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Valuation and Merger Analysis: Chapter 10-1

This document discusses valuation and merger analysis of an oil industry merger between Exxon and Mobil in the late 1990s. It analyzes the reasons for the merger including synergies, deal terms including the exchange ratio and premium, impact on stock prices, and calculates the costs of capital and weighted average cost of capital for the combined firm. The merger was seen as making economic sense given complementary operations and an estimated $7 billion in synergies that analysts predicted.

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46 views7 pages

Valuation and Merger Analysis: Chapter 10-1

This document discusses valuation and merger analysis of an oil industry merger between Exxon and Mobil in the late 1990s. It analyzes the reasons for the merger including synergies, deal terms including the exchange ratio and premium, impact on stock prices, and calculates the costs of capital and weighted average cost of capital for the combined firm. The merger was seen as making economic sense given complementary operations and an estimated $7 billion in synergies that analysts predicted.

Uploaded by

PRAJWAL S N
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Valuation and Merger Analysis

 Valuation approaches and tests


• Comparable companies or transactions
• Spreadsheet and formula approaches
• Test whether transaction makes sense
• Test whether premium paid is justified by
potential synergies
 Additional analysis
• Nature of industry
• Value drivers (historical and projected)
• Competitive and antitrust effects of merger
• Issues related to implementing the merger
Chapter 10-1
Merger Analysis:
 Oil industry experienced a merger wave in the
late 1990s
 Characteristics of the oil industry
• Oil is a global market
• Strategically important for industrial, political,
and military reasons
• OPEC has historically played a large role
• Large costs for environmental protection
• High degree of price instability – mergers can
be seen as a response to lower breakeven levels

Chapter 10-2
Merger Analysis:
 Reasons for the merger
• Stronger presence in promising oil regions
• Better position to invest in costly programs with
high risks and returns
• Complementary operations in South America,
Russia, Canada, Asia, Africa
• Synergies: predicted $2.8B, analysts estimated to
be $7B by 2002 (actual)
 Deal terms
• Mkt. value before: XON $175B, MOB $59B
• XON offer: 1.32 XON shares x $72 share price x
780 outstanding MOB shares = $74B (26%
premium over premerger mkt. cap.)
Chapter 10-3
Merger Analysis:
 Impact of the deal
• Premerger, Exxon shares represented
75% of combined market value
• Postmerger, Exxon shares represented
70% of combined market value
 Event analysis
• (-10,0): +14.8% Mobil, -0.5% Exxon
• (-10,+10): +20.6% Mobil, +3.1% Exxon
• Positive returns reflect market view that
the merger made economic sense
Chapter 10-4
Cost of Capital:
 Cost of equity: ke = rf + ERP(beta)
• rf = risk free rate (10 yr. treasuries) = 5.6%
• ERP = equity risk premium (historical market
return patterns) = 7%
• Beta = firm’s systematic risk = 0.85 (Exxon),
0.75 (Mobil)
• Exxon ke = 5.6 + 7(0.85) = 11.55%
• Mobil ke = 5.6 + 7(0.75) = 10.85%
 Cost of debt (before-tax)
• Exxon: AAA (160bp over treasuries) = 7.2%
• Mobil: AA (190bp over treasuries) = 7.5%

Chapter 10-5
Cost of Capital:
 Capital structure
• Oil companies have usually had debt-to-total capital
ratios between 20 and 40%
• During acquisitions, ratios at upper end
• Plausible target ratio would be 30% (B/V)
 Weighted average cost of capital
• WACC = (S/V) ke + (B/V) kb (1–T)
• Cash tax rates estimated: 35% Exxon, 40% Mobil
• Exxon=(70%)(11.55%)+(30%)(7.2%)(1–35%)= 9.49%
• Mobil=(70%)(10.85%)+(30%)(7.5%)(1–40%)= 8.95%
• Combined firm should have a lower beta due to
reduced business risk – cost of equity = 11.2%
• WACC=(70%)(11.2%)+(30%)(7.2%)(1–38%)= 9.18%
Chapter 10-6
Valuation:
 Valuation considerations
• Historical patterns are only the foundation for
projections
• Projections are modified by business-economic
analysis of future prospects for the industry
• Revenue growth reflects the economics of the
industry
• Net operating margins depend on realization of
synergies and oil prices
• Individual value drivers may need adjustment

Chapter 10-7

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