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What Would Warren Buffett Think About This Massive Acquisition?

Last month, there was quite a bit of chatter about the possibility of Anadarko Petroleum (NYSE: APC  ) being acquired by one of the oil majors. Perhaps the oil major mentioned the most in these discussions was ExxonMobil (NYSE: XOM  ) . In 2013, Warren Buffett's Berkshire Hathaway purchased 40.1 million shares of ExxonMobil, giving it an almost 1% stake in the company. What would the Oracle of Omaha think about ExxonMobil buying out Anadarko Petroleum?

I will answer this question based on the principles embodied in two of his most famous quotations. First, "Rule No.1 is never lose money. Rule No.2 is never forget rule number one." Second, "If, when making a stock investment, you're not considering holding it at least ten years, don't waste more than ten minutes considering it." We can adapt the second quotation to a business acquisition case by understanding the principle to be that a company should make acquisitions to gain long-term benefits.

Applying these principles to this possible acquisition will shed light on two critical questions: Would acquiring Anadarko Petroleum help ExxonMobil strengthen its cash flows, and would the acquisition help bolster ExxonMobil's future productivity?

Never lose money

APC Gross Profit (Annual) Chart

Source: APC Net Income (Annual) data by YCharts

In 2011, Anadarko Petroleum posted a loss that was driven by a settlement and payment to BP for the Deepwater Horizon oil spill. The extraordinary circumstances surrounding the incident constitute grounds to not consider this a violation of Buffett's first rule, especially since it doesn't indicate a fundamental flaw in Anadarko Petroleum's business. We can see this in how revenue and gross profit were greatly divergent from operating income in 2011. This is further supported by the fact that the company has not lost money since 2011.

APC CAPEX to Revenue (Annual) Chart

Source: APC and XOM data (Annual) data by YCharts

An issue for ExxonMobil is rising capital expenditures with falling revenue. The capex-to-revenue ratio expresses the relationship between how much a company is spending to acquire and upgrade physical assets and how much it generates in revenue on an annual basis. This ratio has been rising for the company since 2012. Greater capital expenditures yielding decreasing amounts of revenue signals that ExxonMobil is having greater difficulty generating revenue.

Unlike ExxonMobil, Anadarko Petroleum maintains a declining capex-to-revenue ratio with revenue increasing at a greater rate than capex. Anadarko Petroleum's capex spending is resulting in more efficient returns than ExxonMobil's capex spending.

Acquiring Anadarko Petroleum would help ExxonMobil by bringing an efficient unit under its umbrella that generates revenue and is profitable. Warren Buffett would likely find this point in favor of the acquisition.

Think about 2024 before acquiring
Production growth is a constant concern for any oil and gas producer. ExxonMobil's production has declined for three consecutive years. Additionally, its reserve-replacement ratio -- which measures the amount of proven reserves added to a company's reserves relative to its production per annum -- has been trending lower over the past five years.

Year Reserve-replacement ratio
2009 133%
2010 209%
2011 107%
2012 115%
2013 103%

Source: ExxonMobil news releases

A contributing factor to this state of affairs is that ExxonMobil, like other supermajors, has missed much of the American shale boom. Still, the company has made some significant moves over the years to become a shale player. One move was the acquisition of XTO Energy in 2009, which CEO Rex Tillerson described as being not about the near-term, but "about the next 10, 20, 30 years." More recently, ExxonMobil swapped assets with LINN  Energy in May to strengthen its position in the Permian Basin. Acquiring Anadarko Petroleum would help combat declining production and, like the XTO Energy acquisition, help ExxonMobil over the coming decades.

Anadarko Petroleum is a global company, but is particularly strong in its U.S. onshore assets. ExxonMobil would instantly become a major player in the American shale boom after acquiring Anadarko Petroleum, a top Eagle Ford and Marcellus producer.

Source: Anadarko Petroleum website

With significant positions in highly productive plays, Anadarko Petroleum has been able to increase production by 7% per year since 2009. The company has set its long-term growth target at 5-7%. Further, it has achieved truly impressive reserve-replacement ratios since 2009.

Year Reserve-replacement ratio
2009 140%
2010 153%
2011 159%
2012 162%
2013 194%

Source: Anadarko Petroleum news releases

Anadarko's future prospects appear bright, given its presence in highly productive plays and projected growth. ExxonMobil would improve its production capacity and reserve-replacement ratio by buying out the company. Warren Buffett would likely find Anadarko's projected performance, too, as a point in favor of the acquisition.

Foolish bottom line
A few of ExxonMobil's problems include rising expenditures and falling revenue and production. Anadarko Petroleum's revenue is rising at a greater rate than its capex spending and the company is poised for years of growth. From the two perspectives embodied in Buffett's quotations, it seems that the Oracle of Omaha would have a favorable view of an acquisition of Anadarko Petroleum by ExxonMobil.

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Comments from our Foolish Readers

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  • Report this Comment On July 21, 2014, at 11:53 AM, rtichy wrote:

    Yes, without talking about a price to acquire, it would be very attractive for XOM to buy Anadarko...

    You didn't even bother talking about a price to acquire, since it likely is not Anadarko's current market cap, how high could the purchase price be before it didn't make sense?

  • Report this Comment On July 21, 2014, at 4:53 PM, DWiley wrote:

    Hello rtichy, thank you for your comment. Of course, the acquisition price is an important consideration. In all likelihood, Anadarko would be bought at a premium to its current valuation. This point was outside of the scope of this article, which considered the fundamentals of each company using the principles embodied in two of Buffett's quotations.

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Dajahi Wiley

Dajahi is a graduate of Cornell University, where he earned his Bachelor of Arts in Government. His work largely focuses on energy. His analyses help readers to identify and understand micro- and macro-level drivers and trends. Follow on Twitter @DWCommentary.

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8/31/2015 4:01 PM
APC $71.58 Up +0.64 +0.90%
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ExxonMobil Corp CAPS Rating: ****