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Exxon Mobil merger is a mega merger deal which took place on November 30, 1999. Exxon, a leader of oil sector, acquired Mobil in all stock transaction valued at $74 billion. Both companies originated from John D. Rockefeller's Standard Oil trust, which had been separated by government in 1911. The deal reunited companies again under the name of Exxon Mobil Corporation. The merger formed a conglomerate of oil companies with market capitalization of $270 billion dollars, 122,000 employees, 4% of world oil production, 8% of global oil refinery capacity and 40,000 service stations.

Industry overview

Industry structure and developments

During 1990s oil industry was a very competitive play field. The industry can then be categorized as follows:

• Majors. Large integrated players. Traditionally this comprised Exxon, Royal Dutch/Shell, British Petroleum (BP), Mobil, Chevron and Texaco. Prior to 1984 this group also included Gulf Oil. They were known as the “Seven Sisters”. Chevron acquired Gulf Oil in 1984. To some degree a group of slightly smaller integrated companies could be added to this list, e.g. Amoco and ARCO and, since their privatization, Total, Elf and ENI.
• Other Integrated. This group was similar to the majors but smaller in size and with less geographical reach. It comprised companies such as Amerada Hess, Conoco, Diamond Shamrock, Marathon, Occidental, Philips, Unocal and Ultramar.
• Independents. These were yet smaller companies, most of whom specialize in a single segment. They include, for example, Anadarko, British Borneo, Enterprise, Kerr-McGee, Lasmo, Ramco, Saga and Talisman.

The structure of the private sector remained extraordinarily stable, with a few key players - the Majors - prevalent from the 1920s until the late 1990s. The main industry developments in 1990s affected each business stream and introduced new sources of competition. There were several new tendencies:

• Natural maturity of previously advantaged fields. The resource base of the Majors, especially in the upstream began to erode. Big fields such as Prudhoe Bay, Brent, Forties, Statfjord, Ekofisk etc. matured and began to decline. Equally the onshore and shallow water offshore of the Lower 48 states of the United States was also in decline. The producing assets werereplaced in volume terms, but usually only by fields which were less profitable due to smaller size, higher costs and, in some cases, less favorable taxation regimes.
• Tighter fiscal terms for new fields and new provinces.

• Expansion of state-owned oil companies beyond traditional boundaries (e.g. Saudi Aramco, PDVSA, KPC). Asian countries (especially China) tried to mitigate its dependence on foreign oil by internationalizing the national oil companies. In other words, the governments were exploring international opportunities to acquire experience, gain exposure to advanced technologies, and have access to foreign supplies.
• The privatization of previously state owned oil and gas companies e.g. Total, Elf, ENI.
• Changing geography. The fastest growth occurred in non-OECD markets. These markets were often closed to international investors or incumbent firms proved advantaged.
• International financial markets deregulated, giving many private and state oil companies increased access to capital.
• New technologies in exploration and production, new generation of drilling facilities, development of information systems allowed expanding into new, previously inaccessible oil and gas provinces.
• Intermediate commodity markets developed which effectively disintegrated the oil industry on an operating basis. This gave the opportunity for new entrants (so called “petropreneurs”) to enter specific parts of the previously integrated value without being disadvantaged. For example:

- Tosco, Valero, Clark and Petroplus in refining in the US and Europe.

- Retailers such as Carrefour (France), Tesco and Sainsbury's (UK), Walmart and Costco (US) in the gasoline business.

- Williams and Koch growing rapidly in the pipeline and terminal business.

- The success of new upstream independents such as Apache.

All these trends were accompanied with oil prices collapse (see Appendix I). The real price of oil and refining margins fell (see Appendix II)). Petrochemicals margins also fell. A renewed deep downswing in the chemicals cycle developed as capacity expansions yet again exceeded demand growth. Thus petroleum industry was relatively unsuccessful in generating earnings growth and in achieving above average returns for shareholders.

M&A activity

During 1998-2001 above-mentioned factors triggered a remarkable wave of horizontal cross-border mega-mergers, with the public sector still playing a significant role.

The BP/Amoco merger (announced on 8/11/98) projected $2 billion in savings, stimulating other oil companies to seek improvements in operations. The Exxon/Mobil combination was announced on 12/1/98. In December 1998, the French oil firm Total announced the acquisition of PetroFina, a large Belgian oil company. On 7/5/99, the new TotalFina began a $43 billion hostile bid for the former state-owned Elf Aquitaine. The deal was completed at a price of $48.8 billion and became the fourth largest world oil company. On 4/1/99, an agreement was reached for BP Amoco to acquire Arco following negotiations initiated by Arco’s management. The U.S. Federal Trade Commission (FTC) required that Arco sell its Cushing, Oklahoma operations and its Alaskan crude-oil assets (Phillips Petroleum became the buyer). After rejecting a merger proposal from Chevron in June 1999, Texaco agreed to a takeover announced 10/16/00. In October 1998, DuPont did an equity carve-out of 30% of Conoco. The remaining 70% was spun-off to shareholders in August 1999. On 5/29/01, Conoco purchased Gulf Canada Resources. Phillips Petroleum acquired Tosco, the largest U.S. independent refiner, on 2/4/01. On 11/18/01, Phillips and Conoco agreed on a “merger of equals”. ConocoPhillips would become the world’s sixth-largest oil and gas company based on reserves.

M&A activity played central role in corporate strategy of that time. It had been regarded as a strategy to exploit synergies, access new sources and reduce overheads. The alternative strategy to M&As (adopted by small and medium-sized companies) had been to focus on a special geographical or technical niche. Cross-border mergers helped to spread political and financial risks as well as to access newer and cheaper oil fields outside Europe and North America.

Companies overview

Exxon

Brief History

In 1911 famous Standard Oil Company (founded by John D. Rockefeller) was accused of monopolizing the petroleum industry. The United States Supreme Court ordered the separation of Standard Oil into several geographically separate and eventually competing firms. The largest autonomous part was Standard Oil Company of New Jersey.

Jersey retained an equal number of smaller companies spread around the United States and overseas, representing $285 million of the former Jersey's net value of $600 million. Jersey remained a company oriented to foreign markets and supply sources. On the supply side, Jersey secured a number of valuable Latin American producing companies in the 1920s. In marketing, Jersey's income showed a similar preponderance of foreign sales. Jersey's domestic market had been limited by the dissolution decree to a handful of Mid-Atlantic States.

Following World War II, Jersey was in need of crude to supply the resurgent economies of Europe. For Jersey, which had changed its name to Exxon in 1972, the oil embargo of 1970s causes increased corporate sales, allowing it to double, within two years, its 1972 revenues of $20 billion. By 1980 that figure rose to $100 billion. However in 1989 Exxon was no longer the world's largest company, and soon it would not even be the largest oil group (Royal Dutch/Shell would take over that position in 1990), with the help of the March 24, 1989 tanker Exxon Valdez disaster. It cost Exxon around $7 billion. Although, in the late 1990s years of cost cutting and stock repurchasing pay off with annual profits of $7.5 billion, more than any other Fortune 500 company. Shareholder return for the year 1997 was 74%.

Company profile, strengths and weaknesses

Before the merger, Exxon was a highly centralized organization with six major divisions (Exploration, International, USA, Chemical, Coals and minerals, and Exxon Computing Service). The corporate headquarters played a major role in the decision-making process, particularly with regard to investment decisions. In general, Exxon was a multifunctional geographically-based regional organization with strengths in finance (AAA credit rating) and engineering (deepwater drilling). For general profile see Appendix III.

Exxon was notorious for its tightness with the capital-spending, generous dividends and buying back 27% of its common shares since 1983. The company was focused on return on capital, not growth. For years the company topped its industry in profitability. Its five-year (1993-1997) average return on capital was 11.1%, compared with the other majors' average 9.8%. Another Exxon’s strength was chemicals. Exxon's 1997 $11.4 billion in chemical revenues would have ranked it third in the industry as a standalone company. Many of Exxon's chemical plants adjoined Exxon refineries and turned the refineries' lower-value products, like naphtha and propylene, into higher-margin products.

Exxon was also one of the first in oil industry to expand into power generation. In China, the company had interests in Hong Kong and Guangdong electricity generation facilities totaling 6,883 megawatts. Electric generating capacity at Exxon's large cogeneration facilities at refineries and chemical plants around the world totaled about 1,500 MW. The electricity was for internal use, with the surplus sold.

Exxon’s oil exploration production strategy was over-focused on the old core areas in North Sea, North Americaand Malaysia. The company was lagging behind in developing new crude reserves. Exxon failed to get involved in perspective region of the Caspian Sea. Gas marketing was pre-merged Exxon's weakness as well. Much of its production came through partnership arrangements in which the gas already was committed to buyers under long-term contracts. In other words, no salesmanship was required from Exxon, which often was a passive partner in these joint ventures.

One key issue with Exxon-Mobil merger was cultural differences. Exxon was generally considered to be tight-lipped and conservative with slow decision making. It took months, or even years, of studies before a decision was made. Exxon’s top management had a subdued style of working, with a sharp focus on efficiencies and cost-cutting. The company’s public relations efforts had been fairly unimpressive (especially in case of Exxon Valdez disaster). It used a stalking tiger in its advertising.

Mobil

Brief History

Mobil also appeared as a result of Standard Oil Company break up in 1911. Among the 34 splinters were Vacuum Oil and Standard Oil Company of New York (Socony).

Socony established its position in Europe and Africa and built a thriving business in Asia as well. Vacuum Oil made a number of important domestic acquisitions. The two companies, similar in profile and complementary in product mix, joined forces in 1931 when Socony purchased the assets of Vacuum. This merger created base for future Mobil (in 1955 Socony-Vacuum was renamed Socony Mobil Oil Company and in 1966 at 100th anniversary “Socony” was dropped from the corporate name). Of Mobil's two progenitors, Socony was the larger and more generalized oil company, while Vacuum's expertise lay in the production of high-quality machine lubricants.

During the 1960s Mobil’s 9% annual increase in net income was the best of all majors. During oil crisis of 1970s Mobil's sales nearly tripled to $32 billion. In the early 1990s, it enjoyed one of the closest relationships with the Saudis. As earnings across the gas and oil industry dropped, Mobil's profits fell by only 0.5%, but the corporation braced for a deepening recession with restructuring and internal investment. By 1994, Mobil's position had stabilized, as rising natural gas prices pushed up the company's profits, one-third of which were from natural gas. Ending 1996 with $81.5 billion in revenues, the company announced that it had essentially met its target for two years hence, 1998, of more than $3 billion in earnings.

Company profile, strengths and weaknesses

Mobil had more relaxed central control of the organization, permitting branch officers and operative entities a larger degree of autonomy. The company had always been riskier and innovative with high marketing expertise. For general profile see Appendix III.

It ventured into natural gas back in the 1970s before it was popular with major oil companies. Mobil was as much a gas company as it was an oil company. It was the largest US firm extracting natural gas in Indonesia, which was one of the world's largest producers of that resource. Natural gas constituted 50% of Mobil's worldwide resources at that time. Worldwide fast growing liquefied natural gas (LNG) business was a major strength. In 1998 Mobil succeeded in securing sole negotiating rights for the sale of 7.5 million metric tons of LNG a year to an Indian consortium.

Mobil had been a very strong player in developing new reserves. In 1998 the company replaced 165% of the oil and gas reserves. Proved reserves increased to 7.6 billion barrels of oil equivalent, and total resources increased to 28 billion barrels. Mobil increased production in key growth areas, including the Tengiz field in Kazakhstan, the Hibernia field offshore Eastern Canada and Equatorial Guinea's Zafiro field. It had strong positions in Saudi Arabia, Nigeria, and Asia's Pacific Rim. Mobil also ventured more confidently into politically charged Central Asia, taking advantage of the dissolution of the Soviet Union. Mobil’s strengths were its industry’s most accomplished dealmakers and high-powered gas-marketing arm.

On the retail side, Mobil operated 7,711 highly successful gas stations, concentrated in 18 states, only 600 of which were company-owned. Expanding into full-scale convenience stores, the company introduced about 150 “On the Run” outlets. Mobil was one of the first companies in the world to test a new Internet-based bill delivery and payment service.

The riskiness of operations predetermined relatively lower financial capabilities, which are crucial in capital intensive industry such as oil. It was a limiting factor, especially for new projects in LNG. Upon the completion of the merger, both Moody's and Standard and Poor's Corp. upgraded their ratings of Mobil's debt. Moody's moved its Aa2 rating of Mobil's unsecured debt to Aaa.

Mobil had a more open culture and was receptive to new ideas. Mobil’s management was far more risk loving. Mobil had been far more successful in handling the media. For example, the company took on the media in the 1970s with editorials and radio shows that accused the media of biased coverage during the oil embargoes. Mobil was the first oil company to encourage energy conservation by urging the US to improve its mass-transit system and set speed limits at 50 miles per hour. It used a whimsical flying horse in its advertising.

Synergy

The motivations for the Exxon-Mobil merger reflected the industry forces described above. Companies needed a secure presence in the regions with high potential for oil/gas discoveries and stronger position to make large investments. The benefits of the merger fell broadly in two categories: near-term operating synergies and capital productivity improvements.

Near-term operating synergies. $2.8 billion in annual pre-tax benefits from operating synergies (increases in production, sales and efficiency, decreases in unit costs and combining complementary operations). Management expected to realize the full benefits by the third year after the merger. During the first two years, the benefits should had been partly offset by one-time costs at $2 billion for business integration. The firms also planned to eliminate about 9,000 jobs. A year later, pre-tax annual savings were re-assessed and increased to $3.8 billion.

Capital productivity improvements. Management also believed the combined company could use its capital more profitably than either company on its own. These improvements were realized due to efficiencies of scale, cost savings, and sharing of best management practices. The businesses and assets of Exxon and Mobil were highly complementary in key areas. In the exploration and production area, for example, Mobil's and Exxon's respective strengths in West Africa, the Caspian region, Russia, South America, and North America lined up well, with minimal overlap. The firms also had a presence in natural gas, with combined sales of about 14 bcfd. And Mobil contributed its LNG assets and experience to the venture.

There were technology synergies as well. In upstream, Exxon and Mobil owned proprietary technologies in the areas of: deepwater and arctic operations, heavy oil, gas-to-liquids processing, LNG, and high-strength steel. In downstream, their proprietary technology focused on refining and chemical catalysts. Exxon’s lube base stocks production fitted well with Mobil's leadership in lubes marketing. Generally, the Exxon-Mobil deal was a move by the dominant partner to increase its asset base by 30% while raising capital productivity.

Deal

Pre-deal events

On June 16, 1998, Mr. Lee R. Raymond, Exxon's CEO, met with Mr. Lucio A. Noto, Mobil's CEO, at Mobil's headquarters in Fairfax, Virginia. At the meeting, Mr. Raymond and Mr. Noto had preliminary discussions about the possibility of a combination of the two companies. Later management continued discussions and permanently informed the Boards.

On August 11, 1998, The British Petroleum Company p.l.c. and Amoco Corporation announced the terms of their merger agreement. Shortly thereafter, Mr. Raymond and Mr. Noto resumed their discussions taking into account this new pricing benchmark. In mid-August 1998, the management of Mobil asked Goldman Sachs to undertake an analysis of strategic alternatives available to Mobil. On September 14, Goldman Sachs presented to the Mobil Board its analyses regarding the various possible transactions, including a possible merger with Exxon.

At a meeting on October 19, 1998 at Exxon's headquarters attended by Messrs. Raymond, Matthews, Noto and Gillespie, the parties reviewed the possible relative ownership ranges and expanded the discussions to include such issues as the representation of current Mobil directors on the board of the combined company.

During November 1998, Exxon and Mobil exchanged due diligence request lists and representatives and their advisors participated in a video conference and numerous telephone calls and meetings to conduct reciprocal legal, business, accounting and financial due diligence. A reciprocal confidentiality agreement was entered into on November 12.

On November 26, 1998, Mr. Noto and Mr. Raymond spoke by telephone to discuss reports that had appeared in the media about a possible transaction between Exxon and Mobil. On November 27, prior to the opening of NYSE trading, Exxon and Mobil issued a joint statement confirming that the two companies were in discussions of a possible business combination.

Over the course of the weekend of November 27, 1998, Exxon and Mobil representatives and outside counsel continued discussions towards resolving open issues. On the evening of November 30, Messrs. Raymond and Noto reached agreement in principle, subject to Board approval, on the exchange ratio and the resulting exercise price in the stock option agreement.

Following the approval of their Boards, Exxon and Mobil officially signed an agreement and plan of merger on December 1, 1998. Shareholders of both Exxon and Mobil approved the merger in May 1999. In September 29 of that year the European Commission granted antitrust approval. In November, 30 1999, the historic merger was completed. Mobil became a wholly owned subsidiary of Exxon. The combined company changed its name to Exxon Mobil Corporation.

The event analysis is very limited as there was no bidding process. The only important public information was merger announcement (December 1, 1998). 10-day cumulative abnormal return (CAR) before the date was +14% for Mobil and +0.4 for Exxon. The main spike in share prices appeared during November 25 – November 30 and negative returns were on the announcement day, i.e. rumors in the media influenced the pricing. Total CAR for 20-day (10 days before plus 10 days after the announcement) amounted +19.5% for Mobil and +1.07% for Exxon (see Appendix IV and appendix V).

Market was very positive on Exxon and Mobil on April 19 and April 21 1999 when FTC approved other two big oil mergers – BP-Amoco and Shell-Texaco. 3-day CAR reached 5.3% for Exxon and 6.8% for Mobil. Market also positively reacted on EU Commission approval: 3-day CAR was +2.2% for Mobil and +2.4% for Exxon. All these signaled that market positively assessed the merger as economically sound and value creating.

Regulators approval

On September 29, 1999 EU Commission granted its approval of the merger with requirement of vast divestitures and breakup of the European refining and marketing joint venture of BP Amoco and Mobil. Mobil wanted to maintain its relationship with BP Amoco, but EC officials feared that the recent rash of mega mergers could kill off downstream competition in member countries. Mobil was also ordered to sell its share in a large chain of gasoline stations (Aral). Exxon and Mobil sold part of their lubricant base oil manufacturing capacity.

BP Amoco bought Mobil's 30% interest in their R&M JV for $1.65 billion, about the value of the assets that Mobil contributed when the deal was established. Mobil also got around $1.08 billion for its interest in Aral.

The US FTC announced on November 30, 1999 that it accepted a proposed settlement of charges that Exxon Corp’s acquisition of Mobil Corp would violate federal antitrust laws. The settlement required the largest retail divestiture in Commission history - the sale or assignment of approximately 2,431 Exxon and Mobil gas stations in the Northeast and Mid-Atlantic (1,740), California (360), Texas (319) and Guam (12). In addition, an Exxon refinery in California; terminals; a pipeline and other assets were also subject for sale.

Ratios overview

For summary of ratios see Appendix VI.

Exxon had better return on assets (6.75%) and return on equity (14.57%) ratios (Mobil’s were 3.95% and 9.01% correspondingly). This situation represented Exxon’s better efficiency at using investment funds (shareholder’s equity) to generate earnings growth. Return on assets dynamics (see Appendix VII) clearly illustrates abovementioned profiles of companies. Exxon was more stable and effective in using its assets, while Mobil was more volatile and risky. During 1983-1999 Exxon was superior with the exception of 1989, when tanker Exxon Valdez disaster happened and cut profits of the company.

Companies had equal gross margin (38.7% vs. 38.52%), but Exxon had higher gross operating margin (7.9%) and profit margin (5.4%) ratios than Mobil (6.56% and 3.18% correspondingly) which means that Exxon was better in cost-cutting and controlling its expenses. But in some cases low operating expenses can damage long-term profitability and competitiveness of the company.

Liquidity ratios definitely show that both companies were financially stable, but Exxon was in better situation that Mobil. The Exxon’s current and quick ratios (0.57 and 0.91 correspondingly) were higher than the Mobil’s (0.48 and 0.67 correspondingly) and merged company had significantly improved these results. Ratio of net current assets as a % of total assets (i.e. working capital to total assets) was distorted after the merger (1.48) probably due to large divestitures that followed the deal.

Solvency status of companies also looked good. Though Exxon again showed its financial supremacy with much higher interest coverage ratio (93.41 compared to Mobil’s 7.78) Generally speaking the better interest coverage ratio means less risk but also might be bad for future performance because of the failure of the management to use additional funds for development. Debt to equity ratio was safe and stable in both companies.

Combined company showed even superior results after the merger, which proved the correlation between positive market reaction on the announcement event and success of the merger.

Deal structure

Under the merger agreement, an Exxon subsidiary would merge into Mobil so that Mobil becomes a wholly-owned subsidiary of Exxon Mobil. As a result, Exxon would hold 100% of Mobil’s issued and outstanding voting securities. Holders of Mobil common stock would receive 1.32015 shares of Exxon common stock for each share of Mobil common stock.

5 days before the announcement Exxon shares price was $72 and 2,431 million shares outstanding ($175 billion market value) compared with $75.25 a share and 779.8 million shares outstanding for Mobil ($58.7 billion market value). With the exchange ratio 1.32015, Exxon paid 1,029.4 million its shares for Mobil or $74.1 billion. This was a $15.4 billion (26.2%) premium over Mobil’s market value or $94.9 a share. After the price run-up Exxon shareholders would own approximately 70% of the combined Exxon Mobil entity, while Mobil shareholders would own approximately 30%. The merger qualified as a tax-free reorganization in the US, and that it was accounted for on a “pooling of interests” basis. The characteristics of the deal are presented in Appendix VIII.

In addition, the merger agreement provided for payment of termination fees of $1.5 billion. Exxon and Mobil also entered into an option agreement that granted Exxon the option to purchase up to 136.5 million shares (14.9%) of Mobil common stock at a strike price of $95.96. Exxon could exercise the option after the occurrence of an event, entitling Exxon to receive the termination fee payable by Mobil.

The termination fee and option were intended to make it more likely that the merger would be completed on the agreed terms and to discourage proposals for alternative business combinations. Among other effects, the option could prevent an alternative business combination with Mobil from being accounted for as a “pooling of interests”. Although companies introduced protection against hostile takeover, they didn’t use any collar to protect shareholders. J.P. Morgan & Co. and Davis, Polk & Wardwell advised Exxon, and Goldman Sachs & Co. and Skadden, Arps, Meagher & Flom advised Mobil.

Valuation

J.P. Morgan performed traditional P/E analysis. Such analysis indicated that Mobil had been trading at an 8% to 15% discount to Exxon. J.P. Morgan's analysis indicated that if Mobil were to be valued at price to earnings multiples comparable to those of Exxon, there would be an enhancement of value to its shareholders of approximately $11 billion.

Goldman Sachs also reviewed and compared ratios and public market multiples relating to Mobil to following six publicly traded companies:

• British Petroleum Company plc,
• Chevron Corporation,
• Exxon,
• Royal Dutch Petroleum Company,
• Shell Transport & Trading Co. plc,
• Texaco Inc.

P/E multiple for these firms ranged 19.3-23.8. The analysis showed that Mobil was undervalued 5-16% relative to comparables with fair price $79-89 a share. It’s needed to notice that comparables analysis couldn’t capture the synergy effect, value creation and differences. Simple DCF analysis of Mobil as a standalone company gives range of intrinsic value of $59.8-79.5 billion or $76.7-102 per share depending on cash flow growth rate.

DFC analysis, based on the estimated pre-tax synergies of $2.8 billion expected to result from the merger, suggested a potential value creation in the short term of approximately $22-25 billion. J.P. Morgan's review suggested that over the long term, the potential for value creation from these elements could be as much as $47-57 billion. So Mobil intrinsic value for this deal was $95-$118.8 a share depending on growth rate.

Since Exxon's market capitalization was significantly larger than Mobil's, Exxon's shareholders would have enjoyed a greater proportion of the value creation if no premium were paid by Exxon in the merger. By offering a premium to Mobil's shareholders, this potential value creation was instead shared in approximately equal proportions between the companies' shareholders and such sharing was deemed to be a reasonable allocation of value creation. J.P. Morgan's analysis showed that for transactions involving smaller companies with a relative market capitalization comparable to that of Mobil pre-announcement, a premium of 15% to 25% matched market precedent. In comparison, BP paid 35% premium for Amoco. For summary of valuation see Appendix IX.

10 days before the completion of the merger, Exxon market value was $184.5 billion ($76 a share) and Mobil – $77.1 billion ($98.5 a share). Pro forma market value of merged company was $261.6 billion. Right after the merger was completed, the share price of combined Exxon-Mobil was $80.56 with 3,461.5 million shares outstanding, which gave $278.8 billion market value or $17.2 billion of additional value created. This figure would be even higher if we consider pre-announcement pro forma combined market value of $233.7 billion. In this case created value reaches $45.1 billion.

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