Gulf Oil Analysis Essay

Statement of Problem & AlternativesGeorge Keller of the Standard anele Compevery of atomic number 20 (Socal) is considering how much to bid for gulf Oil Corpo symmetryn ( disjuncture), which is currently in the middle of a bidding war. disconnection is unwilling to consider bids infra $70 per shargon even though their sh be monetary value was $39 at the time Boone Pickens began purchasing component parts in the hopes of a takeover. II. Statement of Facts and Assumptions low the direction of James Lee, Gulf pursued a twofold strategy. First, Gulf renewed its focused on oil whereas in the quondam(prenominal), Gulf had substantial into an energy conglomerate through various acquisitions of coalmines, uranium mines, and synthetic raise plants. These ventures would be de-emphasized going forward. For second part of the strategy, Gulf planned to impose a policy of increased expenditures on exploration and development (E&D).During the age leading up to the takeover attempt, Gul f more than doubled its exploration outlays. While Gulf was continuing with its ambitious E&D weapons platform, the concrete price of oil and natural gas declined from 1982 through 1983. As 1984 began, most all industry experts were in agreement that the price of oil (in ceaseless dollars) was non expected to change for the following 10 grades. Lee mown exploration expenditures in 1983 in response to these changing fundamentals. Even at the reduced level, spending for exploration in real terms equaled or exceeded that of every year before Lees arrival b arly one. Based on this picture, Socal inevitably to value Gulf. There be several(prenominal) sources of value that can be considered the value of Gulfs fossil oil militia the embody savings related to the immediate suspension of Gulfs E&D program the tax benefits associated with special leverage the value added by shortening the recovery lag and the value of any adverse effects due to the acquisition of Gulf by a compet itor1.In addition to calculating Gulfs reserve value, Socal needs to be mindful of its competition. Both Atlantic Richfield Company (ARCO) and Kohlberg KravisRoberts & Company (KKR) are financially limited should Gulfs dower price sojourn to escalate. It would be difficult for ARCO to bid more than $75.00 per share given that its resulting debt-to- crown ratio would exceed 60% (historically racy). KKR is in a similar situation. Mesa, led by Pickens, currently holds 13.2% of Gulfs stock at an comely acquire price of $43. In order to bid successfully, Mesa would have to adopt many times their net worth. With banks queuing up to lend money to mount an $80 share price (or higher(prenominal)), Socal will have to take on a considerable amount of financial leverage.III. Analysis Although there are multiple sources of value, this analysis focuses on valuing Gulfs militia, assuming E&D activities will cease post acquisition (liquidation value). The critical elements that throw in int o the valuation of Gulfs reserves are Acquisition accompaniment Since we are trying to establish why Gulf became so valuable within a short period of time from when their share price was $39 to when a minimum bid level of $70 per share was established, its appropriate to use January 1st, 1984 as the first year Socal fictional ownership of Gulf. Reserve life Assumed a reserve-to-production ratio of 121. It takes approximately 4 years for the stream to come online and the field, once online, is procreative for another 7-10 yrs. Based on this ratio, Gulfs reserves are depleted at a rate of 192.75 million barrels per year over a 12-year period. Inflation rate 4.67% based on the middling inflation rates observed between 1982 and 1983.There was an unusually high rate of inflation between 1978 and 1981 so years prior to 1982 were not included. However, a sensitivity analysis was performed to observe the effects of a higher inflation rate based on historical averages (see Exhibit 1). Oil sales Oil price is expected to stay at $22.42 in constant dollars (prices are adjusted for inflation). Production costs Production cost per barrel is expected to stay at $6.48 in constant dollars (prices are adjusted for inflation). See Exhibit 2. Exploration costs The capitalized portion of past extraction costs are recognized as depreciation when the correspond oil is produced.These depreciation expenses vary from year to year based on historical costs. See Exhibit 3. Working capital For this analysis, working capital is fictitious to be negligible given that the analysis is geared towards find Gulfs reserve value. Capitalexpenditures For this analysis, capital outlays are assumed to be zero given that the analysis is geared towards determining Gulfs reserve value. Gulfs E&D program ceases post acquisition.Discount rate Gulfs weighted average cost of capital calculated to be 15.35%. See Exhibit 4. Utilizing a discount rate of 15.35% and the assumptions outlined above with a rationalise silver meld model (see Exhibit 6), Gulfs reserves are worth an estimated $80.73 share ($16,120.69M)2. Adjusting the inflation upwardly to 8.37%, Gulfs reserves are worth an estimated $96.16 per share ($15,895.35M). Since Socal would be taking on additional debt, its important to check whether or not future day free cash flows cover the incremental interest expense. Exhibit 7 shows that future cash flows easily cover interest expense associated with up to a $90 per share purchase price.Additionally, taking the free cash flow derived in Exhibit 6 (basis for an $80.73 share price) and discounting based on Socals WACC (16.96% see Exhibit 5), we arrive at a reserve valuation of $75.56 per share. Adjusting inflation upwards to 8.37% and discounting at Socals WACC, Gulfs reserves are worth an estimated $89.65 per share.3 IV. Recommendations Based on the analysis, a bid of $75.56 per share for Gulf is appropriate. A bid above this price would result in a loss for Socal sh areholders. This price is also above the $75 threshold, which if offered by ARCO or KKR would send their leverage above historical highs (greater than 60%). apt(p) the valuations sensitivity to the assumed inflation rate, discount rate, and recovery lag, $75.56 represents a disheartened valuation giving Socal management room to adjust its bid upwards if necessary.These estimates do not consider the possibility of recovering Gulfs unrelated fixed assets. Its important to note, the analysis is very excellent to the discount rate assumed, recovery lag, and the inflation rate.