Warren Buffett's Bold Oil Case Does Not Make Sense – The Fool Motley

Petroleum giant Western Oil (NYSE: OXY) desperately wants to buy rival Anadarko Petroleum (NYSE: APC). The company's executives traveled to Omaha, Nebraska last weekend to meet with super-investor Warren Buffett. They wanted his help to finance their battle against the oil giant Chevron (NYSE: CVX) to control Anadarko and its privileged position in the Permian-rich oil basin.

Occidental left this meeting with Buffett's $ 10 billion pledge Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B), which gives him ammunition in his hostile fight for Anadarko. The agreement, however, does not make much sense from the Western point of view. Not only is he ready to pay a heavy price for Buffett's support, but he has offered a significant bonus to beat Chevron. This seems excessive, since Anadarko is not the best strategic solution.

An epic battle in the oil

Occidental Petroleum has long admired Anadarko Petroleum, which occupies an important position in the Permian Basin, as well as in the Rockies, the Gulf of Mexico and Africa off the coast. It considers these assets as highly complementary to its portfolio, which includes a leading position in the Permian, as well as in Latin America and the Middle East. This is why three Anadarko acquisition offers have been offered since the end of March. However, instead of engaging with Occidental, Anadarko agreed to merge with Chevron for a sensational $ 50 billion deal, lower than that proposed by Occidental.

Undeterred, Occidental publicly announced his battle by resuming his proposal to acquire Anadarko at a price of $ 76 per share, well above the $ 65 per share accepted by Chevron. CEO Vicki Hollub also told CNBC why she believes Occidental is the right buyer for Anadarko. She stated that:

We are the right buyer for Anadarko Petroleum because we can make the most of shale. We have much more experience [in the Permian]. We perform really, really well, and we did not talk much about it, it's that the good side of this deal is the shale game.

She noted that Westerners in the Permian are operating 74% better than those in Anadarko and that they spend less money on drilling and fracturing. For this reason, the company expects to be able to extract more value from Anadarko's assets. This leads the company to estimate that it can realize cost savings of $ 3.5 billion and create additional synergies through the combination of these synergies, well beyond the $ 2 billion that Chevron believes can achieve.

Occidental also directly addressed the concerns of analysts and investors regarding the deal. While Anadarko's positions in the Gulf of Mexico and its LNG project in Mozambique align well with Chevron's expertise, these assets account for only about 15% of the value. of the transaction, according to Hollub. As such, they are not as significant as it may seem.

Another problem raised by analysts is that Westerners will have to incur considerable debt to conclude this agreement. They see the company's leverage ratio grow from less than 1 times its debt / EBITDA ratio to about 2.4 times its expected EBITDA by 2020. The company plans to address this problem by selling assets of $ 10 billion to $ 15 billion. dollars from here a year or two. closing of the transaction. Investors, however, fear that the company will stretch too much, especially if the price of oil falls again in the meantime.

Buffett's backup

Occidental is striving to resolve these balance sheet issues by calling on Buffett to help finance the transaction. His company, Berkshire Hathaway, agreed to invest $ 10 billion in Occidental in the form of perpetual and cumulative preferred shares. The preferred stock will pay Berkshire an annual dividend of 8%, representing a significant cash flow of $ 800 million a year, from Occidental to Berkshire.

Buffett will also receive purchase warrants to acquire up to 80 million Western common shares at $ 62.50 each, which is slightly lower than the current price. This represents another potential $ 5 billion investment in the oil company. It should also be noted that Occidental can not redeem the preferred stock for a decade, although there is a mandatory redemption feature on certain capital yield events, such as a share buyback. Meanwhile, Buffett is 11 years old to serve.

This is a great deal for Buffett and Berkshire since the preferred stock pays a very high rate. In addition, Buffett recovers low-risk warrants that could pay off dramatically if the merger offers the benefits envisioned by Occidental.

This financing agreement, however, makes no sense for Western investors. First, the company would pay almost double the preferred share rate as if issuing new debt to finance the transaction. While they would help ease the potential burden of leverage, the company is paying a hefty cost for Buffett's support since most analysts believe it could issue preferred shares in the part of a 6% public offer.

In addition, the warrants give Warren Buffett the opportunity to purchase sufficient shares to dilute existing investors by 10%. As such, it transfers some of their upside potential to Berkshire Hathaway.

This battle could end badly for Occidental

Occidental Petroleum is doing everything in its power to position itself to become Chevron's winner in the fight for Anadarko. The company is not only willing to pay a much higher price for the company, but also to obtain expensive and potentially dilutive financing in order to have the firepower needed to deal with the oil giant.

While this may be enough for him to win the auction war, Occidental might not finish victorious in the end. Additional interest payments could hinder the company's ability to operate – and could even jeopardize its high-yielding dividend – particularly in the event of a drop in oil prices. This is why his deal with Buffett does not make much sense for Western investors, but certainly for Berkshire shareholders.