E&P Mergers and Acquisitions – A Case Study


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Abstract 

The process of bringing two companies under a single roof can send an organization to new heights but also has the potential for rocky transitions. In the oil and gas industry, E&P mergers or acquisitions tend to strengthen physical positioning and induce an expanded asset portfolio but it often comes with extra baggage in the form of outstanding debt. Such was the case when Occidental Petroleum acquired Anadarko Petroleum as the outstanding debt left the oil major struggling to keep their head above water. By investigating the acquisition process as a case study, analysis can be made regarding Chevron’s new acquisition of Noble and whether or not the merger can be considered a success.


Introduction 

In the most simple of terms, mergers and acquisitions (M&As) is the process of two companies becoming one. More specifically, the purpose of a merger or acquisition is to increase the value or accelerate the growth of a business by consolidating companies or assets, with an eye toward stimulating growth, gaining competitive advantages, increasing market share, or influencing supply chains [1]. Clearly the goal is growth and that can come with access to new technologies or intellectual property, a wider customer base through expanded distribution channels or experienced staff, or even a reduction in competition, costs, and overhead. There are many benefits to such activities, but downsides can also occur when bringing two companies together under a single roof. There may be a clash in cultures, resources diverted while managing the merger, reduction of staff, or devaluation of assets. While most mergers and acquisitions benefit both companies, there are also dangers to such activities. 

One company in particular, the tech giant Amazon, has been known as the king of M&As because they have acquired so many companies and consolidated them all under one umbrella. Some of their more successful acquisitions include Whole Foods Market, allowing them to enter into the fresh food market; Zappos Shoes, expanding their retail business utilizing Zappos’ platform as the leading footwear and apparel website in the world; and  PillPack Inc. with an effort to expand into the online prescription business aided by Amazon’s extensive delivery network [2]. Clearly each of these acquisitions has helped the company grow into various focused platforms on e-commerce, cloud computing, digital streaming, and artificial intelligence to make it one of the largest and most successful companies in the world. 

How does this apply to oil and gas? Well, Amazon is a success story with multiple M&As generating more and more profit, soaring Amazon’s stock price to new heights. That scenario cannot be said for all E&P mergers and acquisitions, especially the one made by Occidental Petroleum of Anadarko Petroleum in August of 2019. Since the deal, Occidental has been put through the ringer by management decisions and poor market conditions. One year later, another large merger has surfaced: Chevron Corporation’s acquisition of Noble Energy. The two acquisitions have many similarities and relate to each other, so it is reasonable Occidental’s acquisition can be used as a case study to predict Chevron’s future fate. 


How E&P Mergers Are Unique (And Why They Make Sense)  

Similar to M&As in the tech world, the goal of a merger between E&P oil and gas companies is to grow. But, the targets are quite a bit different. First and foremost, E&P companies are typically seeking physical positioning and an expanded asset portfolio. While many are looking for an expanded asset portfolio, they also want further portfolio streamlining, meaning they are often seeking assets similar to what they currently operate. For example, BP is ahead of schedule for its 2019 divestment plan after its acquisition of BHP Billiton’s domestic onshore assets. After selling its Alaska position and Oklahoma SWOOP acreage, its other legacy acreage remains [3]. Basically, companies want more assets similar to what has made them successful historically and will typically divest those that might be foreign to them. While this is not always the case, it is certainly what the E&P sector has been displaying over the past two years. 

An important item to note is when one company takes over another, they assume both the assets and also often take over the debt. Selling foreign or lower tier assets is one strategy of paying down this debt. The problem with debt is that too much leverage can significantly devalue the stock of a company. This was seen with Occidental after they took on loads of debt from Anadarko and have been unable to divest many foreign assets. 


Occidental Petroleum’s Acquisition of Anadarko Petroleum 

Now it is time to take a deeper look into Occidental Petroleum’s acquisition of Anadarko Petroleum to uncover why the deal became a burden to the purchaser so quickly. From this information, conclusions can be drawn relating to Chevron Corporation and their acquisition of Noble Energy. 

Prior to Occidental’s official closing on Anadarko, Chevron was a major player in the bidding process. In fact, Chevron was in an agreement to purchase Anadarko before eventually being outbid. On May 5, 2019 Occidental increased the cash component of its $38 billion bid to acquire Anadarko from 50% to 78% cash and the remaining amount stock, removing a requirement for any deal to receive approval by Occidental’s shareholders [5]. The deal was accepted by Anadarko and on May 9, 2019 Chevron abandoned its pursuit of Anadarko, citing price discipline, and Occidental declared victory [4]. Even though the deal was not officially closed until August 8, 2019, problems began to arise almost immediately. 

On the same day Occidental increased their bid that eventually closed the deal, they also seemed to have clinched an agreement to sell Anadarko’s African assets to Total in the event of acquisition [4]. Occidental planned to take on $13 billion of debt to help finance the Anadarko deal along with the help of the above Total agreement for $8.8 billion, which would cover part of the cash portion OXY proposed [5]. OXY’s ambitious plan to pay off the new debt and Anadarko Petroleum’s existing liabilities has encountered many obstacles in the past year. Not only have they been unable to close some asset sales, including its remaining Africa assets, but plummeting crude oil prices reduced asset values, making it impossible to achieve the company’s target [10]. Because of that, the oil company has had to shift gears as it works to address the new, massive debt load. It abandoned its plan to sell its assets in Algeria and might not be able to sell its business in Ghana. 

As a result, Occidental has a looming problem in the form of a significant amount of debt coming due over the next couple of years. On a positive note, it doesn’t technically have any notes maturing in 2020, but holders of its 2,036 zero-coupon notes could force the company to redeem them in October costing as much as $992 million [11]. Things may get worse next year as it has $6.4 billion in notes maturing and an additional $4.7 billion of debt coming due in 2022 [11]. With only $1 billion of cash on its balance sheet, Occidental needs to work fast to address these upcoming debt maturities. 

How extreme is this debt? The easiest way to get a better picture of the debt load is by investigating OXYs debt to equity ratio prior to the acquisition, immediately after the acquisition, and in 2020 after crude prices crashed. A graphical view of the company’s debt to equity ratio can be seen in Figure 1. Before their acquisition, OXY had a debt to equity ratio of 0.51 indicating their assets were twice as valuable as their debt – not a bad position to be in [8]. After their acquisition when they assumed all of Anadarko’s assets and liabilities, the ratio climbed to 1.19 meaning the debt being carried was more than the value of their assets [8]. This type of leverage is still acceptable as long as you are able to generate enough cash flow to make payments on said debt. Finally, after the March 2020 price crash seen in Q2 2020, OXY carried a debt to equity ratio of 1.7 in July of 2020 [8]. The problem was OXY quadrupled their debt to $48.26 billion in the deal while the price slump devalued their assets by $6.6 billion [6, 15]. Basically, as their debt to equity ratio skyrocketed their stock value tanked. 

Figure 1: Quarterly Change in OXY Debt to Equity Ratio [14]

Ever since, OXY has been desperately trying to get rid of their assets, restructure, and reduce CAPEX to stay afloat. Chief Executive Vicki Hollub identified that the most likely sale prospects are Anadarko’s offshore assets in the Gulf of Mexico, its pipeline business, and its African assets [5]. Why? Occidental had limited exposure to these areas before the acquisition and thus many are quite literally foreign assets. Unfortunately, most of the divestiture deals have fallen through. On a brighter note, OXY recently agreed to sell Wyoming, Utah, and Colorado land grant assets to Orion Mine Finance for $1.3 billion; very welcome news for a company struggling to keep their head above water [7]. Down the road, the acquisition’s success will depend on how quickly Occidental can sell off some of Anadarko’s assets and focus on optimizing and integrating what it keeps to prepare for paying off bonds due over the next two years. 


Chevron Corporation’s Acquisition of Noble Energy 

Clearly, the OXY-APC acquisition has been a rough road, and it is currently difficult to label it as a success story. Almost exactly a year after Chevron decided not to pursue the Anadarko purchase, it decided to acquire another major shale player: Noble Energy. On July 20, 2020 Chevron Corporation announced that it has entered into a definitive agreement with Noble Energy, which has not yet closed, to acquire all the outstanding shares of Noble Energy in an all-stock transaction valued at $5 billion [13]. As with most M&As in the oil and gas industry, the list price comes with a lot of debt. With Chevron assuming all of Noble’s debt, the total enterprise value of the deal is $13 billion [12]. 

Remember when Anadarko backed out of the deal with Chevron? Part of breaking that agreement required Anadarko to pay Chevron a $1 billion breakup fee for backing out of their initial deal [4]. That is quite a bit of cost added to the price tag OXY paid and additional revenue created for Chevron to spend on an acquisition of another company, a company with far less debt. While Anadarko’s valuable holdings in the Permian Basin of West Texas and New Mexico appeared to be a good match, Chevron said at the time that it favored discipline over “winning at any cost” [12]. Chevron held out and found a better deal that appears to fit their portfolio without damaging their bottom line. With the acquisition of Noble’s low-cost, proven reserves in addition to cash-generating offshore assets in Israel, the move strengthens the company’s position in the Mediterranean [12]. Noble’s portfolio will also add to Chevron’s U.S. acreage in the Permian Basin and in Colorado’s DJ Basin [12]. Even though Chevron’s total debt increased by $7 billion to $30.3 billion after the acquisition, they are still poised to be successful due to a profitable asset acquisition [9]. 

Figure 2: Quarterly Change in CVX Debt to Equity Ratio [16]

Although this still seems like a large amount of debt to acquire, the size and asset base of the supermajor will keep the debt to equity ratio strong. Before the acquisition, Chevron maintained a cool 0.16 debt to equity ratio that climbed to a 0.23 immediately after the purchase [9]. Chevron has written down assets since the acquisition which has caused that ratio to climb slightly to 0.25 [9]. While an ideal acquisition would maintain or even lower such a ratio, it does not impact the company’s leverage the same way as OXY. As a result, Chevron’s stock valuation has remained relatively unchanged. In the coming months, Chevron will likely choose to sell off some of the Noble assets not aligned with their current expertise and free up cash. Along with the additional $1 billion on hand from the failed Anadarko agreement, Chevron seems to have their debt under control and is still positioned to be successful far into the future. 


What This Means For The Industry – Consolidation Mindset 

The two case studies above, as well as the many other mergers and acquisitions seen in 2019, show a consolidation mindset is beginning. While Chevron has diversified their asset portfolio with Noble’s Mediterranean assets, it has also focused on increasing its presence in the Permian and DJ Basins. Occidental has eliminated many assets like Wyoming, Utah, Colorado, and Africa to focus on their core assets in the Permian. Mergers can bring efficiencies to allocate spending across a larger, consolidated portfolio of shale assets, as opposed to the patchwork more common in the oilfield [3]. Clearly, interest in the currently devalued shale producers remains, meaning sellers and management teams need to be willing to forgo significant premiums to get deals done, achieve synergies and economies of scale, and focus on deleveraging their debt which may make the stock more valuable [3]. One-off deals are hard to predict by their very nature, especially with rumors and speculations abound. One prediction for the future can be sure – smaller companies will abandon spreading themselves too thin across basins and asset types to focus on consolidating their business model for success moving into the rocky future. 


Conclusion 

The Occidental acquisition has thus far been a failure because OXY piled on debt, was unable to divest inexperienced assets, and their overleveraged debt eventually crushed them with the untimely price crash. The Chevron and Noble acquisition will most likely be more successful because Chevron’s size maintains a solid debt to equity ratio while continuing expansion on the existing asset portfolio. Future companies can learn from the failures and triumphs of the above case studies by paying off debt to fix a weak bottom line. Oil prices fluctuate, so companies can’t plan on high prices for a bail out. High prices increase cash flow but when crude inevitably crashes, the asset values crater and the debt remains unchanged. In addition, many oil and gas companies continue to struggle to adapt to current, challenging markets and demonstrate positive returns on capital spent in recent years. A focus on acquiring key core assets through mergers may be the new direction of the major and large independents as they continue to divest non-core international assets to streamline their portfolios [3]. Smaller companies eager to find their next core asset may be able to adapt more quickly which could mean picking up divestitures by large companies. Either way, the era of continuously leveraging debt to pay for capital development for E&P companies has come to an end. For the near term, a focus on the balance sheet will be a major driver for any company planning mergers and acquisitions.


References 

[1] https://debitoor.com/dictionary/mergers-and-acquisitions#:~:text=Benefits%20of%20mergers%20and%20acquisitions,Access%20to%20new%20technologies

[2] https://www.investopedia.com/articles/markets/102115/top-10-companies-owned-amazon.asp

[3] https://www2.deloitte.com/us/en/pages/energy-and-resources/articles/oil-and-gas-mergers-and-acquisitions.html

[4] https://www.cnbc.com/2019/05/09/chevron-will-not-raise-offer-for-anadarko-petroleum-company-says.html 

[5] https://www.reuters.com/article/anadarko-petrol-ma-occidental-chevron/timeline-occidentals-victory-over-chevron-for-anadarko-idUSL2N22L10Q

[6] https://www.reuters.com/article/us-occidental-divestitures/occidental-to-sell-parts-of-anadarko-after-debt-fueled-acquisition-idUSKCN1SY0XW

[7] https://www.houstonchronicle.com/business/energy/article/Oxy-to-sell-Wyoming-land-grant-assets-for-1-3-15495832.php 

[8] https://www.macrotrends.net/stocks/charts/OXY/occidental-petroleum/debt-equity-ratio

[9] https://www.macrotrends.net/stocks/charts/CVX/chevron/debt-equity-ratio

[10] https://www.fool.com/investing/2020/05/16/with-asset-sales-off-the-table-occidental-petroleu.aspx 

[11]  https://www.fool.com/investing/2020/05/16/with-asset-sales-off-the-table-occidental-petroleu.aspx 

[12] https://www.washingtonpost.com/business/chevron-acquires-noble-for-5-billion-in-all-stock-deal/2020/07/20/dab488f2-ca7a-11ea-99b0-8426e26d203b_story.html

[13] https://www.chevron.com/stories/chevron-announces-agreement-to-acquire-noble-energy

[14] https://www.tradingview.com/x/Tbkgzwn3/

[15] https://www.fool.com/investing/2020/08/10/occidental-petroleum-gushes-red-in-q2-as-low-oil-p.aspx

[16] https://www.tradingview.com/x/ESz0jz7k/

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