(Bloomberg Opinion) -- If Occidental Petroleum Corp. was thinking of trying to come between Chevron Corp. and Anadarko Petroleum Corp., it’s first warning is the drubbing Chevron’s stock has taken. As of Monday morning, Chevron shares have dropped 4.6 percent since the oil major announced an agreed-upon offer for Anadarko of $65 a share.
The second warning is the drubbing Occidental has taken. It suffered one of the biggest drops in the sector Friday — when most oil stocks were up — though not as much as Chevron’s. By lunchtime Monday, though, it was down more than 6 percent from Thursday’s close. Besides oil prices taking a breather, the big news was that Occidental had reportedly considered a rival offer for Anadarko for at least $70 a share.
As I wrote here, Chevron may have paid a premium of almost 40 percent (based on Thursday’s closing prices) but was getting Anadarko relatively cheap; its stock was trading at $65 only six months ago. By early Monday, Chevron’s sell-off meant the implied offer (which was 75 percent stock) was down to about $62.50. On that basis, a $70 bid from Occidental might seem like a real contender.
It all comes down to one thing, though: Which currency would Anadarko investors prefer to end up with, Chevron’s stock or Occidental’s? Even though Chevron’s fell harder on news of an actual deal, Occidental’s sell-off on the mere rumor of an alternative looks more telling. In buying Anadarko, Occidental would be taking a bigger leap, and its new shareholders would be taking it, too.
Occidental would have to offer more cash to sweeten its deal. Using the share ratio on Thursday, a $70 bid might involve a cash payment of $23 and change compared with Chevron’s $16.25. Anadarko’s shareholders would end up owning just less than a third of an enlarged Occidental, compared with only about 9 percent of Chevron. These are both strong pitch points for Occidental in trying to win over Anadarko, though its existing shareholders may be less thrilled at the share count rising by almost half.
More cash means more leverage, though. On a pro-forma basis, taking into account the $1 billion of cost synergies Chevron is targeting, net debt would be about 0.9 times estimated 2020 Ebitda under the announced deal. For the Occidental deal, using the assumptions above, it would clock in at almost 2 times, and that’s assuming the same level of synergies despite less overlap in the portfolios.
To address that, Occidental’s deal would depend on asset sales that would most likely come in at the top end of the roughly $10-$20 billion of incremental sales that Chevron is targeting. One big question would concern the fate of Anadarko’s large liquefied natural gas development project in Mozambique. Chevron has lots of experience in that business and the balance sheet to pay for it. Occidental has experience developing large, complex projects, but this would take the company into a whole new business with a big capital expenditure budget attached. There’s a good chance some or all of that position would need to be sold, raising execution risk.
Dealing with the expanded balance sheet would also limit the relative freedom to increase payouts. Occidental can point to a solid track record on raising dividends, and free cash flow has grown by leaps and bounds over the past year, underpinning a buyback program. So, too, however, can Chevron, which is also targeting $1 billion of capex synergies with Anadarko, something Occidental is unlikely to be able to match. Assuming it got half that, but cost synergies were equal, Occidental’s pro-forma free cash flow yield looks to be about 7 percent, using consensus forecasts for 2020. Chevron’s clocks in at about 9 percent.
We will have to wait until the merger proxy appears for more insight into how Anadarko played off what appear to be at least two suitors and why, if a higher bid was in the offing, it chose to take a lower one. Relative risk and a notably more skeptical reception for oil deals these days may well be at the heart of it. As of Monday, the gap between the two has most likely narrowed (under my assumptions, of course) as Occidental’s stock has declined — meaning any counter-bid now might require even more cash to make it stick. It is no doubt frustrating for Occidental to see Chevron swoop in on a potential target at this price. Still, it cannot be lost on Occidental that, in its own case, investors sold the rumor and would most likely sell the news even more.
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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