aduat Gr Schoolof Bus nes A dm i st aton e i s ni r i U ni s t of V i gi a ver iy r ni
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STRUCTURING REPSOLS ACQUISITION OF YPF S.A.
Repsol will seek to negotiate with YPF to achieve a successful integration of the two companies. Repsol S.A.1 It was a shock to Alfonso Cortina, Repsols chief executive, when he was coldshouldered at his first YPF board meeting. . . . The Argentine company, under the leadership of Roberto Monti, appeared determined to resist Mr. Cortinas efforts to start integrating the companies activities.2 In early April 1999, Alfonso Cortina, reflected on the resistance of YPF to his firms overtures. Repsol was the dominant oil company in Spain, and the thirteenth-largest in the world in reserves. Seeking oil reserves and the advantages of larger scale, Cortina had embarked on a strategy of acquiring oil assets throughout Latin America. He began to acquire Yacimientos, Petroliferos Fiscales S.A. (YPF) when the Argentine government announced that it would sell its block of shares in the firm. YPF was the largest oil company in Argentina, and the twelfthlargest in reserves. Management of YPF had resisted negotiating a friendly acquisition. To complete a takeover of the firm, Cortina would need to appeal directly to the shareholders in the form of a tender offer to purchase their shares. Unsolicited tender offers were extremely rare events in cross-border M&A generally and especially between developed and developing economies. It was very important to Repsols management that an offer be structured that would receive the support of YPFs shareholders, and repel potential competitors. A tender offer of this magnitude would be the biggest ever by a Spanish company, and the biggest ever in the energy sector. The first step of planning the tender offer was to settle on the amount of consideration that Repsol would pay for the 85 percent of YPF it did not already own. Cortina had decided to
Presentation to Security Analysts on 22 January 1999, Repsols Web site, www.repsol.com, accessed January 27, 2000. 2 Repsol: The Winner Must Oil the Wheels, Financial Times, accessed at ft.com-Mergers and Acquisitions/Case studies, 27 January 2000. This case was prepared from public information by Fernanda Pasquarelli and Pablo I. Ciano under the supervision of Professor Robert F. Bruner. Copyright 2000 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [e-mail]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of the Darden School Foundation.
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offer $44.783 per YPF share. The next step would be to determine the form of payment, and financing for the offer. Repsol could offer cash, Repsol shares of stock, or conceivably a mix of the two. Any cash offer would need to be financed by an issue of securities debt or equity, since the cash reserves of the firm would not meet the total payment of $13.438 billion. Mr. Cortina contemplated three possible financing alternatives: an issue of debt, an issue of common stock, and a blend of the two. He wondered what were the comparative advantages and disadvantages of the alternatives, and how they should be analyzed?
History of the Transaction In January 1998, the Argentine government announced its intention to sell its holding in YPF, 20.56 percent, that remained after the firms privatization several years earlier. But unexpected volatility in the equity markets caused the auction to be delayed. In September, the government invited 16 companies to bid for a block of 14.99 percent, with a minimum price of $38.00 per share. Of the 16 invitees, only six signed the confidentiality agreement to gain access to private information about YPF and to gain the right to bid in an auction for the block of YPF shares. These included Repsol, ENI SpA of Italy, Consolidated Natural Gas of Pittsburgh, Argentinas Perez Companc SA and Britains BP Amoco PLC. On January 20, 1999, Repsol won the bidding at the minimum price of $38.00 per share, reflecting the absence of any other bidders. This bid was a 30 percent premium to the market price a few days earlier, of $29.25. One analyst remarked, Its a steal,4 noting that Repsol would be acquiring YPFs energy reserves at a comparatively cheap price of $3.65 per barrel. Another analyst team5 opined that the bid was in line with the prevailing EBITDA multiples. A news report noted: Repsol is now likely to start a long and arduous courtship with YPFs loyal shareholders in an attempt to convince them that further integration with Repsol, and its Argentine oil and gas subsidiary Astra . . . makes sense . . . YPFs bylaws say that any buyer who pays a premium for 15 percent of the companys shares or more must pay all other shareholders the similar premium in cash. That rule makes an all-cash tender offer for YPF difficult. . . . Repsol is likely to solicit a vote for an extraordinary shareholders meeting and then ask for a change in bylaws allowing for a tender offer via a stock swap. That move is bound to meet with some opposition, if only because there is a wise perception that Repsol has
Figures in this case are quoted in U.S. dollars, consistent with general practice in international oil transactions, and cross-border M&A. Also, the Argentine peso was convertible into the dollar at parity (i.e., onefor-one). 4 Quotation of Vinod Sehgal in Repsol Wins Stake in YPF with $2 Billion Bid, Wall Street Journal, 21 January 1999. 5 Irene Himona, Rachel Beaver, and Andrew Whittock, Repsol-YPF: A Quantum Leap, ABN-AMRO, 6 September 1999.
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badly managed Astra, which it purchased a few years ago. It has not struck my attention that Repsol is noted for its ability to cut costs and merge companies, said [one money manager].6 The Argentine government would maintain a golden share.7 The government would support a Repsol tender offer for the balance of YPF for a period of three years, including supporting changes to YPFs bylaws to facilitate an acquisition. Any third party interested in launching a tender offer for 100 percent of YPF would have to pay a premium of 25 percent over the price paid by Repsol for its block of YPF. The securities markets expected Repsols management to announce plans to increase control in YPF. Therefore Alfonso Cortina wanted to make a public announcement before the end of April. It was time to choose a form of payment (stock for stock or all cash) and financing (debt, equity or a combination) for the transaction. Mr. Cortina understood that to meet investors expectations and to minimize the cost of the acquisition he needed to assess conditions in the current debt and equity global capital markets especially taking into account the increasing risk in emerging economies and the volatile oil prices.
The Industry Outlook After a long period of weak oil prices, 1999 was likely to be a year of recovery. Prices had been depressed in 1998 due to the Asian flu recession, expansion of Iraqi oil exports, and warm winter weather in Europe and North America. But oil prices had increased unexpectedly in recent months, increasing the attractiveness of firms with proven reserves. Inventories of oil in the United States and Asia were contracting as a consequence of strong demand. This, combined with OPECs compliance with a landmark agreement reached in March to boost sagging oil prices by slashing daily output by 7 percent, was driving prices up. The rebound began in late March and industry analysts predicted that it would likely continue in the future, taking crude prices towards $18 to $20. Exhibit 1 shows oil price fluctuations during the last 11 years. Spot oil prices were trading around $25 a barrel for January/2000 deliveries. Traders seemed anxious about what would happen in March 2000, when the actual OPEC agreement would expire. At a recent meeting, the oil cartel representatives expressed their interest in stable prices. With strong demand, observers speculated that they might increase production. Industry
Ibid. Golden shares were a common feature of most privatizations of state-owned enterprises. They were first introduced by the British Government in its privatization program that began in the 1980s under the leadership of Prime Minister Margaret Thatcher. In YPFs case, the golden share would permit the government to exercise veto power in (1) a merger of YPF with any other company, (2) acquisition by any other company of more than 50 percent of the capital, (3) sales of significant assets involved in exploration and production activities, and (4) dissolution of the company. Unclear was the possible influence of this golden share in the management of YPF.
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players still remembered OPECs inaction for production restraint during 1998 that drove prices to a 30-year low, below $10 per barrel, seriously damaging the sectors profitability. The natural gas sector also looked promising, especially in Latin America which was enjoying strong demand coupled with the final stages of industry deregulation. The construction of various cross-border pipelines would reduce supply/demand imbalances and would make the product available to the countries with perennial need for gas. Experts forecasted an expected growth rate of natural gas volumes at 25 percent for Brazil, 12 percent for Chile and 5 percent for Argentina. A recent wave of very large mergers had suddenly changed the paradigm of competition in the oil industry. Exhibit 2 compares recently announced jumbo deals to Repsols contemplated takeover of YPF. Second-tier firms in America and Europe realized that they were too small to compete with the giants for the biggest of the multi- billion dollar projects in risky but important places such as China and Africa. Yet they were not sufficiently focused to compete effectively against niche firms with geographic or technical specialties. An industry analyst likened the current merger madness to the rush to find a partner, any partner, at a school dance after the big boys have picked the best ones. He suggested that remaining firms could try to succeed alone; but to do so they would have to rethink their strategies.
Repsol S.A. Repsol was an international integrated oil and gas company. In 1998, it was the largest industrial company in Spain in terms of revenues. Compared to other large competitors, it was the oil company without any oil,8 with 1.1 billion barrels in proven reserves, ranking it 13th after YPF, which had 3.1 billion barrels. Repsol was founded in 1987 when the Spanish government consolidated various stateowned oil and gas assets. Spain sold 24 percent of the firm to public investors in 1987, another 66 percent in 1996, and the remaining holdings in April 1997. Its shares were quoted on the Madrid Stock Exchange and in the form of ADRs9 on the New York Stock Exchange. Repsol had operations in 26 countries. Since 1996, the firm had been pursuing a strategy to create a new geographical dimension to its operations in markets with high growth potential. Latin America was the center of Repsols strategy and accounted for $3 billion invested in the region since 1995. In Latin America, Repsol saw excellent opportunities to reinforce important
Quotation of an unnamed analyst in Wall Street Journal, 21 January 1999. ADRs (American Depositary Receipts) are receipts issued by U.S. banks to American buyers as a convenient substitute for direct ownership of stock in foreign companies. ADRs are traded on stock exchanges and in the over-the-counter market. Foreign companies issue ADRs as a way of reaching the American stock market.
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pillars of its corporate strategy, in particular the desire to strengthen its upstream business and to strengthen its gas business, exploiting the links to electricity generation. Prior to the YPF bid, Repsol had acquired refining assets in Peru, and 67 percent of Astra, the fifth-largest energy company in Argentina. Astra derived the bulk of its earnings from exploration and production, and became a platform for the acquisition of other oil assets in Argentina. Cortina intended to merge YPF with Astra,10 which would trigger asset sales to satisfy Argentine antitrust authorities. Exhibit 3 gives Repsols recent financial statements. Repsols share price had risen 27 percent since the acquisition of the YPF stake in January reflecting the rise in oil prices during early 1999, and possibly the markets optimism about the deal. Historically, Repsols P/E ratio had been similar to its European rivals but below major U.S. competitors. With a market capitalization close to 17 billion, Repsol was perceived as a neutral or hold stock by securities analysts. Analysts agreed that if Repsol succeeded in a full acquisition of YPF, then the increase in size of the company, its more balanced revenue mix and its geographical diversity, would help the shares to trade at higher earnings and cash flow multiples than in the past.
YPF S.A. YPF was Argentinas largest company with a market capitalization of $15 billion. It was engaged in the exploration, development and production of oil and natural gas as well as electricity generation activities and in the refining, marketing, transportation and distribution of oil and a wide range of petroleum products, petroleum derivatives, petrochemicals and liquid petroleum gas. Exhibit 4 gives YPFs recent financial statements. YPF played a key role in the energy industry in Argentina, accounting for 51 percent of the total estimated crude oil production, 58 percent of the total domestic and export sales of Argentine natural gas, 51 percent of the total refining capacity and 37 percent of all service stations. The company had been pursuing an aggressive expansion strategy, mainly through joint ventures in areas in which it held concessions. As part of the Government privatization program, YPF completed an initial public offering in 1993. As a result, the Argentine government ownership of YPFs equity was reduced from 100 percent to approximately 20 percent. Exhibit 5 contains the current YPF structure of equity ownership. In addition, YPF restructured its internal organization and significantly reduced the number of its employees, from over 51,000 at December 1990 to 7,500 at December 1993. At December 1998, YPF had approximately 9,500 employees. Thanks to this restructuring, the firm outperformed its peer group of Latin American oil companies, and generally was regarded as an efficiently run firm.
CMS Keeps Eye on YPF-Repsol Merger, Alexanders Gas & Oil Connections, Company News, Latin America, 11 June 1999, www.gasandoil.com, accessed 27 January 2000.
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Despite its low cost structure, strong management, commanding position in Argentinas downstream and the strong export potential of natural gas to Brazil, YPFs future performance could be affected by certain risk factors, such as, economic and political risks in Argentina and other countries where YPF had operations and volatility in oil prices. Argentinas economy experienced periods of slow or negative growth, high inflation, currency devaluation and the imposition of exchange rate control measures. The currency board system11 adopted by Argentina in 1991 brought more uncertainty about the confidence in the peso, in that it differed from an orthodox currency board system. An orthodox currency board system had no central bank and no room for discretionary monetary policy. Argentinas monetary system, in contrast, had a central bank with room for discretionary monetary policy.12 Moreover, YPFs revenues in dollars and YPFs costs in pesos increased the risks of any change in the exchange rate policy in Argentina. The tight link between Argentina and other emerging countries amplified uncertainty about the timing of this transaction. Although emerging economies seemed to be recovering from the financial collapse started by the Russian debt moratorium in August 1998 and followed by the Brazilian currency devaluation on January 13, 1999 (5 days before the Argentine auction of YPF shares), investors might still be reluctant to invest in emerging economies. Foreign petroleum exploration, development and production activities were subject to a variety of regulatory and political risks, including: foreign exchange controls from other countries, expropriation of property, risks of loss in countries due to civil strike and guerilla activities. These risks might interrupt YPFs operations. Exhibit 6 presents the actual sovereign ratings for all the countries where YPF currently had operations, as well as capital market conditions. Fluctuations in oil prices would affect the timing and reduce the amount of projected capital expenditures related to explorations and development activities, which in turn, could have a negative effect on YPFs ability to replace reserves. The ability to replace reserves is a crucial factor for companies in the commodity sector, because it indicates the companys ability to continue in the business. Credit ratings and cost of financing depend not only on the level of reserves but also on their estimated average life. For this reason, YPFs exposure to oil prices could ultimately increase investors concerns about the future outlook for YPF.
Under Argentinas currency board system, the peso trades at a fixed rate one-to-one with the dollar and is convertible on demand. See Steve H. Hanke and Kurt Schuler, A Dollarization Blueprint for Argentina, Foreign Policy Briefing, Cato Institute, 11 March 1999, 1. 12 Ibid., 8.
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-7M&A Environment13
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M&A activity worldwide had grown explosively. From 1994 to 1998, the value of announced European transactions had grown at a compound average rate of 42 percent. In the first quarter of 1999, announced deals in Europe amounted to $449 billion, compared with $128 billion a year earlier. This reflected both the increases in the number of deals, and in the average transaction size. European M&A activity was driven by both global influences (such as deregulation, globalization, buoyant equity markets, etc.), and European-specific influences (such as the creation of the European Monetary Union, pressure by governments to create national champions, and consolidation of previously fragmented markets.) In Latin America, many of the same forces exerted influence on M&A activity, though with an emerging markets twist. Generally, the liberalization of markets through trade, deregulation, and privatization pushed firms to use their resources more efficiently. The rise of regional trading blocs (such as Mercosur) and globalization made it attractive for foreign buyers to establish regional platforms for business activities and further acquisitions in key markets. As business and capital markets matured, equity market volatility in those markets gradually declined. Strengthening business fundamentals and relatively low valuations meant that business assets might be acquired at reasonable prices. These factors, combined, created a compelling argument for foreign and domestic firms to seek to acquire in emerging markets. M&A activity in Latin America had increased at a compound rate of 58 percent from 1995 to 1998. Latin American deal volumes in 1997 and 1998 were greater than the previous 10 years combined. European-based acquirers had increased their activity by four times between 1996 and 1998. Acquisition activity was not slowed by the Brazilian crisis in early 1999. 75 percent of recent transactions were in Brazil, Argentina and Mexico. 73 percent of M&A volume occurred in capital-intensive industries.
Motives for the Acquisition Repsol management noted several advantages from this transaction: Geographic diversification. YPF would deepen Repsols business base in Argentina, and give it a material presence in other Latin American countries. Business diversification. Repsols activities were concentrated in the downstream segment of the oil industry: refining and marketing. YPF had a substantial presence in exploration and production. Also, YPF would add a significant activity in natural gas. Acquisition of reserves. The transaction would convey YPFs substantial reserves at relatively low average price.
This section draws upon presentations at the Mergers and Acquisitions Conference, Credit Suisse First Boston, 14 May 1999.
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Competitive pre-emption. Acquiring this dominant competitor in Latin America would deny other oil companies access to this market. YPF had a strong brand in Latin America. Critical mass. The transaction would elevate Repsol in Rank of Repsol-YPF among the league tables of integrated oil companies. This European and American would permit the exploitation of some economies of Integrated Oil Companies: Total assets 8th scale. More importantly, it would create the financial Operating Revenues 9th th strength to permit exploration for new reserves and Operating Income 7th Net Income 6 more aggressive marketing. Oil & Gas Production 9th
Oil & Gas Reserves Service Stations 7th 8th
The precipitous decline in oil prices during 1998 (West Texas Intermediate grade was down by 34 percent over that year) had encouraged several high profile consolidations in the oil and sector. Cost savings, economies of scale, concentration and consolidation of capital spending motivated these. However, Repsols full takeover of YPF was driven by a strategic step to take advantage of a unique opportunity. For Repsol, the acquisition of YPF represented an opportunity to meet a number of its ambitions quickly. It creates an entity with a much better balance in a business sense, given that YPFs upstream business counterbalances an orientation to the downstream. Exhibit 7 shows the impact of the acquisition on Repsols revenue sources. For both companies, the combined entity represented a geographical diversification from focused country-based current operations. The acquisition was fully in line with Repsols four strategic objectives:14 1. Growing Upstream: YPF would strengthen Repsols upstream business; oil and gas reserves would grow by over four times; oil and gas production would rise by 4.3x. 2. International expansion: YPF would triple Repsols presence in Latin America with 50 percent of the new groups total assets. 3. Diversify into gas/power generation: YPF would raise gas production eightfold. 4. Retain domestic market share: YPFs acquisition would complement Repsols dominance of the Spanish market. Synergies Repsols operating management believed that a combination of Repsol and YPF would yield synergies in three areas: Cost savings after tax of $80 million in 1999, rising to $300-350 million by the end of 2000 achieved primarily through merging YPF and Astra. This savings amounted to 1.6 percent of the combined cost base of the two firms in 1998, and compared with
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Himona, Beaver, and Whittock, Repsol-YPF: A Quantum Leap, ABN-AMRO, 6 September 1999.
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7.1 percent savings in the BP-Amoco deal. Some analysts believed that this estimate was too conservative and that the cost savings might amount to $500 million by 2002. More focused capital expenditure. By combining the two entities, the sum of the two companies capital expenditure in the period 1999-2002 could be reduced from $15.6 billion to $13.6 billion, which would conserve cash as well as reduce net interest expense. Better balance between upstream and downstream operations would generate increases in revenues from the enhanced integration and capital efficiency of the new group. These pretax synergies would start at $50 in 1999-2000 and will reach $200 in 2003.
Repsols managers also expected to divest $2.5 billion of noncore assets by 2002. Financial Effects of the Combination Analysts believed that the new company, compared to the old Repsol, would have lower earnings volatility due to its more balanced source of profits (upstream versus downstream). At the same time it would have increased sensitivity to oil prices as a consequence of higher exposure to exploration and production activities. In sum, Repsol-YPF would enjoy lower earnings volatility at the expense of higher oil price sensitivity. The acquisition of YPF by Repsol might increase Repsols financial risk. The cost of capital might increase due to the political and economical risk that operations in an emerging region would bring. If the cost of capital were higher in developing countries than developed countries, then it would seem that YPFs cost of capital would be higher than Repsols. Combining the two firms would therefore result in a higher WACC after acquisition, than for Repsol on a stand-alone basis, since 40 percent of the assets were going to be located in Argentina. Repsols capital structure and cost of capital would both be affected by the transaction. First, the diversification of business activities would affect the perceived operating risk of the new firm. Second, any choice of form of payment and transaction financing would affect the perceived financial risk of the firm. The cost of capital would be affected by leverage choices and investors beliefs about default risk. Exhibit 8 describes the calculation of the WACC for YPF (10.09 percent), Repsol (6.6 percent) and the new firm, Repsol-YPF (8.26 percent, if the all-debt financing alternative were chosen.) After comparing these two numbers, it was clear that the financing structure would determine the new cost of capital for the combined enterprise and therefore the return on investing in Repsol-YPF.
-10Form of Payment
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Repsols management intended to make a tender offer to buy 85.01 per cent of YPFs shares that it did not own, at a price of $44.78 a share. A tender offer was simply a bid to acquire shares of another firm, made directly to the shareholders of the target. Mr. Cortina needed to make a final recommendation on the form of payment: cash or shares of Repsol. A reporter noted, Repsol had always planned to mount a stock rather than a cash offer to secure control of its prey. But with the YPF board opposed, a messy struggle to change YPFs statutes . . . appeared inevitable.15 Spains Endesa had acquired a stake in Enersis in Chile, and attempted to assume control through a change in the bylaws of Enersis, but encountered great difficulty. The cash deal seemed to be the easiest option to implement, because the acquisition could have been made based on the current YPFs by-laws. The difficulty experienced by another Spanish oil firm in trying to do something similar in Chile with a local firm was not too promising a precedent. In a cash transaction, YPFs shareholders would receive a fixed price and would not participate in any additional gains or losses after the acquisition. Depending upon their expectations and uncertainties in the market, this option could be very attractive. This alternative would also represent a legitimate intention from Repsols management to achieve the strategic synergies and to implement the growth strategy in Latin America. However, in view of YPFs and Repsols similar size, it was generally believed that a cash offer would be outside Repsols capabilities. In addition, the short-term balance sheet risk, created by the abrupt increase in the debt level was something that concerned Mr. Cortina. A financing alternative needed to be completed almost simultaniously to the cash offer in order to minimize the balance sheet risk. On the other hand, a stock for stock deal represented important advantages. A stock for stock transaction would not be immediately taxable to YPF shareholders. Depending on the final price and capital gains obtained, YPFs shareholders could prefer a stock deal and avoid taxes in a cash deal. Moreover, a stock-for-stock deal might not be the best alternative given that Repsols shares were under-performing the European market index by 19 percent.
Repsol: The Winner Must Oil the Wheels, Financial Times, accessed at ft.com-Mergers and Acquisitions/Case studies, 27 January 2000.
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-11Financing a Possible Cash Bid
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In order to support a cash bid, Repsol would have to put together a financing consortium to provide $13.4 billion of cash. However, Alfonso Cortina needed to decide which was the most effective way to finance this cash outlay in the long run. The financial staff had analyzed three alternatives to finance the acquisition base on certain assumptions. Alternative 1: Financing with debt Mr. Cortina explored financing a $13.4 billion cash offer by issuing a global bond. The possible terms of such an offer were not completely certain. Cortina asked his finance staff to recommend the possible structure of a globally issued bond including, currency, maturity structure, coupon rate, fixed/floating rate, required yield, covenants, placement, etc. There were many variables to be defined in a short period of time. The success of the bond issue would depend on the current situation in the debt capital markets. Two important crises affected the debt market recently. The first, triggered by the Russia debt moratorium in August 1998, caused a huge outflow of foreign investment from emerging economies, mainly represented by Asian and Latin American countries. The second crisis occurred in early January 1999, when Brazil suffered one of the most dramatic currency devaluations in its history. Once more, investors moved their portfolios to less riskier instruments, such as U.S. treasury bonds. Even though there were many uncertainties in the debt capital markets, Repsols management was aware that debt financing tended to be cheaper than equity. If Repsol were successful in issuing the global bond, its net debt could move up sharply. Repsols Board was eager to capture the value represented by the tax benefits originated from tax shields. Moreover, the decrease in the combined enterprises cost of capital was a factor that would create value for shareholders, especially in a scenario with future acquisitions and capital expenditures already being projected by YPF. Possibly enhancing the chance of debt financing was the fact that Repsol had already proved that it could do a global bond offering. In early February 1999, Repsol issued a global bond for 1.1 billion euros at a cost for the company of 3.81 percent, or only 45 basis points above the benchmark German government five-year bond rate. This was the largest fixed income offer carried out by a Spanish company in international financial markets, and the second-largest ever denominated in euros. The purpose of the issue was to refinance the payment by Repsol for the Argentine governments shares in YPF. Still, Cortina reluctant was to accept the debt offering as the best way to finance the tender offer for YPFs shares. A sudden increase in Repsols leverage would almost certainly trigger a downgrade in Repsols debt ratings and an increase in the cost of debt. Exhibit 9 gives the S&P rating categories associated with different financial ratios. Cortina was determined to maintain a solid investment-grade ratingin fact, he aimed for a rating of no less than a single-A
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during 2000. In addition to the predictable effect on debt rating, increased leverage would undermine Repsols ability to meet unforeseen financing requirements, as they arose. Exhibit 10 presents an assessment of the probability of default for Repsol under the three financing alternatives. YPFs strength in upstream activities meant that the oil price level and trend would be crucial in determining the profitability of the new company. The all-debt option was highly sensitive to price changes since the companys re-payment capacity was strongly linked to the macro conditions in the sector. Among the many others concerns it had, Alfonso Cortina was not sure about investors reaction to this huge offer. There was also uncertainty about the final price or yield of the bond given the recent global financial crises in Russia and Brazil. Was the market ready for financing new investments in emerging markets? Was there liquidity for a $13.4 billion bond offer? How would the market react to the offer? What would a bond issue signal to the investor community? According to the industry practice and to Repsol practice, long-term bonds were the most typical source of finance. In the 1990s, investment-grade corporations issued bonds with maturities ranging from eight to seventeen years, and coupon rates from 6 to 8 per cent. However, Mr. Cortina was aware that market conditions might have changed. In order to keep the investment grade rating, the maturity would have to be shorter, around 5 years and the coupon rate would include a spread of 300 basis points over U.S. treasury, which reflected the uncertainties related to the size of the deal and the timing in the debt capital market. Alternative 2: Financing a cash transaction with an issue of common equity The second option consisted in a bridge loan followed by a global stock issuance16 after the acquisition had been consummated. Although the Latin American debt capital market was showing some signs of recovery after the Brazilian devaluation, with bond yields falling on a fast pace, and the equity capital market bounding to record highs, analysts were not convinced that the financial crisis was completely under control. Even though the outlook for the equity capital markets was cloudy, Mr. Cortina wanted to examine the implications of an equity transaction as an alternative to finance the $13.5 billion. Some significant advantages could attract Repsols shareholders interest. With an allequity financing, the combined enterprise would maintain or expand its unused debt capacity, and as a consequence, would be prepared to take advantage of sudden acquisition opportunities,
A global offering would include listings in the following stock exchanges: Madrid, New York, London, Frankfurt, and Buenos Aires.
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especially considering YPFs strategy of aggressive growth in Latin America. Under this option, Repsol could maintain its coverage ratios and its credit ratings. On the other hand, Repsols Board was concerned about the impact of an all-equity transaction on the cost of capital of the enterprise. How would the benefit of less gearing impact the cost of capital? Would the less-leveraged firm bring more focus on business risk? Repsols shareholders were also concerned not only about the impact on earnings due to the voting dilution but also about the stock price reaction after the announcement of the financing. Demand for Repsol and YPF shares could be seriously affected by investors perception about the future value of the enterprise. An all equity transaction would be highly dependent on Repsols share price. Was Repsols stock being traded at a fair value? Overvaluation or undervaluation of the stock could bring key information about managements perception regarding the value of the new enterprise. Exhibit 11 shows YPFs and Repsols historic stock prices. Another issue that concerned management about the all-equity option was which type of investor would be the target clientele for Repsols new shares. At the time of deciding between an all cash or all paper offer, it was clear that exchanging the YPF shares for paper in Repsol a Spanish OECD-based company would have led to a large proportion of those holders selling their Repsol shares after the deal since most of YPF shares were hold in emerging markets funds where they will not classify anymore. It was not clear how the market would view the combined company with 50 percent assets in developing countries. Assessing this was key to determine the potential demand and success of the new shares offering. Alternative 3: Finance a cash offer with a mix of debt and equity A possible third option consisted of a mix of equity, equity-linked instruments, and debt. The finance staff modeled the following structure: 1. A global syndicated bank loan would finance the cash offer. This loan would be repaid by a series of issuances of long-term securities: 2. Issue of $7.5 billion of common equity within 6 months of the transaction. 3. Refinance the remainder of the debt with $6 billion of long-term public debt issues. This would occur in a 12-18 month timeframe. This debt would carry a 9 percent coupon rate at an A-rating, assuming Repsol could a meet the requirements for that rating. This alternative was by far the more complex, and would need to be completed in more than one phase. Less reliance on equity financing would reduce the dilution in earnings per share for the current Repsol shareholder. But it would also result in higher leverage. This alternative, while bringing the advantages and disadvantages of the two pure ones, also added a timing type concern. Given the complexity of the transaction, it required a medium
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term schedule of debt and equity issuances that would keep management busy in order to correctly launch each transaction. This fact could bring anxiety to the market that would prefer management to focus more on the implementation of the merger and less on the financial side of the deal. Exhibit 12 provides a valuation analysis for the combined enterprise. Exhibit 13 presents the balance sheet for Repsol-YPF under the all-equity and all-debt alternatives. Exhibit 14 presents an analysis of potential EPS dilution under the all-debt alternative. Exhibit 15 gives comparative financial information on peer firms in the oil sector. Conclusion Alfonso Cortina reviewed the analysis and assembled data. It remained for him to examine the tradeoffs among the alternatives and make a recommendation. He would want to give special attention to how he should frame his recommendation to Repsols board of directors. Strategic goals would be a significant influence on their willingness to endorse a recommendation. All of this would need to occur quickly, to pre-empt any actions by competitors, and any turbulence in capital markets and oil markets.
-15Exhibit 1 STRUCTURING REPSOLS ACQUISITION OF YPF S.A. Structuring Repsols Acquisition of YPF S.A.
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Oil Price, US Dollars per Barrel, Brent Crude
30
28
26
24
22
20
18
16
14
12
10
Source: Bloomberg Financial Services.
-16Exhibit 2 STRUCTURING REPSOLS ACQUISITION OF YPF S.A. Information on Selected Recent Jumbo M&A Transactions
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Buyer Target Announcement Date Value of equity bid only ($ bn) Value of equity bid and debt assumed ($ bn) Form of Payment Accounting
Exxon Mobil 1-Dec-98 $78,945 $86,399 Stock Pooling
Exxon received right to acquire 14.9% of Mobil at 3.1% discount from offer price.
British Petroleum Amoco 11-Nov-98 $48,174 $55,040 Stock Pooling
Amoco granted BP an option to acquire up to 19.9% of shares at 72% discount from offer price.
BP Amoco Atlantic Richfield 1-Apr-99 $27,233 $33,702 Stock Purchase
Repsol YPF TBA $13,152 $17,437 TBA TBA
14.99 % pre-existing stake from Argentine government auction
Lockup Option
none
Attitude Valuation Multiples Price/Book Price/Earnings Ent. Val./Sales Ent. Val./EBITDA Ent. Val./Opng. Income Premium of Bid over stock price 4 weeks prior
Friendly 4.19 27.89 1.37 na 5.28 32%
Friendly 3.07 23.18 1.60 9.33 16.66 22%
Friendly 3.53 nmf 3.12 133.20 na 54%
Unsolicited 2.19 27.31 3.65 9.41 na 42%
Source: Securities Data Company, Merger and Acquisitions Transactions Database.
-17Exhibit 3 STRUCTURING REPSOLS ACQUISITION OF YPF S.A.
Repsol Financial Statements
Balance Sheet Cash Accounts Receivable Inventory Total Current Assets Total Non-current Assets Total Assets Accounts Payable Short Term Debt Total Current Liabilities Total Non-Current Liabilities Total Liabilities Minority Interest Shareholders' equity Total Liabilities&Shareholders' equity Income Statement Net Sales Cost of Sales Operating Income Amortization of Goodwill Other income (expenses), net Net Financial Items Net Income before tax Income Tax Minority Interest Net Income before preferred stock dividends Net Income Shares Outstanding Earnings per share Cash Flow Cash Flow from Operating Activities Net Income Adjustments Depreciation and Amortization Change in assets and liabilities Net Cash Flow from Operating Activities Cash Flow from Investing Activities Acquisition of Fixed Assets Acquisitions of Long-Term Investments and Intangible Assets Net Proceeds on Sale of Investments Other Net Cash Flow from Investing Activities Cash Flow from Financing Activities Proceeds from Loans Dividends Paid Payments of Loans Other Net Cash Flow from Financing Activities 1996 21,891 (20,325) 1,566 (7) (11) (64) 1,484 (436) (109) 939 939 300 3.13 1996 939 1,096 952 (343) 2,644 (1,707) (96) 146 (96) (1,753) 633 (490) (164) 637 616 1997 1,088 2,907 1,365 5,360 12,884 18,244 3,520 1,716 5,236 4,382 9,617 1,873 6,754 18,244 1997 21,920 (20,324) 1,596 (26) 39 (171) 1,438 (416) (161) 861 861 300 2.87 1997 861 1,081 1,157 (58) 3,041 1,962 (1,368) 404 (138) 860 2,368 (508) (1,507) 568 920
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1998 1,144 3,185 1,142 5,472 13,033 18,505 3,674 2,574 6,248 3,617 9,866 1,629 7,010 18,505 1998 22,227 (20,285) 1,942 (28) (62) (200) 1,652 (465) (162) 1,025 1,025 300 3.42 1998 1,025 1,255 1,262 25 3,567 (2,017) (485) 265 (93) (2,330) 637 (605) (979) 811 (136)
$
$
$
Exchange Rate $/Pta
1996 127
1997 146
1998 155
-18Exhibit 4 STRUCTURING REPSOLS ACQUISITION OF YPF S.A. YPF Financial Statements
Balance Sheet Cash Accounts Receivable Inventory Total Current Assets Total Non-current Assets Total Assets Accounts Payable Debt (S+L) Total Current Liabilities Total Non-Current Liabilities Total Liabilities Minority Interest Shareholders' equity Total Liabilities&Shareholders' equity Income Statement Net Sales Cost of Sales Gross Profit SG&A Operating Income (EBIT) Income on Long-term investments Other income (expenses), net Net Financial Items Net Income before tax Income Tax Minority Interest Net Income before preferred stock dividends Dividend requir.on pref.stock of controlled companies Net Income Shares Outstanding Earnings per share Cash Flow Cash Flow from Operating Activities Net Income Adjustments Depreciation and Amortization Change in assets and liabilities Net Cash Flow from Operating Activities Cash Flow from Investing Activities Acquisition of Fixed Assets Acquisitions of Long-Term Investments and Intangible As Net Proceeds on Sale of Investments Other Net Cash Flow from Investing Activities Cash Flow from Financing Activities Proceeds from Loans Preferred Shares Redemption Payments of Loans Dividends Paid Net Cash Flow from Financing Activities 1996 90 1193 282 1,565 10,519 12,084 886 1,485 2,371 3,189 5,560 150 6,374 12,084 1996 5,937 (3,616) 2,321 (782) 1,539 25 (93) (246) 1,225 (369) (12) 844 (27) 817 353 2.31 1996 817 1,065 810 2,692 (1,817) (76) 43 28 (1,822) 1,964 (281) (2,261) (293) (871) 1997 142 1132 324 1,598 11,163 12,761 882 2,088 2,970 2,698 5,668 153 6,940 12,761 1997 6,144 (3,730) 2,414 (782) 1,632 37 (50) (239) 1,380 (479) (15) 886 (9) 877 353 2.48 1997 877 1,093 75 2,045 (1,593) (151) 50 39 (1,655) 52 (63) 0 (319) (330) 1998 70 1177 308 1,555 11,591 13,146 788 1,634 2,422 3,364 5,786 151 7,209 13,146 1998 5,500 (3,594) 1,906 (760) 1,146 26 (44) (264) 864 (264) (11) 589 (9) 580 353 1.64 1998 580 1,061 (1) 1,640 (1,351) (122) (67) 31 (1,509) 115 0 0 (326) (211) 1999E 88 1070 329 1,487 11926 13,413 839 1652 2,491 3230 5,721 160 7532 13,413 1999E 5,649 (3,594) 2,055 (760) 1,295 25 (15) (316) 989 (306) (10) 673 (2) 671 353 1.90 1999E 671 1,131 247 2,049 (1,400) (129) (71) 33 (1,567) 0 0 (100) (349) (449) 2000E 279 1193 362 1,834 12369 14,203 935 1668 2,603 3425 6,028 171 8004 14,203 2000E 5,846 (3,594) 2,252 (760) 1,492 45 (18) (280) 1,239 (382) (12) 845 0 845 353 2.39 2000E 846 1,230 67 2,143 (1,600) (137) (75) 34 (1,778) 0 0 200 (373) (173)
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2001E 409 1316 400 2,125 12824 14,949 1031 1684 2,715 3419 6,134 185 8630 14,949 2001E 6,128 (3,594) 2,534 (760) 1,774 50 (35) (285) 1,504 (466) (13) 1,025 0 1,025 353 2.90 2001E 1,025 1,323 76 2,424 (1,700) (145) (80) 36 (1,889) 0 0 0 (399) (399)
-19Exhibit 5 STRUCTURING REPSOLS ACQUISITION OF YPF S.A. YPF Shareholding Structure as of December 1998
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YPF shares outstanding included 353,000,000 shares of common stock, with a par value of Argentine 10 pesos and one vote per share, which were fully subscribed, paid-in and authorized for stock exchange listing. There had been no change in the number of shares since YPFs privatization in 1993. At the end of December 1998, YPFs shares were divided into four classes, as detailed below: Owner Government (1) Provinces Employees (2) Public (3) Number of Share 72,602,289 16,552,797 1,505,475 263,339,439 Type of Share Class A Class B Class C Class D Percent of Capital Stock 20,56% 4,68% 4.26% 70.5%
(1) The Argentine Government owned one golden share and could retain it indefinitely and for a minimum of three years. (2) Shares had been set aside for purchase by YPFs employees, in an amount equal to 10 percent of total capital, at a price of $19 per share. In July 1997, these were sold to the public. (3) 50 percent of the public shares were held by U.S. investors, typically in emerging market funds. YPF Shareholding Structure as of February 1999 In January 1999, the Argentine Government sold to Repsol 52,914,700 Class A shares in block (14.99% of YPFs shares) at $ 38 per share, which were converted to Class D shares. Owner Government (1) Provinces Repsol Employees Public Number of Share 19,687,589 16,552,797 52,914,700 1,505,475 263,339,439 Type of Share Class A Class B Class D Class C Class D Percent of Capital Stock 5,57% 4,68% 14.99 % 4.26% 70.5%
(1) The Argentine government kept the golden share.
-20Exhibit 6 STRUCTURING REPSOLS ACQUISITION OF YPF S.A. Capital Market Conditions, 5 April 1999
Treasury Obligations 90-day bills 1-year notes 5-year notes 10-year bonds 30-year bonds Other Instruments FED Discount Rate Commercial Paper 60 days 90 days Certificates of Deposit CD 3 months CD 1 year LIBOR Libor 3 months Libor 6 months Libor 12 months Bank Prime Rates Argentina United States US Yields 4.38% 4.66% 5.05% 5.18% 5.62% Yield 4.75% 5.03% 5.04% 4.87% 5.05% 5% 5.05% 5.24% 8.73% 7.75% Spanish Yields 2.77% 2.84% 3.47% 4.24% 5.14%
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Source: Bloomberg Financial Services Date Long-Term Rating Sovereign Argentina Apr-97 BB Brazil Jan-99 B+ Chile Jul-95 AColombia May-98 BBBCosta Rica Jul-97 BB El Salvador Apr-99 BB+ Indonesia Mar-99 CCC+ Mexico Oct-98 BB Peru Dec-97 BB Russia Jan-99 Default South Africa Mar-98 BB+ Spain Mar-99 AA+ United States Jun-89 AAA Venezuela Aug-98 B+ Source: Standard&Poor's - Sovereign Ratings History, April 1999
-21Exhibit 7 STRUCTURING REPSOLS ACQUISITION OF YPF S.A. Distribution of Repsol Revenues before and after the Transaction
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Change in Mix
R&M - Chemicals
53% 45% 25% 42% 22% 13%
20%
Gas E&P 25% 42%
E&P
Repsol Combined
Gas
0%
40%
60%
R&M - Chemicals 53% 45%
Repsol Combined
22% 13%
Percentage of Sales
Note: E&P stands for Exploration and Production segment of activities. R&M-Chemicals stands for the Refining, Marketing, and Chemicals segment.
Source: Quantum Leap, ABN-Amro Bank, 1 September 1999.
-22Exhibit 8 STRUCTURING REPSOLS ACQUISITION OF YPF S.A. Estimation of WACC for Repsol Acquisition of YPF
Repsol in Spain (stand-alone) Pre Tax Cost of Debt % Tax Rate % Post Tax Cost of Debt % Asset Beta Beta in local market Risk Free Rate % for U.S. $ investment Country Beta versus U.S. Market Adjustment to U.S. Risk-Free Rate for Country R Global Equity Market Risk Premium Cost of Equity % D/C E/C WACC % Market Value Weight Repsol and YPF Market Values 5.9% 34% 3.9% 0.26 0.8 5.00% 1.15 1.00% 6.00% 11.52% 65% 35% 6.60% 14,890 57% YPF in Argentina (stand-alone) Merger & Changes in leverage
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Combined Repsol-YPF 9% 34% 5.9%
6.0% Reflect change in debt rating 34% no change 4.0% 0.40 0.75 5.00% 2.00 3% 6% 17.00% 53% 47% 10.09% 11,390 43% 0.32
1.21 5% 1.52 1.9% 6% 17.85% 80.5% 19.5% 8.26%
Note: For the sake of illustration, the estimate in the right-hand column assumes that Repsols acquisition of YPF has been financed entirely with debt. The model accompanying this case may be varied to accommodate a variety of financing possibilities. See Exhibit 13, and enter desired amounts in the Financing Alternatives cells. Repsols historical pretax cost of debt had averaged close to 5.9 percent in 1996-98 (3.9 percent after tax.)1 Going forward, the forecasts indicated an average cost of debt of 3.9 percent after tax for 1999-2003, for Repsol on a standalone basis. Spanish government bonds were returning 5.2 percent; Repsols beta was 0.8 and the Spanish market risk premium was 3 percent. WACC Calculation Methodology The financial forecasts are given in U.S. dollars. Therefore, the appropriate WACC is a dollar-based estimate, but reflecting the risks associated with doing business in Spain and Argentina. Estimating a WACC across borders must account for differences in political risk (through the political risk premium (pi) added to the U.S. risk-free rate), and equity market risk (through the use of a country beta that is multiplied times the b...