Harvard Business School 9-295-029 Rev. November 21, 1994
Research Associate Barbara D. Wall prepared this case under the supervision of Professors Timothy A. Luehrman and Peter Tufano as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 1994 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call (800) 545-7685 or write the Harvard Business School Publishing, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
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MW Petroleum Corporation (A)
In late 1990, executives, engineers, and financial advisors working for Amoco Corporation and Apache Corporation began serious discussions about the sale to Apache of MW Petroleum Corporation, a wholly-owned subsidiary of Amoco Production Company. Amoco had transferred to MW certain of its own assets that it regarded as non-strategic. MW’s size, location, and operations were all very attractive to Apache, which had grown nearly 30% per year since the mid-1980s, largely through acquisitions. The transaction being discussed with Amoco would be Apache’s largest to date. It would more than double the size of Apache’s current operations, as well as its reserves of oil and natural gas.
By the end of January 1991, Apache’s executives and advisors were sufficiently familiar with the properties in MW to begin refining their estimates of operating and financial performance in order to structure a formal offer. Apache’s chief financial officer, Mr. Wayne Murdy, knew that financing would be a challenge, given the size of the proposed transaction. In fact, the availability of external financing, bank debt in particular, was likely to impose some practical limits on both the amount and form of consideration that Apache could offer to Amoco. It was essential that Apache carefully evaluate MW, both the whole and its parts, and study the likely patterns of cash flows so that some creative financing alternatives could be developed.
Amoco Corporation
Amoco Corporation was an integrated petroleum and chemical company based in Chicago, Illinois. With $28 billion in operating revenues and $1.9 billion in net income in 1990, Amoco was the fifth largest oil company in the United States. Its three primary businesses were oil and gas exploration and production (Amoco Production Company), refining and marketing (Amoco Oil Company), and chemical production (Amoco Chemical Company). During the 1980s, Amoco had been an active acquiror of oil and gas properties, particularly the latter. Its 1988 purchase of Dome Petroleum of Canada made Amoco North America’s largest private holder of natural gas reserves and the second largest producer of natural gas. In 1990, Amoco produced 3.5 billion cubic feet per day (BCFd) of natural gas and 782 thousand barrels per day (MBd) of crude oil and natural gas liquids.
For the exclusive use of D. Schwenke, 2016.
This document is authorized for use only by David Schwenke in 2016.
295-029 MW Petroleum Corporation (A)
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As of December 31, 1990, the company had estimated proved developed reserves totaling 5.1 billion barrels on an oil-equivalent basis.
The 1980s had been a difficult decade for the oil industry, Amoco included. [Exhibit 1 summarizes historical financial data for Amoco during 1986-90.] From a high of over $37 per barrel in 1980, the price of oil on the spot market had fallen to just above $10/bbl in July 1986 and had recovered to only a little over $18/bbl by the end of the decade. Low prices depressed the profitability of oil companies, most of which responded with downsizing programs and other cost- cutting measures aimed at overhead expenses. Many major companies also sought to consolidate and rationalize their productive assets, which often meant divesting marginal properties. Since 1983, Amoco itself had sold more than $750 million worth of small properties which, it felt, could be more economically operated by smaller, low-overhead independent companies.
In 1988, Amoco conducted an extensive review of its cost structure and profitability. The study concluded that direct operating costs were well-controlled and offered little opportunity for major savings. However, it also showed that in the United States 85% of the company’s gross margin was provided by just 11% of its 1150 producing fields and that many of the remaining fields had disproportionately high overhead and repair expenses. Based on these and other findings, Amoco initiated a major restructuring to better focus on its most attractive properties and opportunities. The first step was the sale, in 1989, of more than 400 fields in the “tail” of the margin curve, comprising approximately one third of the field portfolio and 12% of leases. These properties were among Amoco’s least profitable, contributing only 3% of the company’s direct margin.
Next, in January 1990, as part of the overall restructuring of Amoco Production Company, Amoco’s board of directors approved a plan to divest up to $1.2 billion worth of additional properties from the middle section of the margin curve. Morgan Stanley was engaged to advise and assist in this process, which began with a review of different divestment alternatives. These included selling the properties in regional packages, spinning off a new public company, forming a joint venture, or retaining the properties until they were depleted but without making further material investment. Among these alternatives, a spin-off was judged most likely to produce the highest value for the properties. However, after further study it became clear that, for various reasons, a spin-off could take two or more years to accomplish, which reduced its attractiveness, not least because the future receptivity of the market was hard to forecast. Consequently, Amoco and Morgan Stanley decided to assemble the properties in a new, free-standing exploration and production entity called MW Petroleum Corporation. MW was to be a fully operational oil and gas company. In setting it up, Amoco faced myriad organizational, managerial, staffing, and other issues beyond the scope of this case. Ultimately, this turnkey operation was to be as large as many independent U.S. oil companies and could be marketed as such to non-U.S. bidders seeking to establish operations in the United States.
During the latter part of 1990, MW was shown to a number of targeted international petroleum concerns. For various reasons, all of these declined to bid. Toward the end of the year, U.S. buyers also were approached and Amoco considered offers from several different bidders. None of these offers was entirely satisfactory, however. One large independent oil company was interested in some, but not nearly all of MW; another oil and trading concern was interested in all of MW, but offered too low a price; and a venture capital group expressed interest, but Amoco doubted that it could obtain financing for its bid. The most promising expression of interest had come from Apache Corporation.
For the exclusive use of D. Schwenke, 2016.
This document is authorized for use only by David Schwenke in 2016.
MW Petroleum Corporation (A) 295-029
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Apache Corporation
Apache Corporation was an independent oil and gas company based in Denver, Colorado and engaged in exploration, development, and production of oil and natural gas, primarily in the United States. It had earnings of $40 million in 1990 on revenues of $270 million and a market capitalization of $850 million. Apache’s proven reserves totaled 106.1 million barrels on an oil- equivalent basis and were concentrated in the Gulf Coast region, in the Rocky Mountains, and in the Anadarko Basin of Oklahoma. Daily production in 1990 had been 259.1 million cubic feet (MMCF) of gas and 9.2 thousand barrels (MB) of oil. At these levels, on an oil-equivalent basis, Apache’s gas production exceeded its oil production by about 4-to-1. Historical financial data for Apache are summarized in Exhibit 2.
Apache had low costs and was considered an efficient operator of small- to medium-sized properties. To exploit these strengths, Apache chairman Raymond Plank developed a strategy he labeled “rationalize and reconfigure.” The strategy involved acquiring producing properties whose operations Apache could control and quickly make more efficient. In the 1980s, Apache’s tactics frequently entailed significant borrowing to finance the purchase of a portfolio of properties, the best of which would be retained and operated, while the remainder was sold to help pay down debt. A total of more than $1.4 billion in assets were acquired in this fashion in the 1980s, with the two largest purchases each exceeding $400 million.
The properties in MW held several attractions for Apache. First, MW was a large company that would more than double Apache’s reserves, and it was comprised mostly of properties well-suited to Apache’s operating capabilities. Further, Amoco itself, on behalf of MW, operated fields accounting for nearly 80% of MW’s production. This was considered a high operating percentage among U.S. producers and it promised Apache significant cost-saving opportunities (the remaining 20% of MW’s production consisted of interests in fields operated by other companies). Adding MW to its portfolio also would shift Apache’s oil-gas ratio from 20-80 to about 40-60. Such a shift was desirable because gas prices had been extremely volatile recently: during 1990 they had fallen nearly 50% from a four-year high at the beginning of the year. The resulting instability in Apache’s revenue stream made high leverage more dangerous and the company’s acquisition-driven growth strategy more difficult. Finally, MW’s properties would further diversify Apache geographically. This would add further stability, enhance the company’s standing among U.S. independents, and could lead to other future acquisition opportunities.
