Chevron’s Acquisition of Unocal

question 66

Essay

Chevron’s Acquisition of Unocal
Unocal ceased to exist as an independent company on August 11, 2005 and its shares were de-listed from the New York Stock Exchange. The new firm is known as Chevron. In a highly politicized transaction, Chevron battled Chinese oil-producer, CNOOC, for almost four months for ownership of Unocal. A cash and stock bid by Chevron, the nation’s second largest oil producer, made in April valued at $61 per share was accepted by the Unocal board when it appeared that CNOOC would not counter-bid. However, CNOOC soon followed with an all-cash bid of $67 per share. Chevron amended the merger agreement with a new cash and stock bid valued at $63 per share in late July. Despite the significant difference in the value of the two bids, the Unocal board recommended to its shareholders that they accept the amended Chevron bid in view of the growing doubt that U.S. regulatory authorities would approve a takeover by CNOOC.

In its strategy to win Unocal shareholder approval, Chevron offered Unocal shareholders three options for each of their shares: (1) $69 in cash, (2) 1.03 Chevron shares; or (3) .618 Chevron shares plus $27.60 in cash. Unocal shareholders not electing any specific option would receive the third option. Moreover, the all-cash and all-stock offers were subject to proration in order to preserve an overall per share mix of .618 of a share of Chevron common stock and $27.60 in cash for all of the 272 million outstanding shares of Unocal common stock. This mix of cash and stock provided a “blended” value of about $63 per share of Unocal common stock on the day that Unocal and Chevron entered into the amendment to the merger agreement on July 22, 2005. The “blended” rate was calculated by multiplying .618 by the value of Chevron stock on July 22nd of $57.28 plus $27.60 in cash. This resulted in a targeted purchase price that was about 56 percent Chevron stock and 44 percent cash.

This mix of cash and stock implied that Chevron would pay approximately $7.5 billion (i.e., $27.60 x 272 million Unocal shares outstanding) in cash and issue approximately 168 million shares of Chevron common stock (i.e., .618 x 272 million of Unocal shares) valued at $57.28 per share as of July 22, 2005. The implied value of the merger on that date was $17.1 billion (i.e., $27.60 x 272 million Unocal common shares outstanding plus $57.28 x 168 million Chevron common shares). An increase in Chevron’s share price to $63.15 on August 10, 2005, the day of the Unocal shareholders’ meeting, boosted the value of the deal to $18.1 billion.

Option (1) was intended to appeal to those Unocal shareholders who were attracted to CNOOC’s all cash offer of $67 per share. Option (2) was designed for those shareholders interested in a tax-free exchange. Finally, it was anticipated that option (3) would attract those Unocal shareholders who were interested in cash but also wished to enjoy any appreciation in the stock of the combined companies.

The agreement of purchase and sale between Chevron and Unocal contained a “proration clause.” This clause enabled Chevron to limit the amount of total cash it would payout under those options involving cash that it had offered to Unocal shareholders and to maintain the “blended” rate of $63 it would pay for each share of Unocal stock. Approximately 242 million Unocal shareholders elected to receive all cash for their shares, 22.1 million opted for the all-stock alternative, and 10.1 million elected the cash and stock combination. No election was made for approximately .3 million shares. Based on these results, the amount of cash needed to satisfy the number shareholders electing the all-cash option far exceeded the amount that Chevron was willing to pay. Consequently, as permitted in the merger agreement, the all-cash offer was prorated resulting in the Unocal shareholders who had elected the all-cash option receiving a combination of cash and stock rather than $69 per share. The mix of cash and stock was calculated as shown in Exhibit 1.

Exhibit 1. Prorating All-Cash Elections
1. Determine the available cash election amount (ACEA): Aggregate cash amount minus the amount of cash to be paid to Unocal shareholders selecting the combination of cash and stock (i.e., Option 3).

ACEA = $27.60 x 272 million (Unocal shares outstanding) - 10.1
million (shares electing cash and stock option) x $27.60
= $7.5 - $.3
= $7.2 billion

2. Determine the elected cash amount (ECA): Amount equal to $69 multiplied by the
number of shares of Unocal common stock electing the all-cash option.

ECA = $69 x 242 million = $16.7 billion

3. Determine the cash proration factor (CPF): ACEA/ECA
CPF = $7.2 / $16.7 = .4311
4. Determine the prorated cash merger consideration (PCMC): An amount in cash equal
to $69 multiplied by the cash proration factor.

PCMC = $69 x .4311 = $29.74

5. Determine the prorated stock merger consideration (PSMC): 1.03 multiplied by 1 – CPF.

PSMC = 1.03 x (1- .4311) = .5860

6. Determine the stock and cash mix (SCM): Sum of the prorated cash (PCMC) and stock
(PSMC) merger considerations exchanged for each share of Unocal common stock.

SCM = $29.74 + .5860 of a Chevron share

If too many Unocal shareholders had elected to receive Chevron stock, those making the all-stock election would not have received 1.03 shares of Chevron stock for each share of Unocal stock. Rather, they would have received a mix of stock and cash to help preserve the approximate 56 percent stock and 44 percent cash composition of the purchase price desired by Chevron. For illustration only, assume the number of Unocal shares to be exchanged for the all-cash and all-stock options are 22.1 and 242 million, respectively. This is the reverse of what actually happened. The mix of stock and cash would have been prorated as shown in Exhibit 2.

Exhibit 12. Prorating All-Stock Elections
1. Determine the available cash election amount (ACEA): Same as step 1 above.
ACEA = $7.2 billion
2. Determine the elected cash amount (ECA): Amount equal to $69 multiplied by the number of shares of Unocal common stock electing the all-cash option.

ECA = $69 x 22.1 million = $1.5 billion
3. Determine the excess cash amount (EXCA): Difference between ACEA and ECA.
EXCA = $7.2 - $1.5 = $5.7
4. Determine the prorated cash merger consideration (PCMC): EXCA divided by number of Unocal shares elected the all-stock option.

PCMC = $5.7 / 242 million = $23.55
5. Determine the stock proration factor (SPF): $69 minus the prorated cash merger
consideration divided by $69.

SPF = ($69 - $23.55) / $69 = .$45.45 / $69 = .6587
6. Determine the prorated stock price consideration (PSPC): The number of shares of
Chevron stock equal to 1.03 multiplied by the stock proration factor.

PSPC = 1.03 x .6587 = .6785
7. Determine the stock and cash mix (SCM): Each Unocal share to be exchanged in an
all-stock election is converted into the right to receive the prorated cash merger
consideration and the prorated stock merger consideration.

SCM = $23.55 + .6785 of a Chevron share for each Unocal share

It is typical of large transactions in which the target has a large, diverse shareholder base that acquiring firms offer target shareholders a “menu” of alternative forms of payment. The objective is to enhance the likelihood of success by appealing to a broader group of shareholders. To the unsophisticated target shareholder, the array of options may prove appealing. However, it is likely that those electing all-cash or all-stock purchases are likely to be disappointed due to probable proration clauses in merger contracts. Such clauses enable the acquirer to maintain an overall mix of cash and stock in completing the transaction. This enables the acquirer to limit the amount of cash they must borrow or the number of new shares they must issue to levels they find acceptable.
-How did Chevron use the form of payment as a potential takeover strategy?

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