Gulf Oil Corporation – Takeover case 4 As the pro forma balance sheet shows (Exhibit 2), SOCAL’s debt increased sharply as a result of the takeover. SOCAL’s debt-to-total-capital ratio will be approximately 50% (substantially higher than the 1983 level of 10% shown in Exhibit 1). Reducing this debt load requires elimination of Gulf’s E&D. SOCAL stated it is interested in reaching a target debt ratio of 30% (halfway between 10% historical and 50% new). SOCAL acquired Gulf’s worldwide reserves for a price equal to about $4.40 per barrel; this was less than half SOCAL’s finding cost over the prior five years (Wall Street Journal, March 7, 1984, page 22). The price of SOCAL’s common stock fell 9% during the first week of March 1994 (period covering first unconfirmed rumors of SOCAL’s interest in Gulf through the day following the announcement of SOCAL’s successful $80 per share bid. By the end of the month, SOCAL’s stock had fully recovered. The market’s initial response reflected investors’ belief that SOCAL had NOT overpaid for Gulf, despite the 100% premium. Following its winning bid, SOCAL announced that it planned to reduce its debt ratio from 50% to 30% by trimming SOCAL’s operation and selling some assets. SOCAL planned to keep Gulf’s oil reserves and trim the E&D. In November 1984, SOCAL announced that it would eliminate 10,000 jobs in the consolidation of the combined SOCAL-Gulf operations. These reductions were in addition to work force reduction by eliminating E&D. If we assume that these employees earned $30,000 each in 1984 dollars, the post-tax (50%) value enhancement from this action alone would be: [(10,000 X $30,000) X .5]/(.17 - .05) = $1.25 billion (or $7.50 per share). Table C NPV/share of Gulf’s E&D as function of selected variables (Scenario Analysis) Base case variables : General rate of inflation 5% Rate of inflation for oil prices 5% Cost of capital for the firm undertaking the oil E&D 17% Average time period from cash outlay to cash recovery for oil exploration & development e x p e n d i t u r e s 8 y e a r s Expected current finding cost for oil reserves $7.94/barrel PV of the tax shelters associated with the finding cost outlays $22.42/barrel PV of the oil produced as a result of the exploration and development $6.98/barrel (marginal) Tax rate 50% Scenario Analysis NPV of E&D program per Gulf share, assuming average elapsed time to oil recovery of 8 years $(50.31) 7 years $(41.50) 6 years $(31.70) NVP of E&D program per Gulf share, assuming oil price inflation rate of: 0% per year $(67.97) 5% per year $(50.31) 10% per year $(25.38) 15% per year $ 8.71
Essay about Gulf Oil case study
690 WordsNov 8th, 20133 Pages
The Standard Oil Company of California(Socal) is trying to determine how much to bid on the Gulf Oil Corporation. George Keller, the CEO of Socal, would need to borrow 14 billion dollars in order to make a substantial bid. While banks are willing to lend the money because of Socal's low to debt ratio, the loan would put the company in a highly leveraged position. In order to alleviate that debt, some of Gulf's assets could be sold. Keller has to consider the value of Gulf's exploration and development program when calculating future returns. Two billion dollars were being spent on the exploration and development program. This money could instead be used to reduce the debt if Socal acquired the company. However, the exploration program…show more content…
Mesa would need a majority hold of Gulf in order to elect alternative directors of the firm. The purpose of electing new directors would be to turn the Gulf corporation into a royalty trust. If Mesa were to put up more money for the company, it would only do so for the purpose of gaining a majority hold. Because this was not an attainable goal, Mesa sought the 21% ownership because it was enough attract the further banking needed.
Advised Decision A prospective buyer has to consider the motives and financial positions of other bidders. Kohlberg wants to buyout the company in order to turn it into a private firm. ARCO has a pretty strict limit in what it can offer because of its highly leveraged position. Even if a company has the ability to take out a larger loan to make a greater offer, it has to consider the consequences of doing so. While a company like Socal has unrestricted credit, its decisions as to how to operate the company after the buyout are very limited. Creating a lot of debt in order to finance the purchase is a large risk. If the company does not perform well in the future it could face tremendous loss. In this case, a bid of $80 per share would be appropriate for an un-leveraged company like Socal. This would be enough to win Gulf while still leaving breathing room for shareholders. Taxes do not need to be considered, because the benefits cancel out the