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Morningstar | Oxy Is Getting Ready to Acquire Anadarko Petroleum

Occidental Petroleum has cut the chaff from its upstream portfolio in the past few years, shedding noncore assets in North Dakota, Colorado, Kansas, Bahrain, Iraq, and Yemen. And like peers, it made huge strides cutting costs and enhancing productivity during the 2015-16 downturn. As a result, the firm is now able to deliver cash-flow-neutral production growth of about 5% per year, with West Texas Intermediate crude averaging just $50/barrel (while maintaining the dividend).On May 9, the firm announced that it has formally entered into an agreement to acquire Anadarko Petroleum in a deal valued at $57 billion, or $76 per share (78% cash). This is a huge undertaking for Occidental, which itself has an enterprise value of about $50 billion. The cash portion will be partly financed by a $10 billion equity investment from Berkshire Hathaway, along with the proceeds from the sale of Anadarko’s Africa assets (which Total has already agreed to purchase for $8.8 billion before tax as soon as the Anadarko acquisition closes). Despite these arrangements, the deal will initially leave Oxy with significantly higher financial leverage, and net debt/EBITDA could approach 3 turns, which is a big step up from the current level under 1 turn.We suspect expanding Oxy's extensive Permian Basin footprint is the primary motivation for acquiring Anadarko. The Permian resources segment is expected to be the primary growth engine going forward. Oxy was already the leading producer on a stand-alone basis, and the proposed Anadarko transaction will nudge its total output beyond 500 thousand barrels of oil equivalent per day. The firm hopes to leverage its scale and experience in the basin to improve the profitability of Anadarko's Permian operations. We agree that substantial synergies are possible. However, while there is no question that Oxy is one of the play's leading operators, the blistering initial production rates it delivers do not tell the whole story as its wells also decline very quickly. Therefore, investors expecting a dramatic step-change in performance from Anadarko's assets could be disappointed.