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					The Gulf Oil Takeover

     Summary Points
  Prof. Mike Vetsuypens
SMU Cox School of Business
                                             Gulf Oil: Epilogue

          Pickens           $65.00
          ARCO              $72.00
          KKR               $87.50 (non–cash)
          SOCAL             $80.00
       Total SOCAL bid:           $13.2 billion

   • PICKENS' PROFIT:              $760 million

         Divested Assets: $1 billion
         James Lee received a $13 million severance pay
         SOCAL cut its workforce by 25,000
Professor Mike Vetsuypens
                                Why hostile takeovers?

   The Market for Corporate Control: a device
    to ensure that assets are deployed effectively
   Strategy/Finance/Capital Markets Interact:
    Don't define strategy without considering
    financial markets… or YOU'LL PAY!
   "If you don’t use your assets the best that
    they can be used, someone else will do it
    for you" (T. Boone Pickens)

    Professor Mike Vetsuypens
                                Technical issues:

   Merger Analysis Should Use Standard
    Financial Tools
   Key Elements of Capital Expenditure Analysis:
      Cash Flows, Cash Flows, Cash Flows!
      After Tax
      Timing of Cash Flows matters
      Inflation: be consistent
      Cost of Capital
      Sensitivity Analysis

    Professor Mike Vetsuypens
                                         Gulf’s Cost of Capital

    Cost of Debt: AA yield=12.76%, after tax=6.38%
    Cost of Equity: CAPM
         Risk free rate=12%, Gulf equity beta=1.15
         Equity Risk Premium= 7%
      - Cost of Equity= 12+1.15*7=20.50%

    Weighted Average Cost of Capital (WACCAT):
    Debt               6.38%     2,646       29%      1.85%
    Equity            20.50%     6,612       71%      14.24%
                                                      16.1% WACCAT

    Professor Mike Vetsuypens
                                 Takeover Strategy Points

   Market Value < "Highest & Best" Value

   With competitive bidding, target company leaves
    very little "on the table"

   Target shareholders get large premiums (15% to 40%+)

   Bidder may overpay: “Winner's Curse”

   Average Bidder % returns > 0, average Bidder $ returns <0

   Combined returns on portfolios of buyer and targets >0

     Professor Mike Vetsuypens
                                Does M&A create value for the bidder?

 A recent academic study of 12,023 M&A deals
  between 1980 and 2001 finds industry-adjusted
  losses in the dollar value of acquiring firms around
  the merger announcement, but small percentage
  gains in stock returns (+1.1%).
 A significant amount of the lost economic value
  occurred in 87 large deals, mostly during the 1998-
  2001 period.
 So a majority of small mergers create value for the
  buyers, but most recent large deals (done with
  bidder stock) destroy bidder value.

    Professor Mike Vetsuypens
                 How do we know if bidders benefit from a merger?

 Test #1: Did the share price of the buyer rise?
       Fails to control for unrelated market/industry factors

 Test #2: Did the buyer’s stock returns exceed a benchmark?
    Over what time period should returns be calculated?
    Too much noise over long periods, announcement period best

 Test #3: Are bidder shareholders better off after the deal than
  they would have been had the deal not occurred?
    Ideal test, but difficult to carry out
    Example: AOL’s purchase of Time Warner

       Professor Mike Vetsuypens
                                Some dubious Takeover Motives

 The target company is undervalued
      Do you trust the CEO’s stock picking ability?
 “Diworsification”
      Can’t shareholders diversify on their own?
      But…reducing unique risk to avoid distress costs is OK
 Redeploy surplus funds
      Will you waste excess cash on bad deals?
 Empire-building (size maximization)
      Mgmt salaries are a positive function of firm size!
      Illusion that growth for growth’s sake is desirable

    Professor Mike Vetsuypens
               The problem with Earnings growth targets

• Growth=Internal (core, organic)+ External

• Internal growth= inflation + real GDP expansion
     + market share gains + productivity gains

• External growth= joint ventures, M&A

• Core earnings growth in mature firms is LOW

• This often leads to frenzied M&A deals:
   “shopping for more growth”

     Professor Mike Vetsuypens
                                Cosmetics vs. Fundamentals

 Growth in EPS is a poor measure of excellence:
     Focuses on earnings instead of cash flows
     EPS is a backward-looking, one-period metric
     EPS ignores the cost of the equity capital needed to create it
     A negative NPV merger can increase EPS!
     A positive NPV merger may dilute current EPS
     May explain what happened at Enron, WorldCom…
 Must focus on creating value for your shareholders:
     Look at discounted cash flows
     Compare IRR against the cost of your capital
     Are you earning economic profits?

    Professor Mike Vetsuypens
                                        Valid merger reasons

 Economies of scale, cost reductions
      Consolidate ops, eliminate redundancies (net of integration
       costs), reduce competition (beware of antitrust laws)

 Vertical integration (but consider outsourcing!)

 Complementary resources, cross-selling

 Eliminating operational or governance problems

    Professor Mike Vetsuypens
                  Which of these 2 deals is the better one for the buyer?

                                        A                    B

Pre-merger target value               $10 billion        $40 billion

Acquisition premium                     30%                20%

Merger value gains                      $4 billion        $7 billion

    Professor Mike Vetsuypens
                                Prime Directive for a good merger

 By themselves, neither the target pre-merger value,
  the acquisition premium, nor the merger synergies
 What matters is that what you pay {target
  value + premium} should be less than what
  you get {target value + synergies}
 Don’t say: “We’re buying a great company with
  superb assets and people, with great growth
  prospects”. This only makes sense if the target is
  undervalued. Is it? Or will you pay full price for
  these assets?

    Professor Mike Vetsuypens
              Form S-4 Registration Statement, 1/11/2006, p 32

ConocoPhillips believes the merger (between COP and BR)
joins two well-managed companies, providing strategic and
financial benefits to stockholders of COP. COP expects the
benefits to include:
 Creation of a leading North American natural gas position
  comprised of high-quality, long-lived, low risk gas reserves with
  significant unconventional resource potential and enhanced
  production growth;
 Enhanced business mix with a higher proportion of exploration and
  production assets, assets in OECD countries and North American
  natural gas;
 Significant free cash flow and synergy benefits; and
 Access to BR’s talented and technically capable workforce

    Professor Mike Vetsuypens
                                    A merger checklist….

#1: Explain the strategic rationale for the merger! Be
 explicit/realistic on how changes and synergies will
 be achieved within the target.
#2: Know the walk-away price! Don’t overpay for the
 synergies. No deal is worth doing at any price!
#3: Perform due diligence: understand what you are
 buying, including people.
#4: Don’t just do a deal because you have ample
 internal cash flows, or a high stock price.
#5: Don’t forget merger integration costs.
#6: Beware of stock deals in hot M&A markets

    Professor Mike Vetsuypens
                            How can we create Corporate Discipline?

     Through Hostile M&A activity

     Internally (Top Management compensation
      + Board oversight)

     Through Competition in Product Markets

     Through increased Borrowings

Professor Mike Vetsuypens

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