Summary of Facts
o George Keller of the Standard Oil Company of California (Socal) is trying to determine how much he wants to bid on Gulf Oil Corporation. Gulf will not consider bids below $70 per share even though their last closing price per share was valued at $43. o Between 1978 and 1982, Gulf doubled its exploration and development expenses to increase their oil reserves. In 1983, Gulf began reducing exploration expenditures considerably due to declining oil prices as Gulf management repurchased 30 million of their 195 million shares outstanding. o The Gulf Oil takeover was due to a recent takeover attempt by Boone Pickens, Jr. of Mesa Petroleum Company. He and a group of investors had spent $638 million and had obtained around 9% of all Gulf shares outstanding. Pickens engaged in a proxy fight for control of the company but Gulf executives fought Boone's takeover as he followed up with a partial tender offer at $65 per share. Gulf then decided to liquidate on its own terms and contacted several firms to participate in this sale. o The opportunity for improvement was Keller's principal attraction to Gulf and now he has to decide whether Gulf, if liquidated, is worth $70 per share and how much he will bid on the company. Problems
o What is Gulf Oil worth per share if the company is liquidated? o Who is Socal's competition and how are they a threat?
o What should Socal bid on Gulf Oil?
o What can be done to prevent Socal from operating Gulf Oil as a going concern? Competition
Major competitors for obtaining Gulf Oil include Mesa Oil, Kohlberg Kravis, ARCO, and, of course, Socal. Mesa Oil:
o Currently holds 13.2% of Gulf's stock at an average purchase price of $43. o Borrowed $300 million against Mesa securities, and made an offer of $65/share for 13.5 million shares, which would increase Mesa's holdings to 21.3%. o Under the re-incorporation, they would have to borrow an amount many times the value of Mesa's net worth to gain the majority needed to gain a seat on the board. o Mesa is unlikely to raise that much capital. Regardless, Boone Pickens and his investor group will make a substantial profit if they sell their current shares to the winner of the bidding. ARCO:
o Offer price is likely less than $75/share since a bid of $75 will send its debt proportion soaring, thus making it difficult to borrow anything more. o Socal's debt is only 14% (Exhibit 3) of total capital, and banks are willing to lend enough to make bids into the $90's possible. Kohlberg Kravis:
o Specializes in leveraged buyouts. Keller feels theirs is the bid to beat since the heart of their offer lies in the preservation of Gulf's name, assets and jobs. Gulf will essentially be a going concern until a longer-term solution can be found. Socal's offer will be based on how much Gulf's reserves are worth without further exploration. Gulf's other assets and liabilities will be absorbed into Socal's balance sheet. Gulf Oil's Weighted-Average Cost of Capital
o Gulf's WACC was determined to be 13.75% using the following assumptions: o CAPM used to calculate cost of equity using beta of 1.5, risk-free rate of 10% (1 year T-bond), market risk premium of 7% (Ibbotson Associates' data of arithmetic mean from 1926 - 1995). Cost of equity: 18.05%. o Market value of equity was determined by multiplying the number of shares outstanding by the 1982 share price of $30. This price was used because it is the un-inflated value before the price was driven up by the takeover attempts. Market value of equity: $4,959 million, weight: 68%. o Value of debt was determined by using the book value of long-term debt, $2,291. Weight: 32%. o Cost of debt: 13.5% (given)
o Tax rate: 67% calculated by net income before taxes divided by income tax expense. Valuation of Gulf Oil
Gulf's value is comprised of two components: the value of Gulf's oil reserves and the value of the firm as a going concern. o A projection was made going forward from 1983...