Political Risk in Cross-Border Transactions-CNOOC's Aborted

question 79

Essay

Political Risk in Cross-Border Transactions-CNOOC's Aborted
Attempt to Acquire Unocal
In what may be the most politicized takeover battle in U.S. history, Unocal announced on August 11, 2005, that its shareholders approved overwhelmingly the proposed buyout by Chevron. The combined companies would produce the equivalent of 2.8 million barrels of oil per day and the acquisition would increase Chevron's reserves by about 15 percent. With both companies owning assets in similar regions, it was easier to cut duplicate costs. The deal also made Chevron the top international oil company in the fast growing Southeast Asia market. Unocal is much smaller than Chevron. As a pure exploration and production company, Unocal had operations in nine countries. Chevron operated gas stations, drilling rigs, and refineries in 180 countries.
Sensing an opportunity, Chevron moved ahead with merger talks and made an all-stock $16 billion offer for Unocal in late February 2005. Unocal rebuffed the offer as inadequate and sought bids from China's CNOOC and Italy's ENI SPA. While CNOOC offered $17 billion in cash, ENI was willing to offer only $16 billion. Chevron subsequently raised its all-stock offer to $16.5 billion, in line with the board's maximum authorization. Hours before final bids were due, CNOOC informed Unocal it was not going to make any further bids. Believing that the bidding process was over, Unocal and Chevron signed a merger agreement on April 4, 2005. The merger agreement was endorsed by Unocal's board and cleared all regulatory hurdles. Despite its earlier reluctance, CNOOC boosted its original bid to $18.5 billion in late June to counter the Chevron offer. About three fourths of CNOOC's all-cash offer was financed through below-market-rate loans provided by its primary shareholder, the Chinese government. On July 22, 2005, Chevron upped its offer to $17.7 billion, of which about 60 percent was in stock and 40 percent in cash. By the time Unocal shareholders actually approved the deal, the appreciation in Chevron's stock boosted the value of the deal to more than $18.1 billion.
CNOOC's all-cash offer of $67 per share in June sparked instant opposition from members of Congress, who demanded a lengthy review by President George W. Bush and introduced legislation to place even more hurdles in CNOOC's way. Hoping to allay fears, CNOOC offered to sell Unocal's U.S. assets and promised to retain all of Unocal's workers, something Chevron was not prone to do. CNOOC also argued that its bid was purely commercial and not connected in any way with the Chinese government. U.S. lawmakers expressed concern that Unocal's oil drilling might have military applications and CNOOC's ownership structure (i.e., 70 percent owned by the Chinese government) would enable the firm to secure low-cost financing that was unavailable to Chevron. The final blow to CNOOC's bid was an amendment to an energy bill passed in July requiring the Departments of Energy, Defense, and Homeland Security to spend four months studying the proposed takeover before granting federal approval.
Perhaps somewhat naively, the Chinese government viewed the low-cost loans as a way to "recycle" a portion of the huge accumulation of dollars it was experiencing. While the Chinese remained largely silent through the political maelstrom, CNOOC's management appeared to be greatly surprised and embarrassed by the public criticism in the United States about the proposed takeover of a major U.S. company. Up to that point, the only other major U.S. firm acquired by a Chinese firm was the 2004 acquisition of IBM's personal computer business by Lenovo, the largest PC manufacturer in China. While the short-term effects of the controversy appear benign, the long-term implications are less clear. It remains to be seen how well international business and politics can coexist between the world's major economic and military superpower and China, an emerging economic and military superpower in its own right.
Cross-border transactions often require considerable political risk. In emerging countries, this is viewed as the potential for expropriation of property or disruption of commerce due to a breakdown in civil order. However, as CNOOC's aborted effort to takeover Unocal illustrates, foreign firms have to be highly sensitive to political and cultural issues in any host country, developed or otherwise.
-Should CNNOC have been permitted to buy Unocal? Why? Why not?

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Definitions:

Consumer Demand

The desire and willingness of consumers to purchase goods and services at given prices.

Economic Profits

The divergence in a company's overall sales versus its combined expenses, spanning both acknowledged and hidden costs.

Perfectly Competitive

A market structure characterized by a large number of buyers and sellers, where no single entity can affect the price of the product.

Realizing Profits

The process by which a firm converts its operations and investments into financial gains or returns.