Wednesday, July 20, 2005

Unocal/CNOOC/Chevron Q&A

Today Unocal’s board moved in an apparent willingness to accept Chevron’s cash and stock bid over a higher all-cash one from CNOOC. Here are my thoughts on 10 questions.

1. In this case, compared with Chevron, What are the advantages and disadvantages for CNOOC?

From the perspective of Unocal's board, it has to weigh the price paid, the quality of the consideration used (cash is better than stock, for example), and the risk that the deal will fall through. To explain this, I want to introduce the concept of expected value -- which is the probability of an event happening multiplied by the value of that event. For example, if company B is willing to pay $100 a share for company A but the chance of the deal being completed is 50%, then the expected value per share of that deal is $50 (50% times $100/share). In effect, Unocal's board must calculate the expected value of the competing offers.

Chevron has offered $63 a share in cash and stock while CNOOC's bid is a higher $67 a share -- all in cash. CNOOC's bid is higher and is all cash which is an advantage over Chevron's. But Unocal's board believes that the CNOOC deal will be blocked for political reasons so it has a lower probability of being completed and thus a lower expected value.

2. Usually, for such big multinational merger, what steps should the company taken in order to ensure the success of this merger? And how to bring into effect?

This merger brings into play the complex relationship between China and the US. Many US companies are manufacturing goods in China and selling the goods at a competitive price in the US. Furthermore, the US is running a large Federal deficit and China is a major buyer of the bonds needed to finance this deficit. Third, oil and gasoline prices are at record levels in the US. Fourth, CNOOC is a state-owned company which makes some in the US nervous. And finally, a Chinese general recently threatened a nuclear attack on US forces should these forces get involved in a military confrontation in Taiwan.

This specific combination of factors makes it particularly difficult for CNOOC to manage the merger. CNOOC has certainly hired well connected advisors to assist with its bid. And the editorial pages of many newspapers are filled with discussions of the proposed merger -- many of these discussions downplay the strategic risks. Ultimately, CNOOC has a chance to prevail if it can lower sufficiently the political, legal, and regulatory risks which threaten the completion of a deal.

3. Is it necessary for CNOOC to study relative laws during the merger? How to adapt to these laws?

CNOOC must study political trends, legal issues, and regulatory concerns and develop a comprehensive plan to tailor their approach in a way that makes the expected value of its deal higher than that of Chevron.

4. Looking from the strategic sense, do you think the offer that CNOOC has offered is reasonable?

CNOOC views Unocal as a rich source of Asian energy assets -- specifically oil and gas fields in Asia, mainly in Indonesia, Thailand, Myanmar and Bangladesh, as well as a scattering of assets in North America, which hold a total of 1.7 billion barrels of proven oil and gas reserves.

From CNOOC's perspective, it makes sense to increase Chinese energy self-sufficiency and thus obtaining access to relatively close energy assets helps achieve that objective.

Furthermore, CNOOC is bidding a higher price in cash for these assets which indicates their value is very high for CNOOC. This also suggests that Unocal has important strategic reasons for the bid.

5. How to do the PR with US government? Facing the opposite voices from US congress and public, what are the breakthrough points for CNOOC?

CNOOC's biggest problem seems to be that its strategy does not fully reflect the complexity of China's relationship with the US which I outlined in my answer to question 2 above. I do not know whether it is possible for CNOOC to coordinate its strategy for Unocal with other aspects of China's policy towards the US. However, in my view the US is looking at the CNOOC bid as a component in this broader US strategy rather than as an independent business transaction.

6. Chevron has claimed that they are competing with Chinese government, and say this is unfair. Moreover, they want to indict China on WTO issue. In your views, how should CNOOC respond to such attack?

CNOOC should try to coordinate its response with the Chinese government's broader US policy. Chevron is trying to fan the flames of protectionism in the US so that it can increase the political risk to CNOOC and thereby lower the expected value of CNOOC's bid for Unocal while paying less for it. Chevron's effort to link the CNOOC bid to the WTO issue is another effort to increase the perceived political risk of the CNOOC deal to Unocal's board.

7. What are the risks for CNOOC after the merger? (such as oil exploitation/organization management/operate mode/culture amalgamation etc.) How to ensure the successful integration?

I think that the big question facing CNOOC, if its bid succeeds, is whether it should retain Unocal's existing management or whether it would be better off putting its own managers in charge. If CNOOC wins the bid, it will probably need to reduce costs quickly to earn back the price premium it paid to control the assets. So it will face another challenge about how to identify and cut costs that do not add value to the combined company.

Furthermore, CNOOC will need to draw on the best practices of companies that have made successful multinational mergers work effectively -- such as forming cross-company integration task forces that identify ways that companies can work together in a productive manner while achieving short-term cost savings and putting in place longer-term revenue generating initiatives.

8. What are your overall judgments about the CNOOC’s gesture? And why?

CNOOC's gesture makes strategic sense from its perspective and it could lead to a better deal for Unocal shareholders if CNOOC can increase the likelihood that the deal will close. In my judgment, CNOOC has not yet done enough to increase its chances -- as reflected in the Unocal board's willingness to accept a cash and stock offer from Chevron that is $4 a share lower than CNOOC's.

9. Up to now, what’s your prediction about this merger? And why?

If CNOOC raises its offer enough or can lower the risks that the deal will not close, then it may ultimately succeed. Otherwise, I think this bid can be thought of as another valuable learning experience for CNOOC's management. It may then wish to consider whether it should make a bid for another company or to use the money that it would have spent on Unocal to explore for oil and gas in Asia.

10. Anything else you want to say about this topic.

I think the world is a better place if there is more economic integration between the US and China. Unfortunately, the political climate in the US seems to be leaning more towards the idea of limiting that integration. I hope that cooler heads will prevail in both countries.


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