The oil M&A scene is looking less like a game of playing hard-to-get; more like playing hard-to-want.
Big deals are conspicuous by their absence in this oil crash, and those wistful souls on Wall Street are wondering why there isn't a little more love in the air.
In response to a question at Exxon Mobil's recent analyst day, Chief Executive Rex Tillerson put some blame on a well-known mood-killer: money problems.
But I think the other thing that's happened is there's been a fair amount of value destruction in the last year of some of these companies as they have continued to access capital markets and levered up...It's like buying a home with a big mortgage on it and there's not a lot of equity left there that you can build on.
Debt is simultaneously an aphrodisiac and a turn-off. By weighing on the stocks of highly levered exploration and production firms, it makes them alluringly cheap (how's that for romantic?). But debt is also a stubborn obligation, like getting married only to find that you also agreed to have your in-laws move in.
Anadarko Petroleum is thought by many to be on Exxon's mind, but its balance sheet is something best seen with the lights off -- as this chart of its enterprise value over time illustrates:
It isn't just the amount of debt that is problematic, but also the conditions attached.
Anadarko's latest 30-year bonds, which raised $1.1 billion this week, are a perfect example. The thing is, they may also be a good way of betting on Exxon finally getting its reluctant bride to the altar.
The bonds yield 6.42 percent, according to Bloomberg. Moody's rates them as high-yield, while Standard & Poor's and Fitch have them teetering on the edge of investment grade.
What makes them problematic for an acquirer like Exxon is their make-whole provision. Under this, if the bonds are called, then the buyer has to pay the bondholder the present value of all the remaining coupon payments and principal using a discount rate much lower than the current yield -- assuming Treasury yields don't rise much -- meaning a hefty premium.
Right now, the bonds yield 3.73 percentage points over 30-year Treasuries. Say Exxon buys Anadarko in six months. Being a triple-A rated company and a stickler for financial discipline, it would make sense to retire the target's higher-yielding bonds and replace them with cheaper Exxon bonds; the latter's 30-year debt yields just 1.23 percentage points more than Treasuries.
That would be expensive: Buying back Anadarko's bonds at an effective yield of 3.19 percent -- the current Treasury yield plus the half a percentage point stipulated in the provision -- would mean paying a 64 percent premium to par value, according to Bloomberg calculations. File that one under "not happening."
Make-whole provisions are pretty standard; but Anadarko, like many other E&P companies, seems reluctant to be bought. Last year's half-cocked approach to Apache looked like an attempt to escape the attentions of a bigger buyer such as Exxon.
A deal still could happen, though. Exxon, along with other oil majors, says that, apart from the debt issue, targets are simply holding out for higher prices. In this, they've been helped by the current rally in oil markets, enabling them to issue more debt and shares to keep going.
Of course, enabling E&P companies to keep producing oil also exacerbates the glut that could end the rally. While Exxon says potential targets still demand too high a price, the unspoken corollary is that the oil major must have a pretty bearish view on where oil prices are going. If it is right, then Anadarko's stock would tumble again, reducing the equity check and perhaps giving Exxon the room it needs to assume the company's debt.
If oil drops, then Anadarko's bonds would join its stock in heading south. Look what happened to its bonds maturing in 2039 over the past six months.
The big difference, though, is that Exxon buying the company would make anxiety around Anadarko's bonds vanish. Sure, Exxon might suffer the indignity of losing its triple-A rating, but double-A would hardly make it a deadbeat.
Not only would Anadarko's 30-year bonds erase any losses, they ought to reprice at a yield in line with Exxon's. Even if the latter's cost of borrowing widened by half a percentage point to account for the new debt, a yield of 4.38 percent on Anadarko's bonds would mean a price of 136.5 percent of par value -- roughly a third higher than where they trade today.
In the meantime, those bonds would still have been paying a coupon of 6.6 percent versus the stock, where the dividend has been slashed to almost nothing.
There is a real risk that this particular hook-up never actually happens. If it does, though, one of its biggest obstacles could turn out to benefit handsomely.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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Liam Denning in San Francisco at firstname.lastname@example.org
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