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Morningstar | Occidental Outbids Chevron in Anadarko Acquisition Attempt

On April 24 Occidental confirmed it is vying to usurp Chevron in the race to buy Anadarko Petroleum. Oxy shares reacted modestly on the day, declining less than 1%, and we think this is the correct response. We agree that substantial value can be unlocked by combining the businesses, but by offering a huge premium--over 60% of Anadarko's market value prior to the Chevron announcement--Oxy would be passing most of the benefit to Anadarko shareholders, if the deal is approved. Although our fair value estimate for Oxy has risen to $60 per share from $56 after incorporating this news, half of this increase was driven by marking our near-term commodity forecasts to market after a 16% increase in crude prices since our last update in March. Our fair value for Anadarko has also increased to $72 per share from $69, reflecting an equally weighted blend of the Oxy and Chevron bids. We think the likelihood that both bids will be rejected is remote. Our Chevron fair value estimate is unchanged at $136, as the original proposal did not affect our valuation in the first place.

Oxy's higher bid was partly justified by increased synergies. In the announcement, management highlighted $2 billion of run-rate cost savings, which is double the savings that Chevron thinks it can achieve. Oxy attributes this to several sources, including an expected 10% reduction in drilling costs, supply chain optimization, and reduced administrative costs. Chevron focused mainly on operating costs in its assessment.

On a per barrel basis, because Oxy and Anadarko are comparable in size, it makes sense that substantial economies of scale can be realized, whereas Chevron, being five times larger than Anadarko in enterprise value, would have less benefits. Both firms are a natural fit for Anadarko in the Permian Basin because both are the top two producers here, but the Oxy combination would be more contiguous and conducive to efficient development.

Outside the Permian, Chevron's portfolio is probably the more complimentary of the two because it also has extensive operations in the Gulf of Mexico. It also boasts LNG expertise in Australia, which bodes well for the continuation of Anadarko's Mozambique liquefaction project, and probably has a stronger international pedigree overall (though Oxy has a lengthy track record in Africa and the Middle East). Anadarko's non-shale assets would be much easier for Chevron to digest.

The other disadvantage for Oxy is that substantial borrowing would be necessary to finance the deal because it would be essentially doubling in size. At the end of 2018 it had about $3 billion on hand. But the cash component of its proposed consideration is more than $19 billion. Funding the deficit, and taking on Anadarko's $15 debt-load, would push its net debt to EBITDA ratio up more than 2 times, an increase from 0.7 times currently. This is not egregious, but it would result in less financial flexibility over the next 12 months. In contrast, Chevron can comfortably absorb Anadarko's assets and liabilities with only a modest uptick in financial leverage.