VideoDigging 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.
Copper Blues
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."
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