Fin 671: Kerr-McGee
The goal of this case: Icahn and Rosenstein were buying at ~$60 and expected the price to go to $90 (page 6). Does this seem reasonable? What are they thinking?
1. Kerr-McGee's stock price was $57.79 at the end of 2004. Using a multiples analysis, does KerrMcGee's stock appear to have been undervalued? Assume that Kerr-McGee's chemical business has an enterprise value of $1.5 billion. Please explain any modeling choices you make.
2. What is the NPV of the proposed volumetric production payment (VPP) plan? This plan essentially locks in a price and full upfront payment. K-M is then on the hook to deliver the promised barrels over the specified time.
All revenue from barrels sold in this program is received today in cash-no matter when the oil is actually delivered. Assume the price received per barrel is $35.
There is no cash outflow in year 0. Each year from 1-5, there are cash outflows from two sources: lifting costs and taxes.
Assume lifting cost today (year 0) is $5/barrel and it increases 7% each year (see Ex. 10).
Even though the cash from oil sales is received today, from an accounting perspective, the revenue is not recognized until the oil is delivered. Hence, there is revenue in years 1-5 to go along with the lifting costs. Use this to figure out taxes paid each year. Tax rate is 35%.
Assume a discount rate of 8%.
3. What is the NPV of exploration per barrel of oil found? In other words, if you begin exploring today, what is the NPV of all the costs and benefits by the time a barrel of oil found is completely sold. There's a lot here, but we're trying to come up with realistic numbers.
You need to make assumptions about the length of the exploration, development, and production periods as depicted in Figure B. As a first pass, assume it takes 1 year to find, 4 years to develop, and 8 years to produce a given barrel of oil.
Assume the same lifting cost structure from question 2.
For finding and development costs, use the average value for Kerr-McGee over the last 3 years (02-04)-see Exhibit 7. As with lifting costs, assume these grow at 7% per year.
Assume 75% of exploration/finding costs is expensed immediately (year 1) due to dry wells (top of page 4), while 25% is capitalized and depreciated on a straight-line basis over the production period. (This means there will be a 4 year gap between the capital spending of this 25% and the start of its depreciation.)
Development expenditures are spread over the development period (i.e., 1/4 of the relevant year's development cost each year). These, too, are summed and depreciated on a straight-line basis over the production period.
Assume production is equally spaced over the production period-i.e., 1/8 of a barrel is sold each year during the production period. So accounting revenues occur only during the 8 years of production.
Assume the price of oil remains at today's $50 (Exhibit 13) for the foreseeable future, and that royalty payments and other costs mean Kerr-McGee only gets 80% of this price as revenues.
Assume a discount rate of 8%.
4. Take your best shot at using a sum-of-the-parts analysis to estimate Kerr-McGee's stock price. You will need to decide what the "parts" are. Consider the VPP one "part." Note that the VPP does not use up all of Kerr-McGee's reserves. K-M's total reserves are broken down into developed and undeveloped in Exhibit 7. The VPP uses up some of these developed reserves. If the VPP is worth X, what's a reasonable estimate for the rest of the developed reserves? Qualitatively, what should the undeveloped reserves be worth?