What Did Chevron Pay at Texaco’s Pump?

Not all mergers are created equal. Consider Chevron’s announcement last week that it will buy Texaco for $35 billion.

The deal’s status as the third largest merger in the oil and gas industry’s history was sure to grab headlines, but several industry analysts have drilled into the numbers at the deal’s core in search of answers for some of the most important questions facing Big Oil.

For starters, what’s the key metric driving these mergers? Chevron had to start somewhere to get to $35 billion, and as one analyst group discovered, it likely wasn’t the price of oil as originally thought.

IHS Energy published a report last week that Chevron’s $35 billion offer values Texaco’s oil and gas reserves at $5.90 per barrel of oil equivalent (boe) compared with an average $5.30 per boe for previous oil super mergers in the last two years. But the group also determined that reserve valuations for the industry as a whole in 1998 and 1999 were higher than in 2000 despite much lower oil prices in the earlier years.

“This implies that the prevailing oil price at the time of the transactions may not have been the main motive in valuing the reserves,” HIS Energy says. “Other factors such as company synergies and corporate strategy were also important.”

Fadel Gheit, senior energy analyst at Fahnestock & Co., agrees that the price to boe ratio does not tell the whole story. The price of oil could be cheap, but a company could lose merger interest for other reasons. “It’s considered, but it is not the end game,” he says. “Whether it is in a location with very little political risk, higher quality crude production, lower production costs — all these things are taken into account.”

The political risk for oil companies, Gheit says, can encompass everything from a change of power, as in the case of the U.S. presidential election, to a change of government or legislation in a host country to environmental changes. In either case, the impact is not really known or can be estimated.

Some analysts don’t mind that the price to boe ratio doesn’t tell the whole story. It’s what he can’t see that makes Tom Burnett, president of New York-based Merger Insight, speculate that his $6 per boe estimate leaves room for another suitor to come in and trump Chevron’s offer.

To understand his reasoning, first understand Burnett’s analysis process.

“The problem is there will be a significant amount of divestiture on the downstream assets,” he explains. “So it’s primarily based on discounted cash flow analysis of the remaining assets, and that’s aided by cost savings that will be assumed on the operating side and capital spending side.”

Burnett breaks down his “quick and dirty analysis,” as he calls it, as follows:

Start with a $33 billion price tag on Texaco, assuming a $60 per share price at 550 million shares outstanding. Add $7 billion in debt to arrive at $40 billion. Cut out $4 billion — above the $3.5 billion book value — for what he expects will come of antitrust divestitures, another $4.5 billion for international refining, and $1.5 billion for its global power generator business to arrive at a $30 billion estimate.

Finally, Burnett divides $30 billion by Texaco’s approximate reserve position of 4.9 billion barrels of oil equivalents to reach $6 per boe. “It’s the industry standard,” Burnett says, despite IHS Energy’s opinion that Chevron was paying more than the historical average. “Are they getting it super cheap? I don’t know. It looks to me like they’re paying a fair price, maybe a little on the low side because of Texaco’s checkered past.”

To the extent that there are hidden assets, such as pipelines and acreage rights, Burnett says Chevron may be ultimately paying $27 billion ($5.40 per barrel) or much less. “It might cause a company like [Royal Dutch] Shell to make a counter bid,” he concludes. “It’s not impossible.”

And the practice of underbidding for oil companies can be quite common. “In many of these cases, the target company approaches the buyer, not the other way around,” says Fahnestock’s Gheit. “With targets approaching buyers, the buyers can pretend they are not really interested, putting a lid on how much they are willing to pay.”

The lack of prospective buyers may also have played a role. “Unlike previous ‘mega- mergers,’ it appeared that the Chevron-Texaco merger was instigated more from a lack of size, than from a financial advantage,” notes the IHS Energy report. “The two companies, on a stand-alone basis could not effectively compete with the merged might of the likes of BP Amoco Arco, Exxon Mobil and TotalFinaElf.”

Some analysts skip the whole price to boe ratio issue altogether when showing how a Chevron-Texaco deal differs from all the rest. For example, Merrill Lynch’s Steven Pfeifer is more concerned with the oil’s source than the boe ratio.

“While we estimate cost-savings from the merger to increase Chevron’s EPS by 7%, the real attraction for us is the combined company’s significant exposure to all five of the most important oil provinces of the world (Kazakhstan, Middle East, and deepwater West Africa, Brazil, and Gulf of Mexico),” Pfeifer writes in his report.

CommScan LLC, a New York-based data provider, starts its assessment with the ratio of enterprise value to cash flow excluding depreciation and amortization charges, or EBIT, for earnings before interest and taxes, assuming 100% of the acquisition and including debt. Chevron-Texaco comes to a ratio of 14.4x.

“Surprisingly, this compared to 5.75x for Exxon-Mobil,” says CommScan analyst Ayesha Sabavala. The difference in price is even starker when the Texaco acquisition is compared to British Petroleum’s two big deals of the past few years. BP paid a negative 75.84 times cash flow for Amoco in 1998 and a negative 39.87 times cash flow for Atlantic Richfield (ARCO) in 1999.

But Sabavala says the huge disparity for the enterprise value to cash flow ratios between Chevron’s deal for Texaco and the other mergers is aggravated by the exclusion of depreciation and amortization costs. The disparity doesn’t disappear when depreciation and amortization are factored in, but it is turned 180 degrees.

For starters, the negative ratio of the BP deals turns positive once depreciation and amortization costs are added in. What’s more, Chevron’s bid for Texaco is more expensive than either BP deal when depreciation and amortization are left out, but it is less expensive when the costs are brought into the equation.

According to Sabavala, the enterprise value to EBITDA ratio for Chevron-Texaco is 9.4x; Exxon- Mobil, 4.9x; BP-Amoco, 32.3x; and ARCO, 38.9x.

Lastly, CommScan looks at equity value (not including debt) to EBIT:

Chevron-Texaco, 11.2x;
Exxon-Mobil, 5.7x;
BP-Amoco, minus 68.9x;
and ARCO, minus 33.6x.

Here , too, the addition of depreciation and amortization alters the relative cost of the mergers.

Equity value to EBITDA:

Chevron-Texaco, 7.3x;
Exxon-Mobil, 4.67x;
BP-Amoco, 29.3x;
and ARCO, 32.9x.

So did Chevron pay too hefty a price for Texaco? Or did it get a bargain? If Merger Insight’s Burnett is right and there’s room for a rival bid, then Chevron may have to refuel its offer. But if Fahnestock’s Gheit is on the mark, Chevron may be the only game in town for Texaco.