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Investment Banking Assignment
Investment Banking Assignment
Question 1
Part A A few months before the announcement by Freeport-McMoRan to acquire Phelps Dodge in November 2006, a tumultuous series of events occurred in the mergers and acquisitions landscape within the mining industry. In June 2006 Phelps Dodge announced a three-way merger between itself and two other Canadian mining companies, Inco and Falconbridge for a total sum of $56 billion (Stowell, 2010). This merge and acquisition process would have created the worlds largest nickel producer and the largest publicly traded copper producer. This announcement came months into Falconbridges implementation of a poison pill defence in an ongoing attempt to protect itself from a takeover by the Swiss mining giant Xstrata, which had 20% of Falconbridges stock (Stowell, 2010). Ultimately, the three-way merger between Phelps Dodge, Inco and Falconbridge fell apart after Xstrata offered a higher bid for Falconbridge, which lead to Xstrata acquiring Falconbridge(Stowell, 2010). Moreover, A Brazilian mining company by the name of Companhia Vale do Rio Doce (CVRD) made an all cash offer for Inco of $86 a share. Although Phelps Dodge had made a greater bid of $86.89 per share, which was partially equity, the investors favoured an all-cash bid. This allowed CVRD to be victorious in acquiring Inco (Stowell, 2010). On November 19, 2006, FCX signed a definitive merger agreement with Phelps Dodge. This agreement leads to FCX acquiring Phelps Dodge for $25.9 billion in cash and stock. Shareholders of Phelps Dodge would receive $126.46 per share, which is a combination of $88 per share in cash plus 0.67 common shares of FCX. This represents a premium of 33% to Phelps Dodge shareholders closing price on November 17, 2006(Stowell, 2010). Part B Price-Earnings ratio (P/E ratio) = Market value per share / EPS (earnings per share) The market value of the share price before the announcement was $95 and increased to $122.5 after the Freeport takeover was announced. This 28.95% price increase is not accurate for our data as we want to gather Phelpss op erating performance during 2006 so we will use the share price of $95. EPS (Earning Per share) = 3,017.8 / 202.4 =14.9 Therefore: PE Ratio = $95 /$14.9 = 6.375
Theoretically, a high P/E illustrates that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. Phelpss PE ratio has increased over the previous years and assuming it is in correspondence with the industry average, exemplifies to investors that Phelpss is expecting higher growth in the future which could cause attention towards Phelps Dodge as being a target for acquisition which was shown in the case study were Freeport becomes interested in acquiring Phelps Dodge.
Question 2
Part A & B The acquiring of Phelps Dodge by FCX was financed jointly by JP Morgan and Merrill Lynch there involvement started from the very beginning. The investment banks teams were actively coordinating the entire process from acquisition to capital raising, the M&A teams at the investment banks were primary responsible for knowing all the needs and priorities of the Mining Company. These roles included advising the company on the merger valuation, min of cash and stock, timing, and the effect predicted by the shareholders reaction. While the Leverage teams of the investment banks had the responsibility of analysing behind making the bridge financing commitment to the company. This process was important as it enabled FCX to show committed financing to Phelps Dodge. The equity capital market group of both investment banks were responsible for all aspects of the equity offering, which advise the company in regards to structure ,size pricing and timing of financing, they also work with colleagues in their firms institutional equity sales area to determine potential investor interests(Stowell, 2010). Following the announcement of the acquisition of Phelps Dodge by Freeport on November 19, 2006, the investment banks focused on syndicating out the bridge loan in order to raise the capital necessary to complete the transaction. This process included negotiating with credit rating agencies to secure the highest possible rating on the upcoming bond offerings. On February 28, 2007, S&P upgraded FCXs debt rating from a B+ to a BB+ followed later by a further upgrade to a BBB-. On June 7 S&P further upgraded FCX rating to a BBB. Moodys also increased FCX rating from a B1 to a Baa3 by March 27, 2007. The credit upgrades allowed more than $5 billion in equity capital to be raised through common stock and convertible offering and a significant increase in cash flow. After all debt related transactions were sorted, FCX and Phelps Dodge acquisition was successful, this allowed the opening of equity and equity- linked capital raising (Stowell, 2010). Part C Moreover, significant risks were undertaken by the investment banks when accepting to take on this acquisition process. Capital risk was one of the risks undertaken, which is the financial risk related with the banks financing commitment in relation to the acquisition.
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Since the investment banks have committed to the loan they are undertaking a considerable risk. Reputation Risk is also a risk undertaken which is less tangible but still important. This is the risk that comes from associating the investment banking firm with the company for which it is raising capital. Serious issues arising from the company can have a residual effect on the investment banks reputation (Stowell, 2010).
Question 3
Part A JPMorgan and Merrill Lynch were selected to perform the tasks associated with the M&A instead of sharing the tasks among other investment banks was mainly due to their commitment to finance the $6 billion in bridge loans and to underwrite the whole $17.5 billion in debt financing, plus $1.5 Billion in credit lines. This commitment was crucial in facilitating the M&A transaction, and therefore FCX gave all of the tasks including the bookrunning and M&A business to these two firms. JPMorgan and Merrill Lynch guided FCX throughout the M&A pre-deal commencement and the activity targeting Phelps Dodge. In addition to all these benefits JPMorgan and Merrill provided and helped FCX with, both investment banks held high positions in the league tables for financings and M&A and also had existing long term relationships with FCXs management. With all the features provided by the two investment banks the key to FCXs choice of these to investment banks over other investment banks was the risky commitment of providing bridge loans if placement was not achieved in the capital markets (Stowell, 2010). Part B The role of the leveraged finance team at JPMorgan was crucial part of the acquisition process as they were responsible for making the bridge financing commitment on behalf of JPMorgan that permitted FCX to make a firm bid for Phelps Dodge. To guarantee that M&A transaction could be completed, it was vital to line up the acquisition financing. This leveraged financing was crucially important because FCX was taking on a significant amount of new debt and was acquiring a company larger than itself. The leverage finance team had to analyses and assess the new capital structure, the impact on credit rating, and the ability to resell the debt to other investors and banks. The group also had to lead the effort to secure internal firm commitments and gain approval for associated capital charges. The investment banks understanding and experience of the market was crucial to the success of the acquisition (Stowell, 2010). Part C A firm sets aside capital when it takes on an underwriting risk position. If the firm accepts market risk, which means that it will buy securities at the offered price if investors will not, the capital set aside could be significantly important. If the issuer bears market risk, the firm
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still has a small amount of risk, for which it must put aside a small amount of capital. Setting aside capital by placing cash in a risk-free security such as a treasury bond, this provides a return below shareholders equity return requirements, so it is considered an opportunity cost (Stowell, 2010).
Question 4
Part A Credit rating agencies were critically important to the transaction because they determined the credit rating associated with the post-acquisition capital structure of FCX, as the higher the credit rating the lower the cost of debt capital. These ratings could affect valuation of the companys stock and return on equity. Ratings agency groups within the debt capital markets have the responsibility of advising corporate clients regarding the probable rating decision resulting from alternative financing structures. This group works closely with both the high-grade and leverage-loan teams within debt capital markets. With regard to the FCX acquisition of Phelps Dodge, the credit ratings on different debt portions improved due to the significant increase in cash flow and because Phelps Dodge had a higher credit rating than FCX(Stowell, 2010). Part B The Equity Capital Markets Syndicate group coordinates with sales force management to decide among investors when demand exceeds supply, and when limit orders are provided by large potential investors. Ultimately, this group decides the price range at which the security is offered and the final price at which the security will be sold. The group keeps close contact with the markets, especially with regard to comparable offerings, in order to gauge the current appetite of investors for specific structures, deals, and industries. The role of equity research has significantly changed since 2003, before the SEC enforcements changed regulations equity researchers frequently joined investment bankers in beseeching obligations and committed to providing research if an equity transaction was book-run by their company. The opinions of researchers were often favourable which assisted in marketing the deal. However in April 2003 SEC enforcements changed the protocols against investment banks, the new guidelines restricted equity researchers from the process, as investment banks were unable to pay research professionals any monetary or nonmonetary compensation. Apart of the 2003 change in guidelines researchers cannot join bankers in pitches to clients or even communicate with bankers without a referee present on location. Moreover, equity researchers are prohibited to research or suggest their research opinions towards a specific company that is under an investment banking mandate (Stowell, 2010).
Part C A limit order is created when a buyer places a limit, or ceiling, on the maximum price the buyer will pay for a given number of securities. This makes the sales process more difficult because the sales team is asked to sell securities at the highest possible price. If especially large purchase orders include limits, the pricing for the offering will sometimes have to be lowered to accommodate the large orders. Limit orders often come from buyers, such as Fidelity, that the issuing company wants as long-term investors. An inherent trade-off exists, as the sales team must determine the correct balance between allocating shares to large, desirable investors with orders that may include limits and smaller, lower-priority investors that do not require limits(Stowell, 2010).
Question 5
Part A Various financial ratios and performance indicators are able to analyse and assess the financial statements and the performance of FCX before and after the merger occurred. Using a liquidity ratio, such as the current ratio we are able to assess the liquidity and the companys ability to generate cash flow for its operations. FCX current ratio in 2005 was about 1.5:1, which increased to just above 2:1 in 2006. This increase in liquidity suggests that before the merge, FCX was increasing it liquid making it more attractive to financial institutions as it was to satisfy its liabilities comfortably. However, after the merge occurred the current ratio decreased to 1.5:1. This decrease in liquid illustrates that FCX had greater liabilities and its current assets have decreased in comparison to its liabilities. Another ratio that can help assess the companys performance is the Return on Equity (ROE); we are able to recognize how efficient FCX is in using its invested money to generate profits. In 2006 prior to the merge FCXs ROE was reported and calculated to be 60% this high value in comparison to the industry average represents its successful efforts in using shareholders equity to invest in projects that yield high returns. It also exemplifies that FCX has a large supply of excess funds to assist in financing the acquisition process. However in 2007, FCXs ROE was calculated to be 16%, this significant drop in ROE suggests that FCX had less profitability after the merge occurred. Part B As stated pre-acquisition, the goal of this merger was to increase growth as a company. Increasing operations and finances were the main objectives of this merger. If successful, it would make Freeport-McMoran the largest publicly traded copper company in the world, with mining sites geographically scattered around the world (Case study pg487). Shareholders of FCX expected benefits from distinctive cash flow addition, a reduction in the cost of capital and a newly structured, more beneficial geographic and asset diversification (Case study pg487). Post-acquisition, figures had shown these to have been correct.
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Although liabilities had increased significantly, FCX stock price, convertible preferred and equity had all increased in conjunction. This successful financing period allowed FCX to grow according to plan, with increases in revenue and improved asset diversification. The greater geographical capacity achieved allowed FCX to undertake in greater operating activities and produce larger results on a global scale. An assumption can be made that the acquisition of Phelps Dodge was a success according to the Annual report. The financial contributions of the investment banks allowed the transition process to be achieved easier into a global company, without having major effects on operating and financial position of the company. According to the 2007 Annual report released by FCX, there are a number of potential strategic and financial benefits expected to arise in the longer term of these merger efforts. These include: Expected growth opportunities in the global market arising from, greater scales of operations, increased management depth and more effective cash flow. Great demand and little supply, FCX will be strongly positioned to take advantage of a sharp rise in copper prices. Great competitive edge through geographically diverse and long lived mines. In conclusion, this successful merger and acquisition process redirect ed FCXs operational activities. The merge has situated FCX in a competitive and financial position, which increases its business operations and in time increase shareholder wealth.
Reference List
Stowell, D. 2010, Investment Banks, Hedge Funds, and Private Equity, Oxford, United kingdom.