2.1. Shareholder value and its creation

2.1. Shareholder value and its creation

The concept of shareholder value is central in understanding the dynamics of the Saga/Hydro takeover.[8] It is a hypothesis of this paper that the board and management of Saga had as an overriding objective to maximize “shareholder value” of Saga at the expense of other aims.[9] This implied that they sought by a variety of means to increase the share price of the company and a number of the actions they took (or did not take) can best be understood in this light. Hydro’s bid for Saga can also be understood in a similar light even if the goals pursued by Hydro were somewhat more complex.

A key question is how shareholder value is created in the upstream oil business. There are many theories as to what creates shareholder value and to what constitutes the best “proxy” variables for measuring such value. We will assume that an increase in the expected net present value of a company will increase the value for its shareholders. [10]

I will concentrate on three special factors (size, state ownership, M&A) that directly or indirectly are believed to create value in the petroleum industry and which had an influence on our case study.

2.1.1. Size

In the oil industry there was (and still is) a strong and dominant belief that increasing the size of a company is a critical way of having a positive effect on its shareholder value.[11] It is argued that increased size will:

  • Drive down costs through synergies; normally expressed through Finding and Development costs per barrel.
  • Spread risks.
  • Secure better access to exploration acreage and prospects for expanding the business either through organic growth, partnerships or M&As activities.
  • Recruit superior human resources.
  • Gain more access to project opportunities globally.

Empirically there are clear differences between “super majors” and the medium-sized/smaller players in the oil industry. The “super majors” have a market valuation, rate of return, growth prospects and general outlook that is much better than for other and smaller companies.

The conclusion that “big is beautiful” was strengthened during 1998/99 by developments in the real world. Partly in response to dramatically lower prices (in October 1998 the price of crude fell below USD 10/bbl), there was an acceleration of industrial restructuring. The 1998/98 period was characterized by an intense wave of mergers and acquisitions that had a profound effect, setting the mental agenda of decision-makers both inside and outside the industry. It became “normal” for companies to merge or acquire other firms in order to increase size.

Source: Goldman Sachs

Fig.2.1 M&A activity in the petroleum industry 1990-2002

Fig. 2.1 shows that 1998/99 was the absolute high point of M&A activities in the petroleum industry in the 1990s. In addition to the mega-mergers (Exxon/Mobil; BP/Amoco/Arco and Total/Fina [Elf joined the group in the autumn of 1999]) there were also an accelerating number of mergers/takeovers among smaller companies. In addition there was a process of industrial consolidations under way in the European energy scene that pointed to the creation of a handful of very large integrated energy companies. (The two German companies RWE and E.ON as well as a “French champion” based on EdF/GdF to name the most important).

During the winter of 1999 a debate started in Norway that influenced the “mental maps” of key decision makers both in the companies and in the government and that further strengthened the belief that there was a direct correlation between the size of a firm and its ability to deliver positive results. Statoil argued strongly that the company should gain full control of the “State’s Direct Financial Interest” (SDFI). The reason given was that the absolute “size” (and concentration) of a company’s portfolio was key variables for its success, as this would bring down costs and increase efficiency.[12]

There is a “revisionist” school of thought on size that argues that the causality of the above argument is wrong. Firms in the petroleum sector do not achieve growth in shareholder value because they are large; rather they are large because they are efficient.[13] But this kind of argument never carried much weight in the Norwegian debate.

2.1.2. State ownership

State involvement is seen by the financial market as a negative factor – the larger the state’s share the more limited the possibility for shareholder growth. A large state ownership implies:

  • Less liquidity in the share.
  • A constant suspicion that the state, because it has different aims from private investors, will intervene in business decisions to the detriment of the shareholders, no matter how many statements are made to the contrary.[14]

2.1.3. Value creation in mergers and acquisitions (M&A)

M&A has become the standard mechanism by which to try to increase the size, the growth rate and margins of a company in the oil industry. [15] To gain control of an independent, publicly listed firm, an acquirer has to offer the target firm’s shareholders a “control premium”[16]. This means that for the acquirer’s shareholders to benefit, the value of the target has to increase by more than the value transferred in the premium.

The increased value of the acquisitions primarily comes from synergies, i.e. cost reductions in areas where the acquirer and the target have overlap or duplication in their operations. (Hydro and Saga had overlap in their activities and therefore could create such synergies). The financial markets almost exclusively centre their attention on cost (or “solid”) synergies. Investors generally ignore all “revenue synergies” as these tend to be much harder to quantify and take longer to achieve than cost savings. “Strategic synergy effects” are often used as a rationale for mergers. The financial markets tend to ignore such effects, again because they are very difficult to measure.

Value through M&A activities can also be created via a control premium. The idea is that the acquired firm has been badly run and that a new management will improve the return on existing assets.

A third way to create value in M&A is through financial optimisation, mainly though the tax-system.

The additional value that is created in a takeover will be divided between the buyer and the seller. (The government can also play a role through taxing the additional value.) International empirical data suggests that the sellers of shares in takeover situations gain significantly, while buyers very often end up paying too much and hence lose on the transaction.[17] How would we know whether Hydro paid the right price for Saga? A first way to find out would be to observe Hydro’s stock price after the deal was announced. If Hydro paid more than Saga was worth, Hydro’s shares would be expected to drop in a one-time correction. Alternatively, if Hydro paid less than Saga was worth, Hydro’s shares would rise.[18]

The post-deal development in the price of Hydro’s shares was important not only for Hydro’s shareholders, but also for Saga’s shareholders who would receive payment for the company partly in Hydro shares.

Another way is to observe the effect of the takeover for the acquirer is to examine earnings per share (EPS) for Hydro before and after the takeover.

[8] ”Shareholder value” is defined as the market capitalization of a firm expressed by its stock market price times the number of outstanding shares. Shareholder value is a residual claim on the value created in an enterprise. All other factors of production are remunerated at “opportunity cost”, while the shareholders collect the rent (or take the loss) associated with an activity.[]

9We assume that the maximization of shareholder value is equivalent to the maximization of the value of the firm. There are also a number of alternative objectives that a firm can pursue for example the welfare of its employees; the firm’s contribution towards society in general; its long term strategic position. For a further discussion of the relationship between different goals, see section 4.1 below. []

10 The calculation should be done at “consensus” prices and discounted at the company’s cost of capital.[]

11 For a comprehensive overview of this position, see Thierry Desmarets. 2002. “Oil and gas outlook: Does size matter?”. Paper delivered at Sanderstølen Conference. February 7, 2002.[]

12 Since Statoil at that time was not a listed company it is difficult to relate the process to maximization of “shareholder value”, but the underlying thinking is the same.[]

13 The key to success is to have maximum efficiency in whatever size you are today and not at all costs grow in size. This school of thought argues that there are success-firms of every size and within every industry and that it is as important to maximize the utilization of existing investments as it is to grow. Internal transaction costs of the present mega-firms will inevitably grow and force a rethink. In addition there is likely to be reactions from the political community that will stop further “mega-mergers”. See HSBC 2001. “Integrated oil and gas; exploding the myths”. February 2001.[]

14 Sceptics of this view would e.g. point to the state’s ownership in Hydro which has been very much “hands off” to the extent that Hydro in some circles suffered from the opposite perception; namely that the company was too “management run”. []

15 This is in contrast to a strategy of “organic growth” which during the late 1990s was not the preferred strategy of the oil industry. This has recently changed as the amount of M&A activity in the industry has dramatically decreased and the importance of “organic growth” is again being stressed.

[16] In 2000 the median control premium in the 20 largest M&A deals announced globally was 49 percent. This figure has been surprisingly constant over the last 20 years. Cf. Gaughan, Patrick A. 2002. Mergers, acquisitions and corporate restructurings. New York: John Wiley and Sons, p.527. In the Saga/Hydro case it was 35 percent. In a “merger of equals” there is no control premium.

[17] US data suggests that acquiring firm shareholders tend to earn zero or negative returns from mergers. Gaughan, Patrick A. 2002. op. cit., p.324.[]

18 Note that because on average an acquirer’s stock price will decrease, the market’s first reaction to any deal is to send the acquirer’s stock price down. The possible up and down movement of Hydro’s shares referred to in the text would therefore be superimposed on this negative basic sentiment in the market.

Publisert 25. nov. 2010 13:52