of Cyprus Amax, including $6.89 in cash and 0.2203 shares of Phelps Dodge. Based on the prior day's share prices, this deal is valued at $2.77 billion. That breaks down to $1.01 billion for Asarco and $1.76 billion for Cyprus Amax. Shareholders could also choose an all-stock deal, with Asarco shares exchanged for 0.4413 Phelps Dodge shares and Cyprus Amax shares exchanged for 0.3376 Phelps Dodge shares.
At a meeting in New York of the CEOs of all three companies, Asarco and Cyprus Amax offer a deal at $3.1 billion, which Phelps Dodge rejects.
Grupo Mexico, which already owns 10 percent of Asarco, offers to buy the rest of Asarco's shares for cash at $26 a share, or $1.03 billion, $200 million more than Phelps Dodge's offer of September 22.
Cyprus Amax agrees to Phelps Dodge's offer of $20.54 a share, placing the value of the acquisition at $1.86 billion, $100 million higher than Phelps Dodge's previous offer. Shareholders can take the deal in all cash, all stock, or a combination of the two. An all- stock deal exchanges one share of Cyprus Amax for 0.3500 shares of Phelps Dodge. The combination deal gives shareholders $7.61 in cash and 0.2203 shares of Phelps Dodge for each Cyprus Amax share.
Asarco directors meet to consider a new offer by Grupo Mexico of $29.50 per share in cash. Citing financial discipline, Phelps Dodge elects not to submit a counteroffer. Amax offer a deal at $3.1 billion, which Phelps Dodge rejects.