How Losing Control Of The World's Biggest Gold Mine Could Pay Off For Freeport

On Tuesday, Bloomberg reported that Rio Tinto is ready to accept $3.5 billion from Indonesia’s state-owned Inalum for its 40-percent stake in the Grasberg gold and copper mine. Located in Indonesia, Grasberg is the largest gold mine and second-largest copper mine in the world.

Rio Tinto confirmed to Reuters that it is in discussions with Inalum, but said no final agreement has been reached.

The mine is owned and operated by Freeport Indonesia, a subsidiary of Freeport-McMoRan Inc FCX. The deal is part of the Indonesian government’s plan to obtain majority control of the mine.

In response to the news, B. Riley FBR upgraded shares of Freeport-McMoRan from Neutral to Buy and raised its price target from $17 to $20.

“We believe that, should this marker be confirmed in a formal purchase agreement, it holds positive implications for the valuation of Freeport’s interests in Indonesia,” analyst Lucas Pipes in a note.

Why The Deal Matters

Rio Tinto’s stake is not in the mine itself. Rather, it’s in a project that will expand Grasberg’s production dramatically. In the current structure, Rio Tinto only receives 40 percent of production above a certain level, and 40 percent of all production after 2023.

Freeport owns 90.64 percent of the mine, with the remainder currently owned by Inalum.

Indonesia has been keen to take control of the mine, which is seen as a national treasure, and has been doing everything in its power to force Freeport into a cheap agreement — including setting a requirement last month that a deal be made by 2019.

If the deal with Rio Tinto goes through, Freeport would only have to divest about 9 percent of PFTI to Inalum to get Indonesia to the 51-percent ownership it requires.

Why Losing Control Pays Off For Freeport

In the short term, losing control of Grasberg seems like a major loss to Freeport. But after 2023, the company’s stake is only shrinking by less than 2 percent. Operations would continue to be run by Freeport as well.

The mine produces copper at a negative cost thanks to the gold byproduct; the current license runs until 2041, making the equity loss insignificant in the long-term.

B. Riley FBR's Pipes said the Rio Tinto deal, should it go through, would reduce the likelihood of some of the most damaging potential outcomes for Freeport. In other words, it potentially means the end of Indonesia’s regulatory attacks on Freeport.

For the foreseeable future, risks around taxes and environmental standards will continue to be present, the analyst said. 

“Overall, we believe that Freeport offers greater reward than risk in light of [Tuesday’s] development, and we would buy the stock at current levels." 

Price Action

Freeport-McMoRan shares moved lower Wednesday morning before recovering to trade near Tuesday's close. The stock was up 0.76 percent at $17.30 at the time of publication Wednesday afternoon. 

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