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Financial Analysis on an Oil Corporation Takeover
Gulf Oil Corp.–Takeover
Summary of the facts
o George Keller of Standard Oil Company of California (Socal) is trying to figure out how much he wants to do with Gulf Oil Corporation. Gulf will not consider bids below $70 per share even though the final price per share is $43.
o Between 1978 and 1982, the Gulf doubled its exploration and development expenditures to increase its oil reserves. In 1983, Gulf began to significantly reduce its mining costs due to the drop in oil prices when Gulf management bought 30 million of its 195 million shares.
o The participation of Gulf Oil was due to the intention of Boone Pickens, Jr. in the recent Mesa Petroleum Company. He and a group of investors spent $638 million and acquired around 9% of the outstanding Gulf shares. Pickens made a proxy fight for control of the company while Gulf executives fought to hire Boone while pursuing a tender offer of $65 per share. Gulf then decided to liquidate on its own terms and contacted several companies to participate in this sale.
o The opportunity for improvement is what attracts Keller to Gulf and now he must decide if Gulf is worth $70 per share, if it breaks even, and how much to bid for the company.
o What is Gulf Oil’s price per share if the company is liquidated?
o Who is Socal’s competition and how are they a threat?
o What should Socal do with Gulf Oil?
o What can be done to prevent Socal from using Gulf Oil as a long-term concern?
The main contenders for the acquisition of Gulf Oil are Mesa Oil, Kohlberg Kravis, ARCO, and of course, Socal.
o Currently holds 13.2% of Gulf stock at an average purchase price of $43.
o Borrowed $300 million in Mesa securities, and made an offer of $65/share for 13.5 million shares, which would increase Mesa’s ownership to 21.3%.
o Under reincorporation, they would have had to borrow several times the value of Mesa’s wealth to get the majority needed to get a seat on the board.
o Mesa is unlikely to get that much capital. Either way, Boone Pickens and his group of investors stand to make a huge profit if they sell their shares now to the winning bidder.
The price of the offer can be less than $75/share because the offer of $75 will increase their debt ratio, making it difficult to borrow more.
o Socal’s debt is 14% (Empire 3) of total capital, and the bank is willing to lend enough money to make a bid at $90.
o Specialize in leveraged buyouts. Keller feels that theirs is the winning bid because the heart of their bid is to protect Gulf’s name, assets and operations. The Gulf will definitely be an ongoing problem until a permanent solution is found.
Socal’s offer will be based on the value of the fund in the Gulf without further research. Other Gulf assets and liabilities will be included in Socal’s chart.
Gulf Oil’s weighted average cost of capital
o Gulf’s WACC is determined to be 13.75% using the following assumptions:
o CAPM used to calculate the value of equity using beta 1.5, risk free rate of 10% (1 year T-bond), 7% market risk (data from Ibbotson Associates on arithmetic means from 1926 – 1995). Cost of equity: 18.05%.
o The equity market value was determined by multiplying the number of shares outstanding by the 1982 price of $30. This price was used because it was the value that did not increase before prices were inflated by attempted takeovers. Market equity value: $4,959 million, weight: 68%.
o The amount of debt was determined using the long-term debt book value, $2,291. Weight: 32%.
o Cost of debt: 13.5% (provided)
o Profit rate: 67% calculated from pre-tax income divided by tax expenses.
The assessment of Gulf Oil
The value of the Gulf consists of two components: the value of the oil reserves in the Gulf and the value of the company as a whole.
o A forecast was made starting in 1983 to estimate oil production until all reserves are exhausted (Empire 2). Production in 1983 was a combined 290 million barrels, and was expected to remain constant until 1991 when the remaining 283 million barrels were produced.
o The cost of production has been kept constant compared to the amount of production, including the reduction due to the production method used by the Gulf today (Production will be the same, so the cost of discount)
o As Gulf uses the LIFO method of accounting, it is assumed that new reserves are expensed in the year they are discovered and all other exploration costs, including geological costs and geophysical are charged to revenues.
o Since there will be no future research, the cost to consider is the cost of production to reduce the stock.
o Oil prices are not expected to rise in the next decade, and since inflation affects oil prices and production costs, it cancels itself out and is removed from the income analysis.
o Expenditure revenue determined revenue from 1984-1991. The flow of money stopped in 1991 when all oil and gas reserves were exhausted. Cash flow is an account of the liquidation of oil and gas assets only, and does not include the disposal of other assets such as current assets or assets. Current income is discounted to present value using the Gulf’s cost of capital as a discount rate. The total cash flow until liquidation, discounted at Gulf’s 13.75% discount rate (WACC), comes to $9,981 million.
The value of the Gulf as a long-term concern
o The second component of the Gulf’s value is its operational value.
o Valuation related because Socal does not plan to sell any Gulf assets other than oil as part of the divestment plan. Instead, Socal will use other Gulf assets.
o Socal may choose to reinstate Gulf as an issue at any time during the liquidation process, all that is required is for the Gulf to begin exploration again.
o The operating cost was calculated by multiplying the number of shares issued by the 1982 price of $30. Price: $4.959 million.
o The 1982 price was chosen because it was the value given to the market before the price was raised by the expropriation attempt.
o When two companies merge, it is common practice for the acquiring company to overpay the acquired company.
o It creates profits by overpaying shareholders of the acquired company, and losing value to the acquiring company.
o Socal’s liability is to its shareholders, not to Gulf Oil’s shareholders.
o Socal determined the value of Gulf Oil, at break-even, at $90.39 per share. Any payment of this amount would result in a loss to Socal’s shareholders.
o The maximum bid price per share was determined by finding the value per share at Socal’s WACC, 16.20%. The price is $85.72 per share.
1. This is the share price that Socal must not exceed in order to profit from the merger, as Socal’s WACC of 16.2% is closer to Socal’s expected dividend payout ratio. – money.
o The minimum bid is usually determined by the current trading price, which may be $43 per share.
1. However, Gulf Oil will not accept an offer lower than $70 per share.
2. Also, the addition of a competitor’s willingness to bid at least $75 per share raises the price of the winning bid.
o Socal took the average of the highest and lowest bid prices, resulting in a bid price of $80 per share.
Maintaining the value of Socal
o If Socal buys Gulf for $80 it is based on the liquidation value of the company and not on long term welfare. Therefore, if the Gulf operates as a long-term concern of Socal, its value will be reduced by about half. Socal stockholders fear that management may take over Gulf and take control of the current company, which is estimated at the current stock price of $30.
o After the acquisition, there will be significant interest payments that may force management to improve operations and operational efficiency. The use of debt in initiatives is not only a financing technique but also a tool to hopefully force changes in management behavior.
o There are a number of strategies that Socal can use to ensure shareholders and other related parties that Socal takes over and uses the Gulf at the right value.
o Acceptance can be done on or before the time of bidding. It outlines the future responsibilities of Socal management and will include their divestment strategy and projected revenue. While managers may honor contracts, there is no real incentive for them not to fulfill their own agenda.
o Can supervise the management of the executive; however, this is often an expensive and ineffective process.
o Another way to protect shareholders, especially when control is too expensive or too difficult, is to make the interests of managers equal to those of stockholders. For example, an increasingly common solution to the difficulties arising from the separation of ownership and management of public enterprises is the partial payment of shares and share options in the enterprise. This provides a powerful incentive for shareholders to act in the best interest of their owners by increasing shareholder value. This is not a perfect solution because some managers who have many options have committed fraud in the accounts to increase the value of these options so that they can pay for some of them, but it harms their company and the owners. other duties. .
o It may be beneficial and cost-effective for Socal to align its managers’ concerns with those of its stockholders by paying its managers a portion of the stock and choice. There are risks associated with this strategy but it will certainly be an incentive for management to break up Oil Gulf.
o Socal will bid for Gulf Oil because its cash flows indicate it is worth $90.39 in an unregulated state.
o Socal will offer $80 per share but limits further bids to a ceiling of $85.72 because paying a higher price would hurt Socal’s shareholders.
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