By Isak Muhr, Elsa Henriksson (Stockholm School of Economics), Chris Leung, and Vinay Naik (University of Warwick) – Date: 22/11/2019
Overview of the Deal
Acquirer: Occidental Petroleum (NYSE: OXY)
Target: Anadarko Petroleum Corporation (NYSE: APC)
Estimated value: $55 billion
Announcement date: 06/05/2019
Acquirer Advisors: Citi, Bank of America Merrill Lynch
Target Advisors: Jefferies LLC, Goldman Sachs, J.P. Morgan, Evercore Inc.
In April 2019, Anadarko Petroleum Corporation (APC) agreed to sell its business to Chevron for $65 a share. In May, Occidental Petroleum (OXY) presented a revised buyout offer to Anadarko, offering to buy the company for $76 a share. This deal would pay shareholders 78% cash and 22% in stock as they aimed to derail Chevron’s acquisition of Anadarko, which was structured as a 75% stock and 25% cash deal. Chevron did not make a counter bid, despite such expectations. Occidental thereby outbid their competitor to acquire Anadarko in a transaction valued at $55 billion, including the assumption of Anadarko’s debt, making it the largest U.S. oil and gas merger in more than 20 years (since Exxon bought Mobil). Backing by Warren Buffet’s Berkshire Hathaway helped Occidental, a much smaller player than Chevron, close the deal and grab a major oil industry prize: Anadarko’s nearly a quarter million acres in the Permian Basin, where the low-cost outputs has helped turn the United States into the world’s top oil producer. In August, Occidental completed the deal with more than 99% of shareholders voting in favor of the merger.
“We begin our work to integrate our two companies and unlock the significant value of this combination for shareholders. We expect to deliver at least $3.5bn annually in cost and capital spending synergies and the focus of our Board and management team is on execution to achieve the promise of this exciting combination.”
– Occidental Petroleum President and CEO Vicki Hollub
Company Details (Acquirer – Occidental Petroleum)
Occidental Petroleum is an international oil and gas exploration and production company with operations in the United States, Middle East and Latin America. Occidental is one of the largest U.S. oil and gas companies based on market capitalization. Occidental’s four main business units are oil & gas, chemicals, marketing & other midstream and WES midstream. The company’s wholly owned subsidiary OxyChem manufactures and markets basic chemicals and vinyls.
- Founded in 1920
- Headquartered in Houston, Texas, United States
- CEO and President: Vicki Hollub
- Number of employees: 11,000
- Market Cap: $34.8bn - EV: $94.6bn
- LTM Revenue: $18.9bn - LTM EBITDA: $8.4bn
- LTM EV/Revenue: 5.0x - LTM EV/EBITDA: 11.3x
Company Details (Target – Anadarko Petroleum Corporation)
Anadarko Petroleum Corporation is among the world’s largest independent oil and natural gas exploration and production companies, engaged in gathering, processing, treating, and transportation of petroleum and natural gas. Their portfolio of assets encompasses premier positions in the DJ basins onshore U.S., oil-focused opportunities in the Gulf of Mexico and deepwater basins worldwide.
- Founded in 1959
- Headquartered in The Woodlands, Texas, United States
- CEO: Robert A. Walker
- President: Robert G. Gwin
- Number of employees: 4,700
- Market Cap: $22.5bn. - EV: $42.4bn (December 2018 – pre transaction)
- LTM Revenue: $13.1bn - LTM EBITDA: $6.0bn
- LTM EV/Revenue: 3.3x. - LTM EV/EBITDA: 7.1x
Projections and Assumptions
Following Anadarko accepting Occidental’s bid in May, fears that Occidental could be overpaying for the acquisition drove its shares to a ten-year low at $56.33. Occidental’s bold acquisition of Anadarko didn't have the immediate impact Occidental had hoped, as they reported $93 million, or $0.11 per share, in adjusted net income, which was a disappointing $0.34 per share below the consensus estimate. The poor result came despite the addition of Anadarko's oil and gas operations, and can partly be explained by the worsened performance in three of Occidental’s four business units.
The boost from Anadarko, however, masked some weakness in Occidental's legacy oil and gas operations. Overall, its production declined by 0.5% from the second quarter. That weaker legacy output, when combined with lower oil prices, put pressure on Occidental's oil and gas earnings during the period.
In order to finance the acquisition of Anadarko, Occidental took on roughly $40 billion in debt, including loans and Anadarko’s existing debt load, while making a bet on relatively healthy oil prices going forward. Occidental plans to take additional steps to pay down debt by sales of assets and cutting their capital spending in 2020. Hollub has already completed one big sale: France’s Total SA agreed to pay $8.8 billion for Anadarko’s oil-and-gas producing assets outside the United States, including its biggest future expense, a multibillion-dollar liquefied natural gas project in Mozambique. Occidental and Anadarko are on track to spend a combined $9 billion on capital projects this year. However, the merged company intends to spend only about $5.4 billion next year, a 40% reduction. This will enable Occidental to generate more FCF to accelerate their debt reduction efforts while still allowing them to grow their output by about 2% year over year. While that's well below the 5% annual growth the company initially planned to produce after combining with Anadarko, lower oil prices and concerns about their balance sheet are forcing Occidental to be much more conservative next year. Occidental, which at one time had one of the best balance sheets among its rivals, now has one of the worst, following the largely debt-financed Anadarko deal. Occidental has as much debt as industry leader Exxon Mobil, despite much smaller production, cash flow and market value.
Occidental shares are down 34% since acquisition discussions were revealed, and the market’s sour response has dampened enthusiasm for further deals in the industry. The global average value of announced oil and gas asset transactions is an important indicator of market activity. In the first half of 2019, the total deal value skyrocketed due to Occidental’s acquisition of Anadarko. However, despite the explosion in US upstream M&A activity due to higher oil prices in recent years, the massive OXY-APC transaction is a clear outlier. The direction of movement in oil prices will be the main factor in determining whether or not Anadarko was worth the expensive price tag, and ultimately whether this deal will manifest long term upsides for Occidental.
In an interview with CNBC regarding the Anadarko acquisition, Warren Buffet stated that the deal is “a bet on oil prices over the long term more than anything else”. Many analysts state that there is simply too great of an oil supply to push the price significantly higher than its current trading range. There are also several opposing political forces at play, the most significant being the OPEC oil cartel and U.S. President Donald Trump. On the one hand, OPEC are ready to cut back output if prices fall to unprofitable lows, in an attempt to save profits. On the other hand, Trump is determined to ensure gas remains cheap to fuel growth of the U.S. economy. In undertaking this deal, Occidental is operating under the assumption that the Permian Basin is what it is laid out to be, one of the largest oil reserves America has ever known. It is estimated that the Permian ground holds a large enough oil supply to last the next 20 years. In essence, the world has transitioned from a decade of resource scarcity, with the central question being “when do we run out of oil?”, to having more oil than we need.
Occidental’s “key financial goal” with the Anadarko deal was to protect its dividend over the long term, by effectively buying more FCF by leveraging up its balance sheet. However, some analysts argue that the company took on too much material balance sheet risk in doing so, including the deal they made with Berkshire Hathaway. Hollub, on the other hand, has argued the Anadarko deal made strategic and financial sense. In the long run, a question has been raised as to whether whether the strategies of Occidental and Anadarko can integrate properly and thus create more value than if the two companies would stand alone.
Risks and Uncertainties
Volatility in oil prices present a risk to Occidental, who have already seen their share price fall since they announced their bid for Anadarko. If oil prices were to drop, this would force management to decrease capital expenditures. In turn, this cut back would dampen the expected increase in oil production in 2020. These concerns are presented by many, most notably Carl Icahn who owns an approximate 5% ownership stake in Occidental, who calls the Anadarko deal “one of the worst [he has] ever seen”. His stake in the company could allow him to oust Occidental’s leadership and sell much of its assets piece by piece. Icahn points out that since Hollub started as CEO, Occidental’s market value has fallen nearly 40% while the S&P 500 is up 42%. In addition, he argues that that Anadarko was hugely overpriced. To add to the expensive financing of the deal, a fall in crude prices could result in disaster for the Houston-based oil giant.
Anadarko’s Gulf of Mexico business provided nearly a quarter of their total oil and gas output, yet Occidental has never operated in the Gulf before. Whilst Occidental could tackle this problem by drawing upon the knowledge and assets of Anadarko, helping to create more value, this could result in a huge problem for the combined entity. A lack of knowledge surrounding operating in the area may present a potential risk to Occidental. In a capital-intensive commodity business such as oil and gas, success or failure is partly determined by how efficiently companies invest. It cannot be said with certainty that Occidental will be able to successfully integrate Anadarko’s assets, including anticipated annual operating cost and capital synergies. Difficulties in seamlessly integrating Anadarko into Occidental may result in the combined company performing much differently than expected, due to operational challenges or the failure to realise anticipated synergies. On the contrary, Hollub is confident that Occidental “will get these synergies”, and anticipates that the two companies together will create “a global energy leader”.
Occidental quadrupled its debt to finance the acquisition to $40 billion, during a crucial time when investors are calling for spending cuts and higher dividends. This ultimately means that the acquisition’s success will depend on how quickly Occidental can sell off some of Anadarko’s assets and focus on optimising and integrating the assets it decides to keep, especially prime U.S. shale fields. Hollub’s challenge will be to sufficiently balance sales, such as the liquefied gas project in Mozambique, with the need for their cash flow to pay debt and dividends to shareholders and Berkshire Hathaway (which negotiated an 8% annual payout).
“Making sure that we have dollars either from cash flow or asset sales to lower the debt is critically important for us.”
– Occidental Petroleum President and CEO Vicki Hollub
More broadly speaking, methane pollution is easily the most pressing issue facing the entire oil and gas industry today. If oil and gas methane emissions are not brought under control as impacts on health and climate worsen, the whole sector risks losing its social license to operate. So, in relation to this acquisition, the main question to be considered is whether Occidental will support and adopt Anadarko’s efforts to curb methane pollution. This is a pressing risk, not only to Occidental, but to the entire sector.
© 2019 The MergerSight Group