Hess Corp. (NYSE: HES ) announced it will sell its retail business to Marathon Petroleum Corporation (NYSE: MPC ) for a total cash consideration of $2.6 billion. While the deal appears beneficial to both companies, the transaction's metrics suggest that Hess got the better end of the deal. Let's take a closer look at why and what it could mean for Hess' future.
A mutually beneficial transaction?
Under the agreement, Marathon Petroleum will acquire all of Hess' 1,256 East Coast retail locations, fuel transport operations, and 40,000 barrels per day of shipper history on the Colonial Pipeline. The company will pay Hess $2.37 billion in cash, as well as an estimated $230 million in working capital and $274 million for capital leases.
From Marathon's perspective, the acquisition will greatly expand its retail presence along the East Coast, effectively doubling its store count and making it the largest convenience store chain in the country by revenue. And from Hess' perspective, not only does the move mark "the culmination of [its] strategic transformation into a pure-play exploration and production company," but it will also raise significant proceeds that the company will use to buy back more of its own stock.
While the transaction appears mutually beneficial from both companies' perspectives, Hess looks like it got the better end of the deal in terms of the price it received for its assets. That's because the transaction looks expensive from Marathon's perspective on a trailing EBITDA multiple basis.
As Morningstar analyst Allen Good notes, the company is essentially paying 16.4 times last year's EBITDA of $175 million for Hess' assets, which seems lofty given the fact that the assets generate only about a third of the EBITDA that Marathon's retail assets, which are part of its Speedway unit, generate.
Further, the purchase price suggests a per-store value that's significantly less than the per-store value of Valero's (NYSE: VLO ) spin-off of its gas-station and convenience-store retail business into CST Brands last year, even though CST had nearly double the EBITDA margins of Hess' retail business, Good notes.
While Marathon plans on improving the EBITDA of the soon-to-be-acquired assets through $190 million in synergies and marketing enhancements, it will have to spend about $410 million over three years to convert the Hess stores to its Speedway brand. For these reasons, the metrics of the transaction appear more favorable for Hess than they do for Marathon.
Hess' strategy should pay off in the long run
Hess' sale of its retail business marks the end of a major divestment program that it embarked upon last year to become a more focused and more profitable pure-play E&P. The company shed some $6.5 billion worth of non-core assets in 2013 and announced several additional monetizations during the first quarter, including the sale of offshore assets in Indonesia and Thailand and the sale of dry gas acreage in Ohio's Utica shale.
While these asset sales have had a big impact on the company's production, reducing companywide output by 77,000 barrels of oil equivalent per day during the first quarter, they have allowed it to return more cash to shareholders and positioned it for stronger, more profitable growth in the years ahead.
Since Hess began its share buyback program in August, it has repurchased roughly $2.8 billion of its own stock and has raised its existing share repurchase authorization from $4 billion to $6.5 billion. Asset sales have also significantly narrowed the company's operating scope to assets including North Dakota's Bakken shale, Ohio's Utica shale, Tubular Bells in the Gulf of Mexico, and Norway's Valhall field.
In the Bakken, which will be the company's key driver of growth in the years ahead, Hess is generating very strong returns thanks to some of the most productive wells in the play and continued cost reductions. If it can continue to improve its operational performance in the Bakken as it has in recent quarters, its target of 5%-8% compound annual production growth through 2017 just may be achievable.
While Hess' asset sales have taken a toll on its production, they've allowed the company to strengthen its balance sheet, return more cash to shareholders, and focus on its most profitable operations in the Bakken. With a much more streamlined portfolio, Hess is on track to deliver stronger, more profitable growth and should begin generating free cash flow as early as next year. However, the company's high and growing exposure to the Bakken leaves it vulnerable to a decline in Bakken oil prices, especially since it hasn't hedged any of its oil production for this year -- a risk investors should take seriously.
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