Occidental Petroleum Acquisition

Carl Icahn and Warren Buffet are considered some of the most influential living “titans of investment” on Wall Street. Both are self-made investment billionaires, and both have a significant number of books of analysis written about their investment decisions and life stories. You would therefore expect that these two individuals would have a very good idea about the concept of value created by companies.

 

Fundamentally in May 2019 these two individuals have a very different outlook though on a takeover deal. Occidental Petroleum finalised a $55bn takeover of Anadarko Petroleum, beating a rival bid from Chevron. Warren Buffet both backs the deal and his investment company Berkshire Hathaway has pledged $10bn to help finance the deal. Carl Icahn, whose activist investment vehicles have built a $1.6bn stake in Occidental by 30th May 2019 disagreed vociferously, launching a lawsuit against the company for not acting in the best interests of shareholders.

 

In the lawsuit he argues:

 

  • That the acquisition itself “amounted to “little more than an enormous bet on the price of oil”, and said there was a “substantial risk” that Occidental might have to cut its dividend if crude dropped to $45 a barrel or lower”.
  • In addition Carl Icahn fundamentally disagreed with Berkshire Hathaway’s financing of the deal claiming that Occidental Petroleum had “…overpaid for its rival and “botched” the acquisition by agreeing a pricey financing package”.
  • It then goes on to in the lawsuit accuse Occidental of “…an “even bigger botch” by agreeing that it would sell Anadarko’s assets in Africa to France’s Total for $8.8bn.” (FT, 2019).

 

The management of Occidental Petroleum (perhaps unsurprisingly) fundamentally disagree and CEO Vicki Hollub has “…insisted that the deal can create significant additional value for shareholders, promising $3.5bn of annual savings in operating and capital costs. Combining Anadarko’s assets with Occidental’s in the Permian Basin of Texas and New Mexico could add $10bn to their value, the company has said, justifying the premium.” (FT, 2019) Though analysts including the Financial Times itself note that the large investment itself is potentially a large gamble on the part of the management.

 

In the oil and gas industry the vast majority of shareholder value derived to investors is from dividends received. Therefore Carl Icahn’s claim that future dividends would be at risk has interested other shareholders. The FT notes that Mr Buffet’s $10bn financing deal in particular “raised eyebrows across Wall Street” (FT, 2019) due to the near 8% yield that the complex investment is potentially going to re-coup. This at a time when Occidental Petroleum’s latest bond issue in 2016 were issued with a coupon rate of 3% and were trading on 1st May 2019 with a yield of 3.47%.

 

The case (above) describes a complex takeover which is occurring with a number of controversies and different points of view. The links provided in the case should provide the starting point for your examination of this situation. You are expected to use strong and reputable business news sources such as the Financial Times and Bloomberg to read around and develop your understanding of the case.

 

You are in an academic essay format to answer two of the following three tasks relating to the case in a single essay.

 

Task 1: You are to critically evaluate the literature on Dividends and Dividend Policy and come to a conclusion as to whether or not dividend policy for a company like Occidental Petroleum has a substantive impact in the creation or destruction of shareholder wealth.

 

Guidance Notes:

  • In your answer you should specifically make reference to the forward looking nature of the investment Occidental Petroleum is making and the potential impacts on dividends and wealth creation that may occur.
  • Your critical evaluation should conclude with an examination of the issue from the points of view of all the major stakeholders presented in the case.
  • You should come to a judgement pertaining to potential future dividends as to whether, after weighing the academic evidence, you feel that the management of Occidental Petroleum where correct to pursue the deal or Carl Icahn was right to oppose it.

 

Task 2: You are to critically evaluate the literature on cost of capital and capital structure, and come to a conclusion as to whether or not the $10bn cash financing provided by Berkshire Hathaway represents good value for money to shareholders.

 

Guidance Notes:

  • In your answer you should specifically critically examine the claims made by Carl Icahn that the management ““botched” the acquisition by agreeing a pricey financing package”.
  • Your examination should consider the financing package itself and the motivation and point of view of Berkshire Hathaway in providing it, coming to a conclusion as to whether or not this would seem to be a value creating investment for Mr Buffet.
  • Finally you should in your conclusions weight the academic evidence of the effects of significant alterations in capital structure and come to a conclusion as to whether or not these changes are in the best interests of shareholders.

 

Task 3: You are to come to conclusion, based on the academic literature, as to the ability of managers in extraction industries (such as Occidental Petroleum) which have significant key asset price volatility (such as oil) to correctly value a target company in a takeover situation.

 

Guidance Notes:

  • You are specifically to consider the views of analysts that Occidental Petroleum is taking a gamble on the value of oil, concluding as to whether or not you feel that Carl Icahn’s comment that the acquisition “little more than an enormous bet on the price of oil” is justified.
  • You are to consider the likelihood and impact of the “substantial risk” Carl Icahn’s lawsuit mentions of the value of oil dripping below $45 a barrel on the valuation of the company being acquired, concluding if you feel that managers can ever have certainty as to whether they paid the “correct” value in highly volatile extraction based industries.

 

 

Your answers should specifically be written in an academic essay format and not in the format of a business report. Essays specifically should not include headings, section headings, etc.. Your essay should concentrate particularly ensure that there is considerable flow and cohesion between the paragraphs. It is advised that you make good use of the writing support materials on the Blackboard site. Specifically all students will benefit from reading through the following guidance on essay writing:

 

https://writingcenter.fas.harvard.edu/pages/overview-academic-essay.

 

There is an assessment guidance video on Blackboard for this section of the assignment that all students should view.