Texaco Hitches Its Star to Chevron

You may still be able to trust your car to the man who wears the Texaco star. But that star, made famous in the oil company’s old advertising jingle, had grown a bit tarnished in the eyes of Wall Street in recent times.

Which is why White Plains, N.Y.-based Texaco, its stock price limp and its growth prospects lackluster compared with those of its competitors, announced on Oct. 16 that it had agreed to be acquired by Chevron. It was the second time that San Francisco-based Chevron had tried to buy Texaco. Chevron’s first overture, in May 1999, had been rebuffed.

The combined company, ChevronTexaco, will be the fourth largest oil concern in the world with reserves of 11.2 billion barrels and daily production of 2.7 million barrels. The three largest are ExxonMobil, BP (formerly BP Amoco) and Royal Dutch Shell.

Two Wharton management professors and a Wall Street analyst say both companies had little choice but to seek a partner because size and economies of scale are keys to profitability in the oil business. “There is a certain amount of common activity in each company, and one, Chevron, is operating from a position of strength,” says management professor Daniel M.G. Raff. “Texaco’s back was closer to the wall than it once was. It was inevitable that there would be some deal. It seems a reasonably good one, so Texaco’s management is to be congratulated for keeping its shareholders’ interests in mind.”

“Over the past decade, both companies have worked very, very hard to apply new technologies to make their operations exceptionally lean,” adds Bruce Schwartz, who follows oil companies for Standard & Poor’s. “But both were starting to nearly exhaust a lot of the potential internal cost-reduction opportunities. This [merger] will enable them to achieve more synergies than they could achieve incrementally on their own.”

Management professor Lawrence G. Hrebiniak agrees that the deal makes sense for both firms because big, integrated oil companies need to be even bigger today to compete. “ExxonMobil, BP and others are much larger. Chevron and Texaco separately were far down the line.” Together they will be a more impressive player, although “certainly not dominant…Texaco’s profits have not been strong and Chevron is coming to the rescue, without a doubt.”

Texaco shareholders are to receive 0.77 of a Chevron share for each Texaco share they own. That works out to $64.87 per Texaco share, based on Chevron’s closing price of $84.25 on Oct. 13. Since then, Chevron stock has declined a little, as that of an acquiring company often does after it announces a takeover. It closed at $82.25 on October 24. The price to be paid Texaco holders represents a premium of 18%, based on Texaco’s closing price of $55.13 on Oct. 13. On Oct. 24, Texaco closed at $58.06.)

The companies have said they expect to achieve annual savings of $1.2 billion within six to nine months of the merger’s completion. Some $700 million in savings will come from more efficient exploration and production. About $300 million will come from consolidating corporate functions and $200 million from other operations. The companies also have said they will eliminate 7% of their combined workforce of 57,000.

Schwartz points out that both firms bring strengths to the table. Chevron, for example, has been aggressive in developing new petroleum sources. It is engaged in a $40-billion, 20-year joint venture with the Republic of Kazakhstan, whose fields along the Caspian Sea contain six to nine billion barrels of recoverable oil, according to Chevron.

Texaco, too, has advantages of its own. “Texaco’s stock has languished to some degree recently because of its outlook for very slow growth over the next couple of years,” Schwartz says. “But they have a number of projects that will contribute to production growth from 2003 and beyond. By [combining with Texaco,] Chevron enhances its long-term growth rate.”

One development that will be interesting to watch is whether Texaco and Chevron have any difficulty merging their cultures. “If you merge unrelated businesses, and the companies can continue to operate independently, the cultural aspects aren’t all that important,” Hrebiniak says. “But in a case like this, with lots of duplication, the only way they’re going to save money is to meld the two organizations as quickly as possible. Any differences that exist can get in the way of a smooth transition. We saw that with BP and Amoco. One company was focused on refining and production, the other was focused on research and development and discovery. They’re still having troubles. Putting those two cultures together has been a source of frustration for management.”

Schwartz, though, thinks a culture clash probably won’t happen. While personal relationships are vital in some businesses, they do not count for all that much in the oil patch, he says. “Most of your assets are oil fields and refineries,” he says, and unlike people, oil fields and refineries “don’t complain.”

Meanwhile, Schwartz, Raff and Hrebiniak say the Federal Trade Commission is likely to approve the consolidation but will probably require ChevronTexaco to sell some properties, just as it required certain divestitures before approving the merger of Exxon and Mobil. Chevron and Texaco own overlapping refining and marketing operations on the West Coast as well as marketing operations in the southeastern U.S. In California, the companies’ combined share of the retail gasoline market is 30%.

U.S. Energy Secretary Bill Richardson has indicated he is in favor of the pending consolidation, saying it is in the best interests of consumers. He called the acquisition “one of the inevitable outgrowths of the global economy.”

However, Schwartz adds, while there is no good reason for the government to block the deal, it is too early to say whether or when consumers will benefit from lower prices. The reason for the uncertainty is that, in recent years, companies have been reluctant to spend more money to produce more oil.

“In general, the return on capital in the oil and gas industry has been very low for most of the past decade,” he says. “Companies overall are earning high single-digit and low double-digit returns on capital employed, except periods like today when you have unusually high prices. Due to inconsistent profits, companies have been unwilling to reinvest capital in the volumes needed to maintain oil supply in expectation of dismal returns. The impact on consumers is not clear.”

Raff agrees. “These are vertically integrated companies. It might be true that there are economies of scale in refining, but combining retail distribution channels might mean less competition at the gas pump. This is the kind of thing that government antitrust economists will look at closely.”

Nonetheless, the government is likely, in the end, to give a green light to the deal, Raff predicts, “because companies will have to be bigger to stay viable, and having more viable U.S. companies rather than fewer in the business is likely to strike them as a good idea.”

Raff and Schwartz say they believe that the oil industry may have seen the last merger of top-tier companies; further attempts at consolidation among the largest oil firms would arouse major antitrust concerns.

But Chevron will be in a stronger position to acquire smaller companies in the future, if it wishes, says Schwartz. The stocks of larger oil companies have been trading at higher price/earnings multiples as investors have come to recognize the benefits of size, and the same will likely be true of ChevronTexaco. A more robust stock price could provide the combined firm “with stronger currency to make other incremental acquisitions,” Schwartz says. However, that will not happen for a while, he adds, because Chevron first has to focus on digesting this latest deal.

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