Exxon Mobil Has Ample Firepower To Make The Mother Of All Acquisitions, But Will It Happen?

  • Exxon Mobil has ample resources to make the biggest acquisition in the energy patch, topping the $80.3 billion merger that led to its own creation.
  • Exxon Mobil is the only oil producer with a triple-A credit rating and owns treasury shares worth $278 billion.
  • The company can buy out any of its three closest rivals Chevron, BP, Shell.
  • This will allow Exxon Mobil to reduce CAPEX and operating costs by more than 20% and 40% respectively while sharply lowering the net debt ratio and significantly boosting shareholder value.
  • But I believe a Permian Basin focused acquisition looks more likely, and here, Pioneer Natural Resources comes out on top.

The decline in oil prices is usually followed by a wave of mergers and acquisitions. Although some of the leading energy companies, such as Royal Dutch Shell (NYSE:RDS.A), Marathon Petroleum (NYSE:MPC), Energy Transfer (NYSE:ETE) and Schlumberger (NYSE:SLB) have moved to acquire their peers in the current year, the deals have been few and far between. What is notable is that Exxon Mobil (NYSE:XOM), the world's biggest publicly traded, vertically-integrated oil producer, has stayed on the sidelines.

Buying opportunity

This could be largely due to two reasons. Firstly, Exxon Mobil previously acquired shale producer XTO Energy for $41 billion just ahead of the decline in natural gas prices. In hindsight, that deal appears very poorly timed, and this experience has probably made the company cautious.

Secondly, the valuation of oil and gas producers, particularly those with high-quality asset base, is still not attractive enough. The downturn was supposed to lead towards a large number of bankruptcies which could have pushed the entire sector lower, but so far, even the highly-levered oil and gas producers with low-quality assets have been holding up well.

But this could change in the near future as banks begin to re-assess the value of oil and gas assets. Some of the smaller debt-laden drillers could see their borrowing base decline by up to 15%, according to Citi's estimates. The subsequent cash crunch could lead towards an uptake in bankruptcies, which could weigh on the entire exploration and production space.

That weakness could be an opportunity for Exxon Mobil to swoop in and acquire a major oil and gas producer. The company certainly has ample firepower to potentially make the biggest acquisition in the energy patch, topping the $80.3 billion merger that led to its own creation.

Firepower

Exxon Mobil has $4.3 billion of cash reserves and generates more cash flow than any other oil and gas producer. The company could generate close to $34 billion in cash flows in the current year, even if these decline by 10% in the second half of the year as compared to the first half owing to the weakness in oil prices. But the company runs a negative free cash flow business, meaning these resources will be used to fund the capital spending and dividends.

But Exxon Mobil is the only oil producer with a triple-A credit rating, which gives it access to cheap credit. The company recently raised debt in the current year in its largest every bond offering, but that doesn't rule out the possibility of the company issuing additional debt to take advantage of the zero interest rate environment.

Besides, Exxon Mobil owns 3.8 billion of treasury shares which are worth $278 billion. That means Exxon Mobil can acquire any of its rivals, including the oil majors Royal Dutch Shell which is currently valued at $158.7 billion, Chevron(NYSE:CVX) at $146.3 billion and BP (NYSE:BP) at $95.15 billion, if it gets a green signal from regulators.

Possible targets

In a research report emailed to me, Oppenheimer's analyst Fadel Gheit wrote that a merger with some of the world's biggest oil companies mentioned above could allow Exxon Mobil to reduce the combined CAPEX and operating costs by more than 20% and 40% respectively while sharply lowering the net debt ratio. It would also significantly boost shareholder value for both companies.

While Exxon Mobil is certainly capable of making an acquisition the likes of which the energy industry has never seen, that doesn't mean that it should. An acquisition of this size and scale would involve substantial regulatory risks due to anti-trust concerns. In addition to this, takeover of a European oil major will also likely face stiff opposition from the government, particularly since the British government has openly warned that it would stand against any takeover of BP.

Therefore, Exxon Mobil will likely focus on U.S. based relatively smaller shale and conventional oil producers that have a high-quality asset base. Such a move will also be in-line with Exxon Mobil's strategy of increasing its focus on shale resources at home. Over the last few years, the company has increased its exposure to the U.S. which was responsible for 22% of the company's production last year as opposed to 15% six years earlier. The company has also been saying that it is eyeing increase in production as it drills deeper in its oil and gas properties in West Texas, North Dakota and southern Oklahoma.

Exxon Mobil may have a number of companies on its watch list that have a high-quality asset base and a great management team. This includes Anadarko Petroleum (NYSE:APC), Apache Corp. (NYSE:APA), Continental Resources (NYSE:CLR), Devon Energy (NYSE:DVN), EOG Resources(NYSE:EOG) and Occidental Petroleum (NYSE:OXY). A recent article from Bloomberg has suggested that Exxon Mobil is looking to expand in Texas's Permian Basin. That makes sense because the company already has significant operations in the Permian Basin, including through XTO Energy which, until last year, operated nearly 20 rigs and had more than 3,000 employees in the region. Over the last few years, Exxon Mobil has made a number of acquisitions here and now controls drilling rights over more than 1.5 million acres. A Permian Basin acquisition could, therefore, lead towards meaningful synergies which will translate into lower combined CAPEX and costs.

The Permian Basin is one of the oldest and biggest oil producing regions of the U.S., home to dozens of different companies, such as Apache, Energen(NYSE:EGN), Occidental Petroleum and Concho Resources. But I believe Pioneer Natural Resources (NYSE:PXD), valued at $18.2 billion, is best positioned here. As I highlighted in the previous article, Pioneer Natural Resources is one of the rare exploration and production stocks that have both, a great balance sheet and a solid hedge book. The fact that this is the best positioned driller in the downturn is a testament to a well-run company. Overall, Pioneer Natural Resources owns more than 11 billion barrels of oil equivalent reserves, but what Exxon Mobil would be looking at is the company high return inventory in the core of the Permian Basin representing more than 20,000 drilling locations. That can easily last more than 40 years, even if Pioneer Natural Resources ramps up drilling activity. That's the kind of company Exxon Mobil should go after.