Conoco acquisition fails to impress

published 21 December 2005

News of ConocoPhillips' $36bn acquisition of Burlington Resources has met with a chorus of dismay from investors and analysts alike.

Conoco's chief, Jim Mulva, is squandering his oil wealth like a Saudi oil Sheik, say Rob Cox and Alex Fak on Breakingviews.com. Conoco is paying $18 per barrel of oil equivalent (BoE) for Burlington's stated reserves. That's more than twice what Occidental paid for Vintage's reserves and much more than Chevron paid for Unocal's. Moreover, it's almost three times the valuation investors put on Conoco's own reserves. "The oil company would have done better to have bought back its stock." Mark Flannery of CSFB agrees, pointing out in a note that "Burlington brings greater size to Conoco at an unacceptable cost". The cost to shareholders has already been significant: Conoco's share price fell 10% after the announcement.

Conoco is paying $92 a share in cash and stock, which represents a 21% premium to where Burlington was trading before the takeover approach was announced. That price cannot be justified, say Cox and Fak. Even if you take into account the possible $375m in cost savings that Conoco ought to be able to achieve from combining the two companies' operations, it is still too much by about £3.5bn an amount that "represents value destroyed for Conoco shareholders". It's no wonder the market has reacted badly.

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This is not to say that there is no strategic sense to the deal. As Cox and Fak point out, Conoco's recent deal with Lukoil had left it rather over-exposed to the Russian market and this deal does hedge that to a degree. Taking on Burlington also bumps up Conoco's reserves,which "will extend the business life of the company". The deal will also turn Conoco into the largest natural gas producer in North America and Mr Mulva is absolutely adamant that the takeover is a good investment, telling the FT that it is a "compelling opportunity" that would still make sense even if the price of natural gas were to fall from its current level of $18 dollars per million British thermal units right back down to $5.

This isn't good enough, say Cox and Fak. Back in November, Mulva hinted that he wasn't planning any deals. But now he's gone ahead and made one anyway and at very much the wrong price. He may think he is building an empire, and maybe he is, but along the way he is also destroying vast amounts of value.