Conoco and Phillips Merge to Form The Third-Largest U.S. Oil Company

Echoing their competitors’ “bulk is better” strategy, Phillips Petroleum Co. and Conoco Inc. agreed in November to merge in an all-stock deal valued at $15 billion. The transaction, presented as a merger of equals, will create a new company to be called ConocoPhillips. The board will be evenly divided but Phillips shareholders come out slightly more than equal with nearly 57% of the company. The headquarters of the new entity will be in Houston, where Conoco’s headquarters are. “ConocoPhillips will move forward to deliver on our legacy growth projects, develop new opportunities in existing and emerging business lines, and enhance returns in our downstream business with our companies’ leading technologies,” said Phillips CEO James J. Mulva. The new management structure will feature Mulva as president and CEO while Conoco CEO Archie W. Dunham will delay his retirement until 2004 and serve as chairman of the newly combined company. The two men will head up a company that will be the sixth-largest oil and natural gas company in the world, based on reserves and production, and the third-largest U.S. oil company. Reaction to the deal has largely been favorable. “This deal is a win-win situation because in the oil industry, size matters. The savings this will produce are important, and it should help both companies make money off their upstream projects. It will also help them downstream in refining and marketing,” says James L. Van Allen, an oil industry analyst at Janney Montgomery Scott. The companies said the deal will add to per-share earnings and cash flow within a year of closing, which is slated to occur in the second half of 2002. They project annual savings of $750 million based on more efficient management of upstream operations and the elimination of redundant administrative and corporate jobs. Past deals laid the foundation for ConocoPhillips The $750 million in savings will help Conoco reduce the heavy debt load it incurred in its $4.3 billion purchase of Gulf Canada Resources Ltd. earlier in 2001. Phillips, under Mulva’s direction, has also been acquisitive. In 2000, Phillips paid $7 billion for Atlantic Richfield Co.’s Alaskan production division when it was divested as part of Atlantic Richfield’s acquisition by British Petroleum PLC. A second deal, the $9 billion acquisition of the leading independent refiner, Tosco Corp., pushed Phillips into a second-place ranking among U.S. refiners. With the combination of Conoco and Phillips, the new company passes former No.1 ExxonMobil Corp. as the largest U.S. refiner. It also makes ConocoPhillips the fifth-largest refiner in the world. While observers see little overlap between Conoco and Phillips, and expect this to auger well for the deal’s reception by regulators, the only area of potential concern is the company’s clout in refining. “The FTC will probably make them sell a number of gas stations in markets where they have more than a 25% market share, but this will largely be a pro forma gesture,” notes Fadel Gheit, an industry analyst at Fahnestock & Co. He estimates that regulators would slice off only a few hundred of ConocoPhillips’ 17,000 filing stations in the U.S. The synergies that management expects to exploit in the deal in-clude a number of exploration projects in Asia, Venezuela, and the Gulf of Mexico that both companies have. Conoco will contribute its North Sea assets as well as its strong position in natural gas development in the U.S. to the asset mix. Also complementary are Phillips’ Alaskan production assets – picked up in the Atlantic Richfield deal – and some of Conoco’s foreign exploration projects, which will potentially contribute to earnings for some years in the future. Gheit also downplays the likelihood of cultural problems popping up to mar the integration of the two companies. He says that it is worth remembering that the oil business is, in some ways, less competitive than other industries. “Oil companies compete, but it’s not the same direct competition you see elsewhere. It’s more like going fishing. If times are good, if oil prices are high, everyone profits. The players don’t take significant market share away from each other.” He adds that this structural characteristic as well as both companies’ deep roots in the same region – Concoo is based in Houston and Phillips in Bartlesville, Okla. – should work to prevent the cultural problems that sometimes slow integration during mergers. The Fahnestock analyst says that Phillips CEO Mulva’s blueprint, which he applied to the Concoco acquisition, could be used for other acquisitions as well. “Phillips could become the new force in the consolidation of the oil industry. Jim Mulva has started an innovative trend by buying Conoco at no premium. There’s no reason to think he couldn’t do other deals on that basis,” he remarks. Actually, the lack of a premium in the Conoco/Phillips merger has raised the hackles of some Conoco shareholders. One such holder, Michael Iorio, has alleged in a lawsuit filed in November in Delaware Court of Chancery that the merger benefits Conoco management at the expense of shareholders. The merger transaction was valued at $24.24 per share, a slight discount to Concoco’s closing price of $24.30 on November 18, the day the deal was announced. But Gheit says that the deal will increase the market value of the companies and enhance shareholder value in that way. In fact, the stock of both companies has continued to rise since the announcement of the deal. “The stock price of the new company should go up by 25% to 30% as the two companies start to work in tandem,” he notes. And if the first element in the Mulva formula for dealmaking is to buy companies without paying a premium, another foundation for this style of dealmaking is that the acquisition be done using the acquirer’s stock. Gheit points out that by buying Concoco with Phillips’ stock, Mulva is able to avoid the debt burden that Concoco had to shoulder as a result of its cash acquisition of Gulf Canada. “Assuming that the integration of Tosco, and now, Concoco, doesn’t pose any unexpected challenges, Mulva will be in a position to approach other potential partners,” he says. Deals by Conoco/Phillips may attract less scrutiny Another element in Gheit’s theory about Phillips as the oil patch’s newest frequent dealmaker is that because the company has a smaller asset base, even when combined with Concoco, than its mega-competitors and because the two companies have less overlap in their operations than there has been in other recent industry deals, ConcocoPhillips will attract less regulatory scrutiny than its competitors if it does try to buy more companies. Gheit also sees a strong incentive for Mulva to continue buying. “He has no choice but to continue to grow. Even though he has tripled the size of Phillips, it is dwarfed by its super-major competitors.” With a market cap of $35 billion, PhillipsConoco is considerably smaller than rivals Exxon Mobil, which has a market cap of $255 billion, and Chevron Texaco Corp., which weighs in at $93 billion. Potential targets mentioned by Gheit for ConocoPhillips include Unocal Corp., Burlington Resources Inc., and Anadarko Petroleum Corp. He says that Mulva can now argue that based on his successes in his previous acquisitions, he will be able to take his next target along with him to the major leagues of the industry.