Spinoffs are all the rage right now, and two attractive deals that are currently being put together within the oil sector are Occidental Petroleum's (NYSE:OXY) spinoff of its California assets, and National Oilwell Varco's (NYSE:NOV) spinoff of the company's distribution business.
An attractive prospect
Occidental's spinoff appears to be more attractive than that of National Oilwell, as Occidental's Californian oil and gas production assets have huge growth potential.
Occidental expects to complete the spinoff by the end of 2014, or early 2015 at the latest. The company is also moving its headquarters from Los Angeles to Houston, where it will be closer to the majority of U.S. operations.
At present, analysts believe the new spun off company could be worth in the region of $19 billion to $22 billion. The unit generated a pre-tax profit of $1.5 billion during 2013, implying a valuation of around 20 times earnings, assuming a 30% tax rate.
What's more, the new company will hold about 2.3 million net acres of land and be California's largest oil and gas producer.
According to Occidental's press release on the spinoff and Californian assets:
Earnings before income, taxes, depreciation and amortization were around $2.6 billion with capital expenditures of approximately $1.7 billion. Due to these strong results, capital expenditures planned for 2014 were increased to $2.1 billion. The company is expected to have a strong and competitive balance sheet with between $4 billion and $5 billion of funded debt.
Opposition to the deal
So, the new Californian company will have a strong balance sheet and plenty of profit to return to investors. However, some shareholders have stated their opposition, instead wanting Occidental to establish a more robust growth program for the Californian assets before they're separated.
Indeed, since 2010 Occidental has not been able to increase Californian production beyond 1% in any three-month period. Nevertheless, it's not as if the company does not have the potential to grow.
For example, back during 2011 some Wall Street analysts put forward the idea that Occidental's Californian acreage could hold as much as 10 billion barrels of oil. Unfortunately, the problem is getting this oil out of the ground.
California's Monterey shale is a vast rock formation that spans much of the state and is different to other shale plays around the country. In particular, Monterey rocks are more varied that those found in the Marcellus and Bakken formations. This means that a producer might target a brittle layer of rock perfect for hydraulic fracturing, only to hit a more resilient, fracking-resistant rock farther along.
So, it would appear that the success of Occidental's spinoff depends upon whether or not the company is able to drive growth via unconventional extraction techniques -- this is reliant on capital spending. Still, it would appear that if Occidental can get an exploration program together for its California assets, this could be a lucrative spinoff.
Oil and gas supermarket
Meanwhile, National Oilwell is planning to spin off its distribution business from the rest of the company.
According to National Oilwell's press release on the matter, the new company will have 415 locations and operations in 26 different countries. In addition, the press release states that revenues from this new company will be equivalent to 85% of National Oilwell's distribution and transmission segment around $4.5 billion.
MRC Global Inc (NYSE:MRC), an oil services and distribution company, which was spun off from PVF Holdings during 2012, has similar traits to National Oilwell's new proposed distribution company.
MRC currently trades at a price-to-sales ratio of 0.5, indicating that National Oilwell's new spinoff could take on a valuation of around $2.1 billion. The problem is that both MRC and National Oilwell's distribution businesses are low margin and low growth. In particular, during the first half of 2013, MRC's operating profit margin was a little above 6.8%, which is actually higher than the operating margin of 5% reported by National Oilwell's distribution and transmission segment for the same period.
All in all, it is likely that National Oilwell's spinoff could be assigned a valuation similar to that of MRC. Still, investors should place some premium on the fact that the new entity will have close ties with National Oilwell Varco, which should boost its product offering and profits.
Admittedly, information surrounding National Oilwell's spinoff is currently thin as the deal is yet to be voted through by both the board and shareholders. Additionally, the company is yet to reveal how much it will receive from the spinoff and how many shares it will make public.
That said, after the spinoff the two companies will be better placed to grow.
It appears that National Oilwell's management is already well aware of this, as the word "growth" is mentioned many times within the press release announcing the spinoff. However National Oilwell structures the deal, the company is likely to make money in the long term, opening the door to growth through acquisitions or shareholder returns in the future.
What's more, National Oilwell had a net debt-to-asset ratio of only 5% at the end of the fiscal second quarter. Keeping this debt on its balance sheet as the parent would give the new spinoff company a clean bill of financial health, allowing it to acquire competitors.