The Case for an Exxon-Chevron Merger

A strange thing happened last Wednesday: Chevron’s market cap briefly exceeded Exxon’s cap, at $142 billion versus $141.6 billion. It was particularly remarkable given that Exxon’s market cap was just under $300 billion at the start of the year.

Now, one analyst thinks it is time for drastic action. Paul Sankey of Sankey Research argued in a note last week that Chevron (ticker: CVX) and Exxon Mobil (XOM) should merge, creating an even more mega mega-major oil company that would be more efficient and resilient during the downturn. And even though Exxon is the most famous name in oil, at least in North America, he thinks the combined company should be called Chevron.

Sankey’s rationale is that a merger would allow the companies to cut costs, reduce capital expenses, and—particularly for Exxon—re-establish a new dividend level so that investors aren’t constantly worrying about it. Exxon has been dealing with constant speculation this year about whether it will have to cut its dividend, because the company has not been able to pay it with free cash flow. Its stock now yields more than 10%.

The new company would have a market cap of about $300 billion and debt of about $100 billion, Sankey projects. Together the two companies make about $50 billion annually in operating cash flow, with $50 billion in capital expenses and dividends that cost $24 billion annually.

A merger would allow them to rebalance that equation. They could quickly become more efficient, cutting administrative expenses ($11 billion for Exxon and $4 billion for Chevron) and reducing capital expenditures by about $10 billion.

The combined company would also have substantial balance sheet flexibility, Sankey argues.

“The combined company’s debt capacity is enormous in the current environment, with Chevron having recently issued debt at an all-time corporate low rate; coupons of under 2.5%,” he writes. “This is also an enormous financial arbitrage as regards both companies but particularly Exxon. They can borrow money at under 2.5% but have a 10%+ dividend yield at Exxon. Obviously, one alternative strategy would be for a massive debt issuance and buyback at Exxon, that could say, double debt, take $30 billion into buyback, and essentially reduce scale by one-third, notably reduce the dividend burden by $2 billion to $3 billion per year.”

Sankey also thinks Exxon needs a rebrand because of what he calls “terrible brand perception as environmental enemy No. 1.” The new company would be rebranded as Chevron and one of its first moves could be to announce “sweeping carbon reduction targets in the context of a new acceptance of climate change,” Sankey argues.

Talk of what would be one of the biggest deals in history comes amid a few recent energy industry combinations. Chevron announced in July that it was acquiring Noble Energy for $5 billion in stock and the assumption of about $8 billion in debt, while Devon Energy (DVN) and WPX Energy (WPX) said late last month that they would merge in a $2.6 billion all-stock deal.

But Sankey acknowledges that there may not be much momentum for an Exxon-Chevron deal now, given that the recovery in oil demand is probably not coming soon: “The outlook remains terrible in oil.”

Other factors also make this very unlikely. It would be no small thing to erase the Exxon name and the decades of history and branding behind it. And the size of Exxon’s dividend may be questionable right now, but few would question its basic financial health, given that the company can still borrow at extremely low rates.

And Exxon has had a very different corporate strategy than Chevron. Although they have cut capital expenditures this year, Exxon’s management and board are convinced that the company needs to increase oil production in the years ahead as demand recovers, and it is spending much more heavily than peers to find new resources. For instance, Exxon is teaming up on a project off the coast of Guyana that could produce more than 10 billion barrels of oil over the next decade. The company is unlikely to abandon this strategy in the near term.

A deal like this could also raise regulatory questions about monopoly power.

Asked for comment on Sankey’s idea, an Exxon spokesman wrote “We do not comment on rumors and speculation.” Chevron did not respond to a request for comment.

Source: Barron’s/Avi Salzman at avi.salzman@barrons.com

 

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