How To Create Addition And Subtraction Formulas In Excel Financial Analysis on an Oil Corporation Takeover

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Financial Analysis on an Oil Corporation Takeover

Gulf Oil Corp.–Acquisition

Summary of Facts

o George Keller of Standard Oil Company of California (Socal) is trying to determine how much he is willing to bid for Gulf Oil Corporation. Gulf will not consider offers below $70 per share, even if the final closing price per share is rated at $43.

Between 1978 and 1982 Gulf doubled its exploration and development expenditures to increase its oil reserves. In 1983, Gulf management repurchased 30 million of its outstanding 195 million shares and began to significantly reduce exploration expenditures due to falling oil prices.

o The acquisition of Gulf Oil resulted from a recent takeover attempt by Boone Pickens, Jr. of Mesa Petroleum Company. He and a group of investors spent $638 million and acquired approximately 9% of all outstanding Gulf shares. Pickens entered a proxy fight for control of the company, but Gulf executives struggled to take over Boone as he pursued a partial tender offer at $65 per share. Gulf then decided to liquidate on its own terms and contacted several companies to participate in this sale.

o The opportunity to improve was Keller’s main attraction to Gulf, and he now has to decide whether Gulf would be worth $70 per share if it were liquidated, and how much to bid for the company.


o What is the per share value of Gulf Oil if the company is liquidated?

o Who is Socal’s rival and what kind of threat does it pose?

o How much should Socal bid for Gulf Oil?

o What can be done to prevent Socal from operating Gulf Oil continuously?


Major competitors to acquire Gulf Oil include Mesa Oil, Kohlberg Kravis, ARCO and, of course, Socal.

Mesa Oil:

o Currently holds 13.2% of Gulf shares at an average purchase price of $43.

o Borrowed $300 million against Mesa securities and offered $65/share for 13.5 million shares, increasing Mesa’s stake to 21.3%.

o Under the reunification, they would have to borrow many times Mesa’s net worth to get the majority needed to win a seat on the board.

o It is unlikely that Mesa will raise that much capital. Regardless, Boone Pickens and his group of investors will make a substantial profit if they sell their existing shares to the bidder.


o The bid price is likely to be lower than $75/share because an offer of $75 will raise the debt ratio, thus making it harder to borrow more.

o Socal’s debt is only 14% of total capital (Figure 3) and banks are willing to lend enough to bid up to possible $90.

Kolberg Kravis:

o Specialized in leveraged buyouts. Keller feels they have the bid to beat, as the heart of their bid lies in protecting Gulf’s name, assets and businesses. The Gulf will essentially be an ongoing concern until a longer-term solution is found.

Socal’s bid will depend on the value of the Gulf’s reserves without further investigation. Gulf’s other assets and liabilities will be withdrawn to Socal’s balance sheet.

Gulf Oil’s Weighted Average Cost of Capital

o Gulf’s WACC was determined as 13.75% using the following assumptions:

o CAPM is used to calculate cost of equity using 1.5 beta, 10% risk-free rate (1-year T-bond), 7% market risk premium (Ibbotson Associates arithmetic average data from 1926 to 1995). Cost of equity: 18.05%.

o The market value of the stock was determined by multiplying the outstanding number of shares by the 1982 share price of $30. This price was used as it was the uninflated value before the price was raised by takeover attempts. Market value of equity: $4,959 million, weight: 68%.

o The value of the loan was determined using the book value of the long-term debt of $2,291. Weight: 32%.

o Cost of debt: 13.5% (given)

o Tax rate: 67% calculated by dividing net profit before tax by income tax expense.

Valuation of Gulf Oil

Gulf’s value consists of two components: the value of Gulf’s oil reserves and the company’s continuing value.

o A projection was made that estimated oil production from 1983 forward until all reserves were depleted (Figure 2). Production in 1983 was 290 million composite barrels and this was assumed to be stable until 1991 when the remaining 283 million barrels were produced.

o Production costs are kept constant according to the production amount, including depreciation based on the unit of production method currently used by Gulf (Production will be the same, so the depreciation amount will be the same)

o Because Gulf uses the LIFO method to account for inventory, new reserves are assumed to be expensed in the year they are discovered and all other exploration costs, including geological and geophysical costs, are deducted from revenue as incurred.

o Since there will be no further exploration in the future, the only expense to be considered is the costs associated with production to deplete the reserves.

o The price of oil is not expected to increase in the next ten years, and because inflation affects both the selling price of oil and the cost of production, it resets itself and turns out to be negative in the cash flow analysis.

o Revenues minus expenses determined the cash flows for the years 1984-1991. Cash flow ceases after all oil and gas reserves are liquidated in 1991. The resulting cash flows only take into account liquidation of oil and gas assets and do not take into account liquidation of other assets such as current assets or net properties. The cash flows were then discounted to net present value using Gulf’s cost of capital as the discount rate. Total cash flow until the liquidation was completed reached $9,981 million when discounted by Gulf’s 13.75% discount rate (WACC).

The value of Gulf as a continuing business

o The second component of Gulf’s value is the business continuity value.

o Valuation related because Socal does not plan to sell any of Gulf’s assets other than its oil as part of its liquidation plan. Instead, Socal will use Gulf’s other assets.

o Socal can choose to return the Gulf to business at any time during the liquidation process, all it has to do is restart the Gulf exploration process.

o The continuing business value is calculated by multiplying the number of outstanding shares by the 1982 share price of $30. Value: $4,959 million.

o The 1982 share price was chosen because it was the market-determined value before the price rose through takeover attempts.

Bid Strategy

o When two companies merge, it is common practice for the acquiring company to overpay for the acquired company.

o It causes the shareholders of the acquired company to gain without overpayment and the shareholders of the acquiring company to lose value.

o Socal’s liability is to its shareholders, not to Gulf Oil shareholders.

o Socal has determined the value of Gulf oil in liquidation at $90.39 per share. Paying more than this amount will be to the detriment of Socal shareholders.

o The maximum bid amount per share was determined by Socal’s WACC finding the value per share of 16.20%. The resulting price was $85.72 per share.

1. This is the price per share that Socal must not exceed in order to profit from the merger, because Socal’s WACC of 16.2% is closer to what Socal expects to pay its shareholders.

o The minimum bid is usually determined by the price at which the stock is currently for sale, which will be $43 per share.

1. However, Gulf Oil will not accept an offer less than $70 per share.

2. Also, adding a competitor’s willingness to bid at least $75 per share raises the winning bid price.

o Socal averaged the maximum and minimum bid prices, resulting in a bid price of $80 per share.

Protecting Socal’s Value

o If Socal buys Gulf for $80, it depends on the liquidation value, not the continuity of the company. Therefore, if Socal operated Gulf as a permanent business, its stocks would lose value by approximately half. Social stakeholder fear that management could take over Gulf and control the company as it stands is only valued at its current stock price of $30.

o After the acquisition, there will be large interest payments that may force management to improve performance and operating efficiency. Using debt in acquisitions serves not only as a financing technique, but also as a tool to force changes in managerial behavior.

o There are several strategies Socal can implement to ensure that Socal acquires and uses Gulf at an appropriate value to shareholders and other interested parties.

o The contract can be made on or before the date of the offer. It will outline the future obligations of Socal management and include their liquidation strategy and projected cash flows. While management respects the convention, there is no real motivation to prevent them from implementing their own agenda.

o Management can be monitored by an administrator; however, this is often a costly and ineffective process.

o Another way to reassure shareholders, especially when monitoring is too expensive or too difficult, is to make management’s interests more like those of shareholders. For example, an increasingly common solution to the difficulties arising from the separation of ownership and management in publicly traded companies is to pay directors in part with shares and stock options in the company. This provides managers with a strong incentive to act in the best interests of the owners by maximizing shareholder value. This is not a perfect solution because some executives with multiple stock options have engaged in accounting fraud to increase the value of those options long enough that they could cash out some of them, but to the detriment of their firm and other shareholders. .

o For Socal, it would probably be most beneficial and least costly to align the concerns of its managers with those of the shareholders by partially paying their managers for shares and stock options. There are risks associated with this strategy, but it will certainly encourage management to liquidate Gulf Oil.


o Socal will bid for Gulf Oil as its cash flows show it is worth $90.39 in a liquidated state.

o Socal will bid $80 per share, but will limit further bids to a ceiling of $85.72, as paying a higher price would hurt Socal’s shareholders.

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