Fred Lucas of JP Morgan has been gazing into his crystal ball:
It is early February 2011 in Irving (TX) and Rex Tillerson, CEO of Exxon Mobil, has just concluded a marathon board meeting ahead of the corporation’s Q4 results. Exxon Mobil normally beats Q4 expectations. He would confirm that the integration of XTO was a success. The board meeting had been lengthened to address a topic that had been vexing Rex and his colleagues for many months – the future of BP.
BP’s rating had continued to languish, despite successfully capping the well in July. BP’s Q4 results followed Exxon Mobil’s. He knew those results would reset BP’s all important dividend – a critical signal of its underlying health and its independence. BP could announce a ‘jumbo’ settlement to cover all government fines; claims from the escrow fund had started to decline. Advisors were encouraging him to make a preemptive offer using Exxon Mobil’s more highly rated paper and so exploiting the stubborn rating differential that persisted.
As fantasy corporate finance goes, an Exxon bid for BP is not as far fetched as it sounds — and certainly more realistic than an approach from either PetroChina (political barriers) or Gazprom (political barriers, high debts, low stock market rating).
First, the anti-trust issues would not be insurmountable. Any Exxon offer could separate BP’s downstream operations (refineries, pipelines, terminals and retail sites) and they could be left in the hands of BP shareholders.
Second, Exxon has higher-rated paper and the financial strength to sweeten any offer with a cash component. This could help limit the transatlantic flowback of stock from BP shareholders.
Third, Exxon has proved its ability to successfully integrate large acquisitions. Last, but by no means least, the strategic fit is very good. BP’s low-cost LNG assets, for example, would complete Exxon’s global jigsaw and transform the company.
In fact, Lucas reckons the economics of an Exxon-BP combination are so compelling, he’s surprised the market is not factoring the possibility of that ever happening.
Now, a cynic may say that’s because no one yet knows what the Macondo oil spill will eventually cost BP, but let’s put that to one side for the moment and dream.
Here’s what a deal might look like and how it would be pitched to shareholders, says Lucas:
So, our simple deal analysis assumes an offer that consists of:
• CASH – $50bn cash or 178 pence per BP share (38% of offer value).
• 1.0 SHARE in BP Downstream – tentatively valued at $50bn or 178 pence per BP share (38% of offer value). Subject to the precise mechanics of such an offer, this entity would have to be returned to BP shareholders at a later date postmerger completion.
• 0.02892 Exxon Mobil shares per BP share – this equates to 543m new Exxon Mobil shares with a current market value of $32bn (24% of total offer value). Table 1 shows the details. We note that 2000-2009, Exxon Mobil repurchased an average of 223m shares per annum – so the new Exxon Mobil shares could, in theory, be repurchased within three years.
So that’s an offer around 473p a share and here are some of the other notable features of Lucas’ fantasy deal (emphasis ours):
Excluding potential merger synergies and measured relative to IBES consensus 2011E EPS, Exxon Mobil would experience 21% pro forma 2011E EPS accretion and 41% post-tax CFPS accretion. We calculate that a total offer price of approximately 700 pence per BP share would be required to extinguish any such EPS accretion.
Exxon Mobil would acquire BP’s 18.3 bn boe of proven reserves for $8.4 per boe versus its 2000-09 average unit finding and development costs of $6.9 per boe.
Exxon Mobil would achieve 83% pro forma proven reserves growth and 89% 2011E production growth. This would be a transformative deal for Exxon Mobil – as was its game-changing merger with Mobil just over ten years ago. Interestingly, that deal was a competitive response to BP’s landmark merger with Amoco. It is very difficult to see how Exxon Mobil’s competitors could respond similarly to such a transaction – if this scenario were to happen, Exxon Mobil would achieve unrivalled global scale and presence.
We estimate that the $50bn of transaction debt could be repaid in 3-4 years by Exxon Mobil’s free cash flow, assuming an $80 per barrel average oil price. Assuming an average oil price of $80 per barrel 2011-12, our financial model shows that Exxon Mobil generates $11-15bn per annum of free cash flow after dividends.
However, at pixel time the market was still not interested in the idea of a BP bid, as share price dipped below 300p:
Can anything stop the falling knife?
Related links:
Borrowing BP – FT Alphaville
BP Turtle-gate – FT Alphaville
Attention knife-catchers… – FT Alphaville