Problem
The way in which a deal is financed is sometimes a tactic to avoid shareholder votes.
The profit performance of firms engaged in shale oil and gas production has suffered in recent years. New wells, in some instances, are producing less than older ones. Therefore investors are pressuring firms to slow the pace of investment in new wells and to return more cash to shareholders through buybacks and higher dividends.
Before the onset of the 2020 global pandemic, larger energy firms with access to greater financial resources showed interest in shale oil and gas extraction in areas such as the Permian Basin of Texas and New Mexico. The huge shale oil and gas deposits in the Permian Basin are capable of producing for decades as a result of lower-cost fracking technology. As a result of the growth of oil output in this region, US daily production rose to 12 million barrels, more than that of Russia and Saudi Arabia.
Against this backdrop, mega energy company Chevron Corp (Chevron) announced that it had reached an agreement to buy Anadarko Petroleum Corp (Anadarko) on April 12, 2019, in a cash and stock deal valued at $33 billion.
Immediately after Chevron's announced deal with Anadarko, Occidental Petroleum Corp (Occidental) blasted publicly Anadarko's board for reaching a deal with Chevron without seeking other bids.
Seizing the moment, Occidental made a counteroffer less than 2 weeks later valued at $38 billion, split 50/50 between cash and stock. The Occidental bid pitted it against Chevron, a firm four times its size. Even though the Occidental bid was superior on paper, Anadarko favored the deal with Chevron. Questions swirled around the Occidental proposal. Would Occidental's shareholders approve such a pricy deal that was predicated on continued high oil prices? Could the already highly leveraged firm finance the cash component of its offer?
There was ample reason for Anadarko's board to be concerned about Occidental's bid. And Occidental shareholders expressed concern that the firm was indeed paying too much and that the firm would not be able to achieve its cost of capital on the investment. This opposition was manifest in Occidental's annual shareholder meeting when the board was reelected with less than 70% of the votes cast as opposed to the normal 95%.
The diminished support was viewed as a protest against the firm's decision to avoid a shareholder vote. Investors were skeptical that Occidental could integrate successfully a much larger firm. Moody's Investors Service estimated that the assumption of Anadarko's debt and additional borrowings to cover the offer would add almost $40 billion in new debt to Occidental. Moody's put the company's debt rating under review for downgrade.
Occidental addressed the first concern by submitting a revised offer consisting of 78% cash and 22% stock. Under the new offer, each Anadarko shareholder would receive $59 in cash and 0.2934 share of Occidental stock per each share they held. This compared to the initial bid consisting of $38 in cash and 0.6094 share of Occidental common.
The new offer entailed far less equity and did not require approval by Occidental shareholders. 143
To address the second issue, Occidental secured a $10 billion investment from Berkshire Hathaway's Warren Buffett consisting of 100,000 shares of Occidental preferred stock, paying an 8% annual dividend and a warrant 44 to purchase $5 billion in Occidental common stock. In addition, Occidental negotiated an agreement with French oil firm Total SA (Total) to acquire all of its non-US assets for $8.5 billion, including its US Gulf of Mexico offshore wells and reserves as well as its liquefied natural gas project in Mozambique.
Under pressure from its shareholders to accept the bid after these two issues had been resolved, Anadarko brushed aside Chevron's $65 per share cash and stock bid, accepting Occidental's revised $76 per share offer. Ana-darko's board secured Occidental's position as the largest shale oil and gas producer in the Permian Basin.
Recognizing that there were other attractive targets in the Permian, Chevron's board reasoned that if it paid too much it would be difficult to earn the financial returns its investors required. In withdrawing its bid, Chevron collected a $1 billion termination fee it had negotiated as part of its earlier deal with Anadarko and promised to return the cash to its shareholders through share buybacks and dividend increases.
On May 4, 2019, the day Anadarko announced it had accepted Occidental's revised bid, its shares jumped 11.6% to close at $71.40, well above the $65 per share offered by Chevron. Investors punished Occidental by driving its shares down by 6.4% to $62 while rewarding Chevron for its discipline by boosting its share by 3.1% to $118.28 per share.
What made Anadarko so valuable to Occidental and Chevron? Chevron needs to replenish its dwindling oil and gas reserves. Anadarko seemed to satisfy that need. In recent years, Chevron had displayed remarkable restraint in managing its spending on oil and gas exploration, preferring to return cash to shareholders through share buybacks and dividends. Anadarko was attractive to Chevron because of its large position in the Permian Basin, the overlap between the two firms' deep-water operations in the Gulf of Mexico, and its liquid natural gas project in southern Africa. The takeover of Anadarko would also have allowed Chevron to achieve substantial economies of scale in the Permian Basin.
Occidental's interest in Anadarko represented a big bet on the future of shale oil and gas and that energy prices would remain high long enough for the firm to recoup its investment. A deal would add nearly a quarter million acres to Occidental's holdings in the lucrative Permian shale basin, double its global production to 1.4 million barrels of oil and gas per day, and enable access to shale fields in Colorado and Wyoming. Occidental's interest in the deal is that it will be positioned to reduce costs significantly and expand its footprint in the booming Permian Basin, an area where it is already one of the largest operators. The deal would allow Occidental to achieve substantial operating savings in the region. However, the plunge in oil prices and the global recession in 2020 raise serious doubts about Occidental's ability to support its increased leverage due to the takeover.
Task
A. Is the highest bid necessarily the best bid? Explain your answer.
B. Speculate as to why Chevron did not increase its initial offer price after Occidental's initial bid. Revised bid?
C. When, if ever, is it appropriate for a board to prevent shareholder votes on matters involved in selling a firm?
D. What were the motivations for Chevron and Occidental to be interested in acquiring Anadarko? Be specific. What were the key assumptions implicit in both firms' efforts to take control of Anadarko?
E. What does the reaction of investors tell you about how they felt about Occidental's takeover of Anadarko? Be specific.