APA / APC / CHK / ECA / RDS.A / SU / XOM
Analysts for a while have been buzzing about Exxon’s position, speculating as to whether, or when, the world’s largest publicly traded corporation will make a bid to acquire a competitor. You could make an argument that Exxon (XOM) is currently in the best shape of any financial company in the history of the world. Their net income for the third quarter of 2008 alone was over $14B dollars and they currently have $38.43B dollars in cash, ready to be deployed. On top of this mountain of greenbacks, they also have roughly $165B in repurchased stock. Exxon has been fairly quiet on the M&A front since they bought Mobil last decade, but many feel things could change with the recent collapse of crude oil prices. I would like to take a look at a few potential targets for Exxon as well as a few other options that I see as very feasible.
Apache Corp.
Apache Corp. (APA) is one of the largest exploration and production companies in the world with excellent geographical resource exposure, something that Exxon dearly covets. Apache also has a stronghold on the Southeast Asian and Australian natural gas markets, two areas that Exxon would be very wise to enter. Apache also has the scale that would lead to a meaningful acquisition for Exxon. Even though Apache looks like a perfect target for Exxon’s management, it is very unlikely that a deal like this would occur because Apache is extremely sound financially. Apache has seen positive free cash flow for the past 22 years. This trend is likely to continue even in this financial crisis. The premium that Exxon would have to pay to acquire Apache would make the relative value of such a deal extremely unfair.
Chance of occurring: <5%
Anadarko Petroleum
Anadarko Petroleum (APC) is a company similar to Apache but with less of a natural gas bias. Anadarko has excellent exposure to Africa, another area that could be lucrative for Exxon to enter. Anadarko had built up a sizable amount of debt in 2006 and 2007 and it seemed like they could have possibly been a takeover target, but their CEO Jim Hackett has done an excellent job of paying down this debt and managing the company over the last few years. This is another situation where an acquisition would be unlikely, although slightly more likely than an acquisition of Apache.
Chance of occurring: <10%
Chesapeake Energy Corp.
Chesapeake Energy (CHK) has been all over the news over the course of the last year due to their stock’s roller coaster ride. Nobody was hotter than Chesapeake during the energy boom and no one has been in worse shape (until recently) when energy commodity prices came crashing down. Exxon’s natural gas exposure is not nearly high enough when considering the likely shift in the world’s infrastructure under the new environmentally conscious hydrocarbon ban, and Chesapeake is the leading natural gas producer in the United States. Chesapeake also has massive leaseholds in the Haynesville Shale, the United States' foremost natural gas play. They have superb management with CEO Aubrey McClendon and I doubt he would let them go down without a fight or a great offer. This acquisition of Chesapeake has a higher probability of getting done, as it makes a lot of sense for Exxon going forward.
Chance of occurring: 35%
EnCana Corp.
EnCana (ECA) is a company that has run into some problems recently with liquidity. They have over $12B in debt and less than $400M in cash on hand as of the end of the last quarter. On top of their abnormally high debt levels for a large energy company, they also had negative un-levered free cash flow for the last quarter totaling approximately $1.9B. This burn rate of cash is not sustainable, and management will have to significantly cut back the capital expenditure program in order to accommodate their new financial situation. Management had been quoted saying that there was a potential for the company to break into two “separate parts to unlock value,” but this seems unlikely given their current situation. Their reserves are mostly spread throughout the United States and Canada, so Exxon wouldn’t really gain any geographical exposure by acquiring EnCana. Still, it would help boost XOM's footprint in the natural gas markets and potentially unlock value if they could manage the company better than current management. An acquisition of this size could also be at risk of antitrust regulation.
Chance of occurring: 15%
Suncor Energy
Suncor (SU) is the type of company I would consider buying if I were in charge of Exxon. The resources are located in Canada, and these resources are oil sands, which are not conventional crude oil resources. Obviously oil sands are extremely out of favor right now, but to me it would make all the sense in the world to buy near the “low” of the market. Exxon could easily finance a takeover of Suncor with an all-cash offer, even with a substantial premium over the current stock price. Exxon has shown that they are really not concerned with environmental issues, and acquiring a company as environmentally unfriendly as Suncor wouldn’t be a problem for Exxon’s management or shareholders.
Chance of occurring: 20%
Royal Dutch Shell plc
As ridiculous as it may sound, Royal Dutch is a possible (though not extremely likely) target for Exxon. RDS.A has a large amount of international exposure that Exxon envies, as well as a fairly impressive reserve replacement ratio that well outpaces Exxon’s own. The key here is the regulators and anti-trust laws, the two main reasons why I don’t see this happening. Without these two factors in the way, I think Exxon wouldn’t hesitate to buy RDS and put to rest a rivalry that has lasted over 100 years between the spin-out of Standard Oil and the European oil giant. All things being equal, Exxon could even buy RDS in a stock only deal (if the shares of Exxon didn’t lose any value).
Chance of occurring: 5%
Foreign Government Joint Venture
This is the option that most of the analysts and writers are buzzing about. Unfortunately for their speculatively racing minds, I think that this is extremely unlikely. Exxon, along with most of the other oil majors, is already having enough problems with nationalized oil producers, Venezuela being a great example. The Venezuelan state-controlled oil producing company is refusing to pay Schlumberger (SLB) and Halliburton (HAL) a combined $1B, and it seems as if the companies will never see a penny of this money. Operating in these types of environments is not worth the risk of losing all your assets to nationalization; just ask ConocoPhillips (COP) and B.P. plc (BP). In case you missed it, ConocoPhillips just wrote down over $10B in Russian exposure in their last earnings report, and the BP-TNK venture has had a world of trouble since the day it was started.
Chance of occurring: 1%.
Resource Acquisition and More Share Buybacks
Now here is an option that not only makes sense, but is very likely. Some form of this will take place with Exxon’s cash load. This method presents a few benefits for Exxon that I believe are not as easy to see. Firstly, resource acquisition in many cases will dodge the regulation barrier that would come with any Exxon acquisition. This way, the oil giant can basically sidestep Obama. Don’t forget that Obama isn’t Exxon’s biggest fan; he had commercials that attacked their profit margins running throughout his campaign. With the public outrage over “big oil profits,” I doubt the U.S. Department of Justice lets anything of this nature slide through easily. Seeing the types of deals that are made around the industry almost daily as companies are scrambling for liquidity, it seems as if Exxon could easily outbid rivals for leaseholds that are up for sale from either other struggling smaller competitors or governments.
Share buybacks present not only an effective, but also an interesting scenario for Exxon. The market may not be able to price in the full value of an acquisition by Exxon, but whenever a firm announces share buybacks, it is much easier to calculate what this will mean for the share price. Often in our markets, irrational exuberance takes over and equities prices can run up higher than they should when share buybacks are announced. Exxon could use this to its advantage to acquire a company in an all-stock deal when their stock price is inflated beyond levels they feel are fair. This approach could potentially kill two birds with one stone. With roughly $40B in cash, Exxon could potentially set more than half of this aside to buy back shares and keep the rest on hand in case of any emergency or a sustained drop in energy prices, something that actually would not be a bad thing for Exxon in the long run.
Chance of occurring: 100%
Final Thoughts
Exxon will most likely choose at least one of these options; it is just a matter of time. Exxon’s management hinted that something was in the works during the fourth quarter earnings call. With Exxon holding that much cash it would be in the best interest of shareholders if they put it to work. Regulators will be the big question, and the option of not having to deal with regulators through the last scenario I listed is very attractive for Exxon.
In the meantime, do not expect Exxon to act quickly. Exxon has waited as crude has dropped from $147 to $39 and will not be afraid to wait longer in order to get the exact deal that they want. Exxon would rather miss calling the bottom and buy in somewhat into the upside than attempt to catch a falling knife with their cash reserves. While I have full faith in Exxon’s management to make the right decision, I would warn long investors to be aware of this pending acquisition before taking a large long bet on the world’s largest company.
- Charles W. Petredis
Full Disclosure: The author’s family as well as the mutal fund the author manages are long APA, CHK, and XOM. The mutual fund the author manages is long SLB.
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