Valuation and Merger Analysis

 Valuation approaches and tests

• Comparable companies or transactions
• Spreadsheet and formula approaches
• Test whether transaction makes sense
• Test whether premium paid is justified by
potential synergies
 Additional analysis
• Nature of industry
• Value drivers (historical and projected)
• Competitive and antitrust effects of merger
• Issues related to implementing the merger
Chapter 10-1
Merger Analysis:
 Oil industry experienced a merger wave in the
late 1990s
 Characteristics of the oil industry
• Oil is a global market
• Strategically important for industrial, political,
and military reasons
• OPEC has historically played a large role
• Large costs for environmental protection
• High degree of price instability – mergers can
be seen as a response to lower breakeven levels

Chapter 10-2
Merger Analysis:
 Reasons for the merger
• Stronger presence in promising oil regions
• Better position to invest in costly programs with
high risks and returns
• Complementary operations in South America,
Russia, Canada, Asia, Africa
• Synergies: predicted $2.8B, analysts estimated to
be $7B by 2002 (actual)
 Deal terms
• Mkt. value before: XON $175B, MOB $59B
• XON offer: 1.32 XON shares x $72 share price x
780 outstanding MOB shares = $74B (26%
premium over premerger mkt. cap.)
Chapter 10-3
Merger Analysis:
 Impact of the deal
• Premerger, Exxon shares represented
75% of combined market value
• Postmerger, Exxon shares represented
70% of combined market value
 Event analysis
• (-10,0): +14.8% Mobil, -0.5% Exxon
• (-10,+10): +20.6% Mobil, +3.1% Exxon
• Positive returns reflect market view that
the merger made economic sense
Chapter 10-4
Cost of Capital:
 Cost of equity: ke = rf + ERP(beta)
• rf = risk free rate (10 yr. treasuries) = 5.6%
• ERP = equity risk premium (historical market
return patterns) = 7%
• Beta = firm’s systematic risk = 0.85 (Exxon),
0.75 (Mobil)
• Exxon ke = 5.6 + 7(0.85) = 11.55%
• Mobil ke = 5.6 + 7(0.75) = 10.85%
 Cost of debt (before-tax)
• Exxon: AAA (160bp over treasuries) = 7.2%
• Mobil: AA (190bp over treasuries) = 7.5%

Chapter 10-5
 Cost of Capital:
 Capital structure
• Oil companies have usually had debt-to-total capital
ratios between 20 and 40%
• During acquisitions, ratios at upper end
• Plausible target ratio would be 30% (B/V)
 Weighted average cost of capital
• WACC = (S/V) ke + (B/V) kb (1–T)
• Cash tax rates estimated: 35% Exxon, 40% Mobil
• Exxon=(70%)(11.55%)+(30%)(7.2%)(1–35%)= 9.49%
• Mobil=(70%)(10.85%)+(30%)(7.5%)(1–40%)= 8.95%
• Combined firm should have a lower beta due to
reduced business risk – cost of equity = 11.2%
• WACC=(70%)(11.2%)+(30%)(7.2%)(1–38%)= 9.18%
Chapter 10-6
Valuation:
 Valuation considerations
• Historical patterns are only the foundation for
projections
• Projections are modified by business-economic
analysis of future prospects for the industry
• Revenue growth reflects the economics of the
industry
• Net operating margins depend on realization of
synergies and oil prices
• Individual value drivers may need adjustment

Chapter 10-7