MW Petroleum Corporation (A)
It had been a difficult decade for the oil industry in the 1980s. Low prices depressed the profitability of oil companies, so many companies 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. Amoco review its cost structure and profitability extensively. It concluded that direct operating costs were controlled and offered little opportunity for major savings. Based on these, Amoco restructured to better focus on its most attractive properties and opportunities. The first step was the sale of more than 400 fields in the end of the margin curve. These properties were Amoco's least profitable. Next step, as part of the overall restructuring of Amoco Production Company, Amoco's board of directors approved a plan to divest up additional properties from the middle section of the margin curve. Apache Corporation was an independent oil and gas company engaged in exploration, development, and production of oil and natural gas, primarily in the United States. It had low costs and was considered an efficient operator of small-sized 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. It is clear that MW properties are more valuable to Apache than to Amoco. MW Petroleum Corporation was judged most likely to produced high value for the properties. But it 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. In setting it up, Amoco faced myriad organizational, managerial, staffing, and other issues beyond the scope of this case. For Apache, the properties in MW held several attractions. First, MW was a large company that would more than double Apache's reserves, and it was comprised mostly of properties suited to Apache's operating capabilities. Further, Amoco itself, on behalf of MW, operated fields accounting for nearly 80% of MW's production. It promised Apache significant cost-saving opportunities. 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. 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. As to source of value, the transaction should satisfy Amoco's desire to sell MW at a good price. Also it should be profitable for Apache. This is the most plausibly account for the difference between buyer and seller. In the case, 13% interest rate mentioned on the Line notes used as equivalent discount rate. And that long-term treasury bonds offered yields between 8% and 8.25%. But the yield of B-rated debt had dropped more than 150 basis points in two month excluded the turmoil in the Middle East. In the last part of the case, it reveals that Apache’s debt could be perceived as B-rated debt. In our point of view, we use the average number of 8% and 8.25% minus 1.5% to get the interest rate. The interest rate is equal to 6.63%. Then we...
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