Matt Badiali has spent more than two decades as a top geologist, operating primarily in the petroleum sector. During his Ph.D. work, Badiali had the opportunity to work with some of the highest-level personnel in the North American petroleum industry, not just on the exploration-and-production side but also in the C-suites of some of the biggest oil producers in the country.
One of those companies was an exploration firm called Anadarko. Badiali got an insider’s look at Anadarko’s operations, working hand in hand with the company’s chief geologist and helping to develop new exploration methods, some of which would prove to be major breakthroughs in the era of shale extraction.
While at Anadarko, Badiali was deeply impressed with the corporate culture, level of expertise and general infrastructure of the firm. He was baffled by the relatively low market capitalization that the company had long been assigned by investors; with so much going for it, Anadarko was trading at just a smidgen above book value. It seemed to be a company that just wasn’t on investors’ radar scopes.
Matt Badiali immediately recognized that Anadarko would make a prime acquisition target for any one of North America’s oil-industry players. That was in 1998. It eventually turned out that he was exactly right. But his timing was off by more than 20 years!
Badiali says the Chevron bid for Anadarko is much savvier than analysts are leading on
In early April, Chevron signed a purchase agreement for the full acquisition of Anadarko and all its assets and subsidiaries. At the time, it looked like a done deal. Many headlines ran about the sale being effectively completed. However, to the shock of Wall Street and the petroleum industry, the deal was snatched from Chevron’s jaws at the last minute when Occidental Petroleum, a major Permian Basin producer, offered a huge $5 billion premium over the Chevron bid.
Ultimately, Anadarko broke the purchase agreement it had signed with Chevron, prompting an automatic $1 billion payment to the latter company — not a bad payday for two weeks’ worth of work.
Despite this high-finance hijinks, Matt Badiali’s cogent analysis from April of Chevron’s motivations for the purchase of Anadarko are now more relevant than ever for those who wish to understand why this dynamic firm has become such a high-valued prize.
With backing from none other than Warren Buffet, the purchase price that Occidental has offered of $38 billion, not including debt, has struck much of Wall Street as being a severe overpay for a company whose main attraction is its Permian Basin holdings. But Matt Badiali says that the Permian Basin angle is only a small part of the overall Anadarko story, a saga that tells of one of the best-run and most-diversified oil and gas exploration companies currently operating in North America.
To understand why Anadarko was undervalued, you must go beyond the Permian Basin
Badiali points out that the hot story, indeed the only story, about the U.S. oil sector over the last 10 years has revolved around shale deposits that are primarily extracted through hydraulic fracturing. And as the Bakken Shale is depleted of its easily fracked resources, the media has turned its attention to the Permian Basin, which contains that largest proven oil reserves in North America. Many experts are touting the Permian Basin’s good chances of becoming the single most productive oil field in the world over the next few decades.
But Matt Badiali says that, while there is a significant chance that the Permian Basin could take off over the next few years, the real attraction to Anadarko lies elsewhere. Specifically, Badiali says that 69 percent of the company’s operations are focused on globally diversified and highly lucrative sectors. These include oil assets in the Gulf of Mexico as well as a liquefied natural gas operation in Mozambique. The latter could prove to be every bit as important as Anadarko’s Permian assets as liquefied natural gas technologies continue to make that energy source a highly attractive option for developing nations that do not have access to advanced power generation or grid infrastructure.
And, as Badiali notes, these highly profitable operations have been reflected on Anadarko’s balance sheet. In 2018, the company could buy back $3.5 billion in stock while simultaneously reducing its debt significantly. And it did all this amid a 500 percent increase in dividends.
Yet, the firm’s stock price was punished right alongside its other oil-sector peers, with a 20 percent loss in market capitalization throughout 2018. Even so, Anadarko’s price did not rebound along with the rest of the oil sector in 2019. Badiali says that this was mystifying, given that current oil prices point to a high likelihood that the company will generate more than $6 billion in cash flow in 2019.
Badiali says that, if his estimate is correct, that would mean that Chevron’s bid represented just five times cash flow. When compared to some other acquisitions that have occurred throughout the oil sector in recent years, the Chevron bid looks like a stroke of financial genius. Badiali points to the BHP Billiton’s shale-asset buying spree, which ended in a $10 billion trail of tears, forcing the company to write off much of the bust-out shale leases it hastily acquired. Badiali says that, throughout the last few years, companies from Shell to the BG Group have been regularly gorging on shale oil leases for at least twice what historical valuations would indicate is reasonable.
The Anadarko bid was about synergies
Ultimately, says Badiali, the Chevron bid for Anadarko was about creating synergies: larger economies of scale, lower operational costs and the insourcing of several services. In fact, Badiali has calculated that the acquisition could have allowed Chevron to have realized up to $2 billion in immediate savings related to its operations and capital structure. It is likely that similar considerations were in play for Occidental.
Warren Buffet’s involvement strongly supports Badiali’s thesis
Although the Chevron offer of $33 billion for Anadarko was already a considerable premium over its total market value, the Occidental deal that ultimately prevailed was a full 14 percent above that. And this doesn’t even include the $1 billion penalty that is due to Chevron.
An outside observer might conclude that such a huge premium on top of a bid that already represented a huge markup from the firm’s market price is likely to be another case, so often seen throughout the petroleum industry in recent years, of a significant overpayment on a questionable deal. But Occidental was backed in its acquisition by none other than Warren Buffet, a man who lives by the creed of only investing in companies where a significant margin of error exists.
Although Buffet didn’t directly invest in the deal, he did provide a $10 billion financing package that allowed Occidental to move forward. But the fact that one of the keenest investors in history saw a much larger bid than Chevron’s as still representing great value goes a long way towards independently supporting Badiali’s thesis as being valid.
Read more of Badiali’s takes on oil and gas at Banyan Hill Publishing
Matt Badiali is an oil-and-gas investment veteran who writes regularly for Banyan Hill Publishing, a company that focuses on disseminating high-quality investment advice through its roster of industry-specific experts.