Stayin' Alive - Oxy's Prospects Hinge On Oil Prices, Cash Flow As Debt Repayment LoomsPLAY T

With Broadway theaters shuttered and Hollywood studios on lockdown, one of the most compelling long-term American dramas is the ongoing saga of U.S. E&P Occidental Petroleum (Oxy). Act One was a compelling David-vs.-Goliath story as Oxy battled oil major Chevron in early 2019 to acquire Anadarko Petroleum and its prime Permian acreage. Among the most fascinating elements was the supporting cast, which featured business legend Warren Buffett, who contributed a critical $10 billion to push Oxy’s deal over the top, versus billionaire investor and corporate raider Carl Icahn, who led an unsuccessful struggle to stop what he called “the worst deal I’ve ever seen.” Oxy snagged Anadarko with a winning bid of $57 billion, the fourth-highest total for an oil and gas transaction and a 20% premium to Chevron’s offer, and predicted strong future production, dividend, and cash flow growth. But those optimistic projections have been upended in the ongoing Act Two, as plunging oil demand and prices from the COVID-19 pandemic have stymied planned asset sales and ravaged cash flows. Oxy has responded by reining in spending, revamping operations, refocusing divestment plans, and restructuring debt. But is it enough? Today, we analyze the company’s current strategies and financial maneuvering, as well as the near-term outlook, under a range of oil price scenarios.

Although almost all U.S. E&Ps have been rocked by the oil market crisis to some degree, Oxy faces an especially difficult challenge because of the massive debt it assumed in its purchase of Anadarko, which includes $11.1 billion due in 2021-22. Before we get to the implications of that debt and Oxy’s plans for navigating it, let’s quickly review the details of Oxy’s blockbuster acquisition of Anadarko.

On April 12, 2019, Chevron announced it had reached an agreement to acquire Anadarko for $65/share or, more precisely, $16.25/share in cash and $38.75/share in stock, plus the assumption of debt. Oxy, which said it had made several private offers to acquire Anadarko in 2018 and 2019, countered on April 24, 2019, with a bid of $76/share, including $38/share in cash, more than twice the cash Chevron was offering and a total 20% premium above Chevron’s bid. On April 30, Oxy boosted the credibility of its offer by announcing that Warren Buffett had agreed to contribute $10 billion of the $19 billion cash offer in exchange for Oxy preferred shares paying an 8% annual dividend. On May 9, Chevron declined to exercise its option to submit a revised bid, and the Anadarko board accepted Oxy’s offer, despite having to pay a $1 billion, or $2/share, deal-termination fee to Chevron.

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In a move that infuriated many of Oxy’s equity holders, including Carl Icahn, the company was able to avoid a shareholder vote on the transaction because of the high cash portion of its offer. In the deal, Oxy doubled its production from 700 Mb/d to 1.4 MMb/d, including a 24% increase in its Permian output. It said it had identified $3.5 billion in pre-tax annual capital, operating, and general and administrative (G&A) synergies that would contribute to 15% and 25% increases in free cash flow in 2020 and 2021, respectively. Oxy also targeted between $10 billion and $15 billion in asset sales — including a tentative $8.8 billion sale of Anadarko’s Africa assets to Total — to rapidly reduce the leverage, which totaled $47.6 billion at deal close. Despite the increased leverage, Oxy expected to accelerate dividend growth and retain its investment-grade credit rating.

Oxy’s optimistic debt reduction scenario began to erode with falling oil prices in late 2019 and early 2020. Although Total did acquire Anadarko’s Mozambique LNG project for $4.2 billion, the Algerian government blocked the sale of Anadarko’s holdings there, and Total backed out of the purchase of the offshore Ghana assets. Negative investor sentiment going into 2020 sent E&P share prices tumbling, which stalled efforts to sell other assets. Oxy’s stock plunged an especially steep 80% from mid-February to early March on investor concerns about high debt and growing fears about COVID-19’s potential economic and energy-sector effects. Also, the price of the company’s bonds fell sharply after its credit rating was downgraded from investment grade to junk because of its high debt.

Oxy responded with a series of announcements, beginning with a March 10 announcement of a dividend reduction, from $0.79/share in the first quarter to $0.11/share in the second quarter, and a 32% reduction in planned 2020 capital expenditures to between $3.5 billion and $3.7 billion, down from the original $5.4 billion to $5.6 billion range. Two weeks later, as the full impact of the pandemic became apparent, Oxy further reduced its 2020 capex to the $2.7 billion to $2.9 billion range and unveiled a plan to reduce operating and corporate costs by at least $600 million, which included significant salary reductions for top executives. Concurrently, the company reached a settlement with dissident investors led by Icahn, who had been conducting a long-term campaign to replace Oxy’s board of directors. Icahn’s group was given three seats, replacing three current board members, and a former Oxy CEO, Stephen Chazen, took a fourth seat from a current member and was named chairman of the board.

In its first-quarter 2020 earnings announcement in early May, Oxy reported net debt of $36.5 billion, up from $8.6 billion in the year-ago quarter and $35.5 billion at year-end 2019 after the Anadarko deal had closed. Of that total, $11.1 billion matures in 2021-22 (Figure 1). In addition, holders of Oxy notes maturing in 2036 have the option to redeem the notes for $992 million in cash in October 2020. The company also announced in early May that its cash reserves fell to $1 billion at April 30, 2020, from $2 billion at March 31. Oxy again reduced its capital budget, this time to between $2.4 billion and $2.6 billion, or 50% of the original guidance, and pivoted its strategy from 5% production growth to merely mitigating its 25% base production decline rate. The company doubled its operating and corporate cost reduction target from $600 million to $1.2 billion and announced it would pay the quarterly dividend on Buffett’s preferred shares by issuing 17.27 million new shares of stock instead of cash. Finally, Oxy cut the quarterly dividend payable at the end of the second quarter again, from $0.11/share to a token $0.01/share.

Figure 1. Occidental Petroleum Debt Maturities. Source: Oil & Gas Financial Analytics, LLC

On June 25, Oxy took its first steps to refinance its near-term debt, announcing a tender offer for $1.5 billion in a series of senior notes with maturity dates ranging from February 2021 to August 2022. It upped the offer to $2 billion four days later. The company is financing the tender offer through $2 billion in new senior notes, with $500 million of that maturing in 2025, $500 million in 2027, and $1 billion in 2030. However, because Oxy’s credit rating had been downgraded to junk, the interest rates on the new notes range from 8% to 8.7%, far above the 2.7% to 4.1% range of the notes they will replace. Although the results of the tender offer will not be released until July 23, the exchange will add approximately $90 million to $100 million in higher annual interest payments. Concurrently with the tender offer, Oxy announced that it would issue warrants to all common shareholders granting the right to purchase one-eighth of an additional Oxy share for every current share owned at a strike price of $20.00/share, not far above the stock’s $16.28/share closing price on Friday, at any time over the next seven years.

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The refinancing leaves Oxy with $9.1 billion in debt maturing in 2021-22, in addition to a possible $992 million in October 2020, should holders of its 2036 senior notes exercise their option to redeem them. On the plus side, the company has $1 billion in cash and expects $2 billion in divestiture proceeds in 2020 — as much as $700 million from the sale of its 7 million acres of land grant mineral/royalty rights in Wyoming and Colorado and the remainder from unspecified other assets. The drastic cut in the common share dividend and payment of the preferred dividend in shares results in annual savings of $3.6 billion from the second quarter of 2020 forward. The recent refinancing also shows that debt markets remain open to the company, albeit at much higher rates that will boost annual interest expenses above the current $1.4 billion. Should the share price rise significantly above the $20 strike price of the recently issued warrants, the company could begin to reap some of the benefit of a potential $2.2 billion in proceeds from shareholders exercising those rights.

However, the long-term key to significant reduction of the still massive $36.5 billion in net debt is steady free cash flow generation. And this, in turn, is dependent on oil prices. Based on Oxy’s first-quarter results, 2020 guidance, and commodity prices, we estimate that the company will report a negative $200 million in operating cash flow for the second quarter of 2020 and a negative $700 million free cash flow after its estimated $500 million in capital expenditures. (The quarterly results are scheduled to be released on August 10.) An analysis of the company’s cost structure indicates a breakeven operating cash flow oil price slightly above $30/bbl and free cash flow generation beginning at a price between $35/bbl and $40/bbl at the expected 2020 capital spending levels. An increase in oil prices above that range would fund meaningful debt reduction as well as reawaken the current moribund mergers and acquisitions (M&A) market, allowing Oxy to pursue more substantial divestments. The company, which has guided to a 3% production decline in the second quarter, could also resume net production growth to further grow cash flows. On the other hand, oil prices under $40/bbl over the next two years would leave Oxy still struggling to repay its higher debt as restricted investment continues to erode production.

Like many other producers, Oxy expects to report substantial non-cash impairments in the second quarter — in this case, $6 billion to $9 billion. But recent higher oil prices have also rekindled some optimism in the E&P sector. The company expects to issue more detailed guidance for the second half of 2020 in its upcoming earnings report, and is also likely to unveil additional debt-reduction initiatives.

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"Stayin' Alive was written by Barry, Robin, and Maurice Gibb, and appears as the first song on side one of the soundtrack album, Saturday Night Fever, featuring the Bee Gees. Recorded at Château d'Hérouville in Hérouville, France, and Criteria Studios in Miami, the song was produced by the Bee Gees, with Albhy Galuten and Karl Richardson. Released as a single in December 1977, it went to #1 on the Billboard Hot 100 Singles chart. It has been certified 3x Platinum by the Recording Industry Association of America (RIAA). Personnel on the record were: Barry Gibb (lead, harmony vocals, rhythm guitar), Robin Gibb (harmony vocals), Maurice Gibb (harmony vocals, bass), Alan Kendall (lead guitar), Dennis Bryon (drum loops), Blue Weaver (keyboards, synthesizer), and Joe Lala (percussion). 

Saturday Night Fever is the soundtrack album from the hit 1977 movie of the same title, starring John Travolta and featuring music from the Bee Gees. It is the second best-selling soundtrack album of all time, with over 45 million copies sold worldwide (as a double-disc album). Recorded between 1975 and 1977 and released in November 1977, the LP went to #1 on the Billboard Top 200 Albums chart, where it stayed for 24 straight weeks. It has been certified 16x Platinum by the RIAA. Six singles were released from the album.

The Bee Gees were a pop music group formed in Australia in 1958. Consisting of brothers Barry, Robin, and Maurice Gibb, the group started out in the rock era of the mid ‘60s, then later migrated to the disco era of the late ‘70s. They released 22 studio albums, two live albums, four soundtrack albums, 15 compilation albums, and 83 singles. They have sold over 120 million records worldwide. They have won seven Grammy Awards, three American Music Awards, and one Brit Award. The Bee Gees are members of the Grammy Hall of Fame (with a Lifetime Achievement Award) and the Rock and Roll Hall of Fame. Maurice Gibb died in 2003 and Robin Gibb in 2012. Barry Gibb continues to record and occasionally tour as a solo artist.