Exxon Mobiles Acquisition of XTO Energy - Coursework Example

? Table of Contents Table of Contents 2 Exxon Mobile’s acquisition XTO Energy 3 Executive Summary 3 Industry Overview 3 Exxon Mobil & XTO Energy: Company Overview 4 Strategy 5 Valuation and Deal Design 8 Financing 9 Regulatory Implications 9 Defence Tactics & Deal Protection Measures 10 Implementation 10 Risks 11 Bibliography 12 Exxon Mobile’s acquisition XTO Energy Executive Summary The up and down swings in the M&A activity in the Oil and gas industry is as volatile as the prices of the commodities. This paper examines an acquisition deal finalized by Exxon Mobil (buyer), the biggest Oil Company and XTO Energy (one of the biggest natural gas company) in 2009. The acquisition was finalized in July 2010 and is deemed to be a good fit with Exxon’s strategic domestic move in unconventional reserves. Industry Overview The discovery of Oil is considered to revolutionize the way world has been working. With an inelastic demand of energy, it is no surprise that the market structure of Oil & Gas industry is Oligopolistic. Unlike other industries, the supply of oil & gas depends on a number of factors such as geopolitical tensions, natural calamities, and clamor for energy security by nations, global oil demand and trading speculations. Considering the unusual demand-supply dynamics of this industry, the landscape of M&A activity is driven by the economics of oil, development-driven increase in demand of energy and a race to secure energy stock and reserves for the future. Bloomberg estimates that 27% of the total M&A deals in the year 2011 would be attributed to the energy sector (Bloomberg, 2010). With the advent of financial crisis in 2007-08, the M&A activities in this sector was incentivized in three cases: 1) major oil companies pursuing growth options 2) independents divesting assets in order to focus capital spending on core assets; and 3) companies combining for survival (Booz and Co., 2009). The key trends observed in the M&A transactions across the industry were (i) an increased M&A activity in the oilfield services domain due to necessity of consolidation and need to manage costs (ii) a limited presence of International Oil Companies in upstream M&A activities as they focus on new exploration acreages (iii) New entrants to the hydrocarbon sector (iv) Presence of private equity deals and (v) The emergence of oil sands and coal bed methane as upstream targets. The upswing in the mergers and acquisitions also accompanies certain challenges encountered by the oil and gas sector. These include (i) financial capital (ii) volatile crude prices (iii) rising competition for reserves (iv) political risks and dealing with National Oil Corporations (v) increased drilling and production costs (vi) environmental risks and (vii) enterprise wide risk management. Exxon Mobil & XTO Energy: Company Overview Exxon Mobil: Texas-based Exxon Mobil Corporation is the world largest integrated and not-state owned oil company in the world with a market cap of USD 417.96 Bn. It was formed upon the $76.6Bn merger of Exxon and Mobil on November 30 1999. The main activities of the multi-national Exxon Mobile Group are exploration, production, transportation and sale of crude oil and natural gas as well as manufacture, transportation and sales of petroleum products. Operating in over 100 countries, Exxon Mobil’s strength lies in its functional and geographical diversity. The company derives its revenues from all across the globe – 25% from North America, 23% from Middle East, 19% from Europe, 13% from Africa, 9% from Asia and 11% from the rest of the world (Deutsche Bank, 2010). 72% of Exxon’s value comes from upstream activities, 17% from downstream activities, 9% from Chemicals processing and 2% from others. Major competitors for Exxon Mobil are BP, Royal Dutch Shell and Cheveron. XTO Energy is another Texan based mid-tier oil and natural gas producing company formed in 1985. As of December 31, 2009, it had estimated reserves of 12.50 trillion cubic feet of natural gas, 93 million barrels of natural gas liquids, and 294 million barrels of oil; and owned interests in 18,815.8 net producing wells (Bloomberg , 2011). XTO Energy Inc. markets its gas to brokers, local distribution companies, and end-users. XTO Energy has created a niche in tapping unconventional resources of oil and natural gas such as Shale gas, Freestone trend and Liquids. In particular, it is one of the leaders in the business of extracting gas from shale and other dense geological formations—a technique that has caused a jump in America’s output of gas and seems likely to boost production elsewhere (The Economist, 2009). Its competitors in local US market are Abraxas Petroleum Corporation, Apache Corporation and BP plc. Strategy The big challenge that Exxon Mobil was facing in the past few years was the question of how to grow. In search of long-term growth options, the company was looking to expand its interest in a variety of new areas, especially non-operating interests in independent outfits. Exxon’s competitors were already moving ahead in such ‘unconventional’ acquisitions such as BP and Statoil’s joint ventures with Chesapeake Energy. As seen from Figure 1, Exxon Mobil has established a diversified portfolio of products. Following are the key strategic drivers behind Exxon’s decision acquire XTO Energy: 1. Reserves: One of the main drivers for XTO acquisition was the reserves or assets that XTO withheld, particularly in natural gas. Since 2006, Exxon Mobil (XOM) was having difficulties in replacing its reserves and the only replacements had been from LNG projects in Australia and Papua New Guinea. For major E&P companies as XOM, unconventional resources like offered by XTO were the only choice that offered scaling up capabilities (as controlled by SEC) and undeveloped opportunities. 2. International Risks: With ongoing war in Iraq, geopolitical tensions and civil war threats in the Arab world, overseas oil reserves are subjected to a lot of political risk. The risks added to additional costs for E&P (exploration and production) companies and did not justify the return in revenues. ExxonMobil’s entry into the North American unconventional gas sector aspired to move the focus of the capital and service provider another step away from the international arena. 3. Demand Growth and Gas Price: In the Bank of America Conference on Global Oil Perspective, New York, November 19th, Exxon Mobile estimated a steady growth in the demand of natural gas from 2015 to 2030. Likewise as oil commodity, the prices of both oil and natural gas will rise (Exxon Mobil, 2009). The rising cost of Oil pushes XOM to invest in unconventional reserves of energy. 4. Supply Reality: Contrary to widespread belief that there are about 100 years of natural gas supply in US, Potential Gas Committee (PGC) estimate of natural gas reserves is about 18 years of supply, one-third of which accounts to shale gas. 5. Prudence to risks: Costs of exploring and producing oil internationally has been consistently increasing because of the rise of state-owned oil enterprises that are given concessions and hence become fiscally unattractive. XOM had a prudent approach and decided to focus instead on North American basins where risks and costs were lower and financial returns more immediate. On December 14th 2009, Exxon Mobil decided to buy XTO Energy as part of their expansion strategy into unconventional resources. The deal was strategic move by both companies. From XOM standpoint, XTO provided a strong reserves position as it is the largest owner of domestic gas reserves has a CAGR of 28% (Datamonitor, 2009). It experienced an increase in revenues and profits with a CAGR of 21% and enjoys a strong cash position that indicates a healthy company to invest in. XTO on the other hand had weakness of concentrated business in US thus restricting its dependence on domestic market. Exxon Mobil presented a great opportunity to geographically diversify with 69% of its revenues coming from non-US markets. XTO energy also had substantial amount of debt making it difficult to invest operating business on its own, more so in a financially critical environment. XOM-XTO merger makes Exxon Mobil the largest producer of natural gas in the US with material positions in 5 major shale gas plays and a strong oil position in Bakken State. Valuation and Deal Design The total value of XOM-XTO merger is $41 billion and includes $10 billion of existing XTO debt and is based on Friday's closing share prices of Exxon Mobil and XTO (FT, 2009). The deal includes purchase of 4500 Bn cubic feet of gas, mostly unconventional such as that is trapped in shale rock, tight sands and coal bed methane. In an all-stock deal, Exxon Mobil agreed to issue 0.7098 of a share of common stock for each common share of XTO that had a P/E ratio of 12.8. Buying XTO with a higher P/E ratio than XOM indicates dilution of XOM’s shares. The deal represents a 25% premium to XTO stockholders, which is a very high price for XTO assets. There has been no mention of the actual value of “synergies” in news releases by both companies that indicates either hedging on the future of shale gas or a hastily packaged deal. Since XTO (seller) themselves approached XOM for the deal to take place, there was no question of XOM to get hostile in its bid. Carve Out: Exxon Mobil was concerned about the possibility of Congress enacting regulations that make hydraulic fracturing “commercially impracticable” thereby impeding the further development of shale gas. Hence, they included carve outs in the deal that permitted Exxon to walk away from the deal if the former scenario happens. Jack Williams, a former vice president of ExxonMobil Development Company, became the president of XTO Energy Inc and Keith Hutton, formerly XTO’s chief executive officer, was elected the executive vice president of the new organization. All of XTO’s 3,300 employees were transitioned into the new company (Exxon Press Release, 2010). The Headquarters (Fort Worth, Texas) and name of the organization (XTO Energy Inc.) would not change after the acquisition. Upon the announcement of the bid, shares of Exxon Mobil, fell by 4.3% to close at $69.69, while XTO Energy jumped 15% to $47.86 (Market Watch, 2009). Financing The $41Bn acquisition deal was financed with the issuance of 416 million shares (9% dilution) to buy 45 trillion cubic feet equivalent of US resources, weighted ~80% to natural gas and over 50% to shale gas plays. Since virtually no cash was involved in the deal, it helped free cash for operations and other capital investments. Regulatory Implications The major regulatory bottleneck in XOM-XTO deal was the risk of banning drilling technique used in North Texas’ Barnett Shale (an XTO Energy reserve) and other big natural gas fields around the country (Dallas News, 2010). At the Congressional hearings related to the merger, several Democratic lawmakers expressed concern that the proposed merger would reduce competition in the oil and gas industry and also lead to an increase in the use of hydraulic fracturing and horizontal drilling. Other lawmakers expressed concern that the technologies could pollute drinking water supplies (Reuters, 2010). Certain lawmakers were also against the gas-lobbyist groups used by oil companies in wake of legalizing horizontal drilling techniques. Hydraulic fracturing involves shooting a high-pressure mixture of water and chemicals underground to crack rock and allow more natural gas to flow out, a process that environmentalists argue can lead to contamination of groundwater supplies. The XOM/XTO merger closed on June 25, 2010 in the absence of any Congressional or regulatory action to limit or ban hydraulic fracturing (Sakmar, 2010). Defence Tactics & Deal Protection Measures Since XTO energy was in a much needy position for credit, pertaining to its high debt and frozen credit markets, there was not much written and discussed with respect to defense tactics of the selling company. Implementation Exxon Mobil’s acquisition of XTO Energy can be in a way treated as a merger of giants if not equals, considering the size of both companies. Every M&A deals are easier done on paper than in practice. Hence, Integration strategy of a merger is most important factor in the failure and success of integration. Following are actions that I would follow to lead successful integration of two pharmaceutical companies: 1. Cost Synergies and Redundancies: Since there are estimated synergies in cost containment, it is necessary to milk these synergies as soon as the merger is finalized. Exxon Mobil would have to cut all redundant positions, manufacturing plants and distribution channels to save money. It is also better to apply outside-in benchmarks to cost synergies. 2. Effective communication: Effective and transparent communication to all levels of employees is necessary to contain chaos during post-merger situations. By preparing effective deal teams specializing in integration from both companies is required to have seamless interactions between the two parties. I would also involve key line managers in the process of M&A well before the deal is saturated in order to take them in confidence and also to prepare everyone with the ground realities of the merger. Risks 1. Shareholder Approval Risk: Since the acquisition of XTO Energy is an all-stock deal, the deal cannot move forward without the approval of shareholders of XTO Energy. It might be possible that there are many shareholders who want more for the company than the premium Exxon Mobil is offering. The $49.00 (or $51) buyout price compared to what is now a $28.64 to $49.10 trading range of the last 52-week period but quite low compared to $60-$70 stock price in 2008 (24/7 Wall Street, 2009). Hence, there is a risk that shareholders may not approve the price offered by XOM. Another risk of an all-stock deal is the risk of devaluation of your stocks in the buyer company. 2. All-Stock Deal Risk: It is noted that all-stock buyout of this sort in companies with high P/E ratios is among the least successful type of deals giving negative signals, especially when there are no collars in the deal design. 3. Regulatory Risk: At the time of the deal, another important risk to the deal, which was a part part of the merger exit language, was whether or not Congress passes an “anti-fracking law”… That would make hydraulic fracturing (fracking) taking gas from shale either illegal or would make it an economic impossibility. There is also likelihood of demands of certain conditions or concessions in the deal by a host of energy-specific regulatory bodies (state and local levels of jurisdictions). Another regulatory issue attached with such deals between giant oil players and giant natural gas players is the undue leverage of scale it gives to the merging companies over suppliers. 4. Cultural Risk: Even though both XOM and XTO are giant companies, the organization cultural difference between the two firms can be a bottleneck to attain post-merger integration and the synergies XOM aspires to attain. XOM is a large, traditional firm with high-efficient assets whereas the culture at XTO is that of a small and independent oil and natural gas producer with experience mostly in domestic markets and who specialize in the short-term nature of the business (which requires constant reinvestment and drilling to maintain production). Bibliography 24/7 Wall Street. (2009, December 17). Risks in Exxon-XTO Merger? (XOM, XTO, CVX, BP, RDS-A, CHK) Read more: Risks in Exxon-XTO Merger? (XOM, XTO, CVX, BP, RDS-A, CHK) - 24/7 Wall St. http://247wallst.com/2009/12/17/risks-in-exxon-xto-merger-xom-xto-cvx-bp-rds-a-chk/#ixzz1Ju8Scu1O. Retrieved April 18, 2011 from http://247wallst.com/2009/12/17/risks-in-exxon-xto-merger-xom-xto-cvx-bp-rds-a-chk/ Bloomberg . (2011, April 18). XTO Energy Inc. . Retrieved April 18, 2011 from Bloomberg Businessweek: http://investing.businessweek.com/research/stocks/private/snapshot.asp?privcapId=27191 Bloomberg. (2010). 2011 M&A Outlook. Bloomberg. Booz and Co. (2009). M&A Strategies in the North American Oil & Gas Sector. New York: Booz and Co. Exxon Mobil. (2009, November 18). Exxon Mobil - Global Gas Perspective. Bank of America Conference . (S. V. Andrew P. Swiger, Ed.) New York, New York, USA. Exxon Press Release. (2010, June 25). ExxonMobil Announces Completion of All-Stock Transaction For XTO. Retrieved April 18, 2011 from Exxon Mobil: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MzE4MzgyOHxDaGlsZElEPTM4Nzk2OHxUeXBlPTI=&t=1 Dallas News. (2010, February 12). Exxon can void deal to buy XTO Energy if drilling method is restricted. Retrieved April 18, 2011 from The Dallas Morning News: http://www.dallasnews.com/business/headlines/20091216-Exxon-can-void-deal-to-buy-4331.ece Datamonitor. (2009). XTO Energy Company Profile. New York: Datamonitor. Deutsche Bank. (2010). Exxon Mobile. Dallas: Global Markets Research . FT. (2009, December 14). XTO bid answers questions on Exxon strategy. Retrieved April 18, 2011 from Financial Times: http://www.ft.com/cms/s/0/746931fe-e8e2-11de-a756-00144feab49a.html#axzz1JqePkSn2 Market Watch. (2009, December 14). Exxon Mobil to buy XTO Energy in $41 billion deal. Retrieved April 18, 2011 from Market Watch: http://www.marketwatch.com/story/exxon-mobil-to-buy-xto-energy-in-41-billion-deal-2009-12-14?pagenumber=2 Sakmar, S. L. (2010). The Future of Unconventional Gas: Legal, Policy and Environmental Challenges to the Development of North American Shale Gas . 29th USAEE/IAEE North American Conference (pp. 13-14). Calgary: IAEE. Reuters. (2010, January 20). Exxon-XTO merger draws scrutiny from Congress. Retrieved April 18, 2011 from Reuters News: http://www.reuters.com/article/2010/01/20/us-congress-exxon-merger-idUSTRE60J53920100120 The Economist. (2009, December 17). Unconventional The unflappable oil giant changes tack. The Economist , p. 35. Read More