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Exxon Might Derail Chevron's $60 Billion Megadeal. Is the Oil Stock Still a Buy?

Motley Fool - Wed Feb 28, 4:05AM CST

Last October, Chevron(NYSE: CVX) made a bold move to counter a similar one by rival ExxonMobil(NYSE: XOM). It agreed to acquire Hess(NYSE: HES) in a $60 billion megadeal shortly after Exxon decided to buy Pioneer Natural Resources for $64.5 billion. The main draw was Hess' 30% stake in the Exxon-operated Stabroek block offshore Guyana. It would help enhance and extend Chevron's growth outlook into the 2030s.

However, Exxon and its other partner in Guyana, China's CNOOC, now say the deal will trigger a change-of-control provision, enabling them to increase their stakes in Stabroek. This issue could delay or potentially derail Chevron's deal to acquire Hess. Here's a closer look at the situation and whether Chevron would still be a good oil stock to buy if it can't acquire Hess.

Drilling down into the issue

When Chevron unveiled its megadeal for Hess, the oil company highlighted: "The acquisition of Hess upgrades and diversifies Chevron's already advantaged portfolio. The Stabroek block in Guyana is an extraordinary asset with industry-leading cash margins and low carbon intensity that is expected to deliver production growth into the next decade." The company noted that the deal would give it a 30% interest in that block, which contains more than 11 billion barrels of oil equivalent discovered recoverable resources. The field produces high cash margins, has a strong production growth profile, and has potential upside from future oil discoveries. It drove Chevron's view that the deal would increase its estimated production and free-cash-flow growth rates over the next five years while extending its growth outlook into the 2030s.

Chevron is now warning that Exxon and CNOOC are considering using their right to counter its offer for Hess' stake in the project. According to a joint operating agreement signed a decade ago when Hess bought its stake from Shell, the existing partners have the right to participate in a potential ownership change with a preemptive offer.

Chevron doesn't believe its deal for Hess triggers a change of control because it's buying the entire company and not just its stake in Stabroek. Hess also has a meaningful operation in the Bakken, assets in the Gulf of Mexico, and a Southeast Asian natural gas business. Those operations are also a strong strategic fit for Chevron because it also operates in the Gulf and Southeast Asia, while the Bakken would enhance and diversify its operations in the U.S.

While Chevron doesn't believe Exxon and CNOOC have the right to preempt its offer for Hess' Stabroek position, their claim could delay or derail the deal. Chevron is currently in talks with the two companies. If those talks fail, it could pursue arbitration. It currently remains committed to the merger despite this latest issue. There are also growing geopolitical concerns after Guyana's neighbor, Venezuela, has laid claims to a large portion of Guyana. It has threatened to annex that land, which would also give it control over the offshore oilfields. That could disrupt operations.

An enhancement, not the thesis

Acquiring Hess would enhance and extend Chevron's already strong growth outlook:

A slide showing how Hess would enhance and extend Chevron's growth.

Image source: Chevron.

As that slide shows, it would provide the company with the fuel to grow production into the 2030s as Exxon completes additional phases of development in Guyana. Meanwhile, the deal would more than double its free cash flow by 2027, assuming oil averages around $70 a barrel (below the current price).

However, while acquiring Hess would certainly bolster Chevron's ability to grow shareholder value, the company is in a strong position without Hess. It currently expects to grow its free cash flow by more than 10% annually through 2027, assuming oil averages $60 a barrel (well below the current price point). Fueling that plan is its focus on investing in high-return capital projects. Chevron has a strong portfolio, with high-return projects currently underway in places like the Permian Basin, Gulf of Mexico, and Kazakhstan. It also has growing renewable diesel and chemicals businesses.

Chevron's existing operations give it strong and growing cash flows to invest in high-return capital projects, pay a rising dividend (Chevron increased its payout by 8% earlier this year), and repurchase a meaningful amount of shares. Chevron can repurchase $10 billion to $20 billion in shares annually (it can achieve the low end at $60 oil and the high end when crude is over $70). That's enough to retire 3% to 6% of its outstanding shares each year. Chevron's rising production, cash flow, and cash returns position it to grow value for investors in the future.

A setback but not a thesis killer

Acquiring Hess would enhance Chevron's near-term growth while extending its visibility into the next decade. However, even if that deal falls apart, the oil company can still create a lot of value for shareholders in the future. Because of that, it still looks like an attractive buy even if it ends up abandoning its deal for Hess.

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Matt DiLallo has positions in Chevron. The Motley Fool has positions in and recommends Chevron. The Motley Fool recommends Pioneer Natural Resources. The Motley Fool has a disclosure policy.

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