Exxon and XTO: Big Oil Just Got Bigger

“Exxon-Mobil and XTO Energy. Exxon is buying XTO for $41 billion. A natural gas play and all stock deal, Exxon-Mobil the biggest percentage loser in the Dow, down 4%.” — Fox Business Network 12/14/2009

On Monday morning, Exxon Mobil (XOM) announced their largest acquisition since Mobil in 1999. Exxon will pay around $51.69 (.71 shares of XOM) per share of XTO Energy (XTO) as well as assume about $10 billion in debt, in sum the deal will cost about $41 billion. Although the offered price represents a 25% premium over XTO’s Friday closing price, Exxon is acquiring America’s largest unconventional natural gas producer.

This increased emphasis on natural gas will put further distance between Exxon and other major oil firms in terms of natural gas reserves. Exxon hopes that natural gas will find favor in Washington and gain wider use as a domestic energy source over coal. Proven reserves of natural gas in the United States have ballooned in recent years thanks to “shale gas” which is attainable through modern drilling techniques and makes natural gas an extremely abundant domestic resource. Clearly, Exxon, already a heavy hitter on K-Street, will commit substantial resources towards these goals.

Exxon has a reputation for being one of the most conservative of the oil giants. Led by CEO Rex Tillerson, Exxon has made a statement with today’s deal that they believe there is a long term trend that will benefit natural gas producers. They obviously see a shift in the way natural gas is utilized, as prices have been suppressed for more than a year and a record 3.7 trillion cubic feet in storage proves supply is swamping demand. However, Tillerson has said that he believes demand for natural gas will outpace both oil and coal in the coming years, based on his belief that natural gas will find more frequent use as a source of electricity generation in the future. Gas burns cleaner than coal, and if cap and trade legislation passes through Washington a shift may be inevitable.

Exxon is looking towards natural gas for growth, and with the natural gas prices still low they hope to have bought valuable resources for a good price. According to Bloomberg, this deal will cost Exxon $13.42 per barrel of oil equivalent reserves, which is expensive when compared to recent deals priced at around $10 per barrel of oil equivalent reserves. But XTO’s assets in the Barnett Shale and other prodigious fields may justify the premium. As for our methodology, we had an Undervalued stance on XTO as of Friday’s closing price $41.52, and given the current fundamentals the offered price does not seem unreasonable. Given current revenue and earnings strength, we think any price south of $60 would have been in line with fundamentals.

This is no doubt a bold strategic move for Exxon and it will be very interesting to see if other domestic natural gas producers like Devon (DVN) or Chesapeake (CHK) are next to be targeted in a wave of consolidation. If Exxon is right and natural gas sees wider adoption for electricity production, this will undoubtedly be a boon to shareholders. From our view, the price paid is well worth the potential that this deal holds for the long term energy market.

Exxon and XTO: Big Oil Just Got Bigger

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