It seems that the huge game-changing deal between Exxon Mobil Corp. (NYSE: XOM) and XTO Energy Inc. (NYSE: XTO) may have more than just one risk associated with it.  The acquisition, announced on Monday, is a $31 billion all-stock transaction ($41 billion after debt assumption) for 0.7098 common shares of Exxon Mobil per share of XTO.  While both boards of directors have approved the deal, it seems as though there are almost certainly cracks which may be in the road ahead of this merger.

How this merger plays itself out could have substantial impacts on Chevron Corporation (NYSE: CVX), BP Plc (NYSE: BP) and Royal Dutch Shell (NYSE: RDS-A) in the oil patch.  It has broad implications on other natural gas players as well if you look at Chesapeake Energy Corporation (NYSE: CHK) stock.  Its shares rose about 6% on Monday after the deal was announced, and if shares hold the gains today they will have risen for three more consecutive days after that 6% gain.  It would not even be fair to show some of the smaller speculative stocks that gained since Monday.  We have tried to lay out the alternative risks here which could come up against this merger other than just the obvious risks of shareholders merely wanting more or the basic regulatory risks.

There are probably many shareholder who want more for the company than the premium Exxon Mobil is offering.  The $49.00 (or $51) buyout price compared to what is now a $28.64 to $49.10 trading range of the last 52-week period.  One problem may be that the stock traded in the $60’s and $70’s back in 2008 during the energy bubble, and the natural gas bulls will be able to argue indefinitely that the spread between natural gas and oil cannot endure perpetually.  This price does not even make (or barely makes) the investors whole who purchased shares after the first big sell-off in summer of 2008.

Thomson Reuters lists the average price targets from analysts as over $54 as a mean target and $52 as a median target.  That alone won’t give holders wanting more any shot of forcing a higher price, but these average price targets are often referred to later on down the road.  The argument can simply b made that analysts believe the company was worth more than the merger price even before the merger was announced.

Another issue to consider is whether XTO holders even want to be Exxon Mobil shareholders.  With a market cap of $326 billion today, some feel that the law of large numbers in mage-cap stocks over $100 billion in value acts as a drag because it takes too much money in supply and demand of shares to push the needle higher.  At $68.75 today, Exxon Mobil’s 52-week trading range is $61.86 to $83.24 and this stock ran into trouble at every point above $90.00 even when oil was well north of $100.00 per barrel.  Admittedly, this issue alone is not enough to block a transaction on the surface.

Exxon Mobil shareholders probably have very little say on this deal as most companies are able to do the deals as they please.  But Exxon Mobil shares did take a 4.3% hit on the day this was announced.  A further vote against the prices might be that Exxon Mobil shares slid on Tuesday and Wednesday.  If today’s 0.4% gain to $68.75 holds, then it will break that losing streak but will still represent a loss of 5.6%.  If that negative share performance continues, then holders might start to get a better argument against the deal in both companies.

A piece from the Deal Journal at WSJ.com yesterday also noted that the all-stock buyout of this sort in companies with high P/E ratios is among the least successful type of deals.  That alone won’t offer an exit or a reason to block the deal, but it gives ambitious suit-blocking holders another leg to stand on.

Another issue which has come up after the fact and that is part of the merger exit language is whether or not Congress passes an “anti-fracking law”… This would make hydraulic fracturing (fracking) taking gas from shale either illegal or would make it an economic impossibility.

The Shareholders Foundation, Inc. announced in a press release today that a lawsuit was filed in Tarrant County District Court on behalf of XTO Energy investors who purchased shares before December 14, 2009 over breach of fiduciary duty by the board of directors of XTO Energy Inc.  Part of the allegations are that management and directors agreed to sell the company through an unfair process and that XTO Energy is worth more due to “likely future global warming regulations” that could curtail carbon emissions.

It seems that other class action suits and “investigation into sale terms” announcements have already been made.  While these class action suits rarely generate outright wins for holders, these sometimes can prevail clearly for holders.

The big wild card comes from Washington D.C.  This has implications in the Federal Trade Commission and possibly in the Department of Justice, and frankly it would seem that there could be a host of energy-specific regulatory bodies and issues at the state and local levels of government that either would want conditions or want concessions in a deal of this size.  Everyone knew that the merger rubber-stamps ran like clockwork under the Bush administration, but how the Obama administration handles large corporate mergers is still an unknown.  Add in the political issue of policing “energy bandits” by the left , and the ‘potentiality’ may be more of a risk than just a possibility.

This next issue is probably a part-two under the regulatory front, but Zacks.com issued a note this week stating its belief that the Exxon-XTO deal “will definitely prompt its peers” to move forward with similar deals.  Those were listed as Chevron Corporation (NYSE: CVX), BP Plc (NYSE: BP) and Royal Dutch Shell (NYSE: RDS-A).  If this occurs, you have to wonder if all of the regulatory bodies want this much of the oil and natural gas supply tied up in even tighter hands.  You can likely find studies which claim that fewer participants in energy lead to lower prices as you can those which claim that the big mergers allowed in the 1990’s and 2000’s led to higher prices.

A part-three on the regulatory front might be a stretch, but still worth consideration.  Equipment and services providers will possibly find themselves in a boom or bust scenario if there is a wave of mergers between giant oil players and giant natural gas players.  Sure, there are already large oil and gas players.  The question is how large these companies can be and what they can do to squeeze the suppliers.  Those suppliers might not find much sympathy from politicians nor from the public, but in theory suppliers and business partners can ultimately claim that larger and larger clients can begin to change their business models in an unfair manner.

The way to tell how the day-to-day swings either for or against this merger will go is in the arbitrage spread of the deal.  This morning there was only about a 3.5% spread between the shares.  Those betting on the deal by being long XTO and short Exxon Mobil will clean up as far as ‘annualized returns’ if this can close in a timely fashion without and delays or moves to block the deal.  But those making the same bet may find themselves in pain if any of these risks or concerns become probabilities rather than possibilities.

So far we have only laid out the risks.  There is of course the flip-side of this stance as far as the benefits and the alternatives that can be found.  To appease holders, Exxon Mobil can always take out its checkbook and offer more money.  It could change the deal and offer holders the all-stock terms in a cash and stock or even an all-cash offer.  On the regulatory front, you’d think the companies both at least indirectly got someone to inquire with regulatory bodies (as usually occurs).  There is also an argument that can be made that this secures more domestic energy in the hands of a US-based player in the quest for energy independence.

It will be interesting to see how this merger pans out.  More importantly, it will be interesting to see how this merger impacts the merger desires of other larger and smaller players in the oil and gas sector.

JON C. OGG
DECEMBER 17, 2009

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