ConocoPhillips / Marathon Oil Corporation: (NYSE: COP to acquire NYSE: MRO in 4Q24): HOLD COP; BUY MRO

STOCK OVERVIEW: ConocoPhillips (NYSE: COP) is one of the world’s largest independent exploration and production (E&P) companies, focusing on upstream oil and gas operations.

Headquartered in Houston, Texas, it operates in 15 countries, including the United States, Norway, Canada, Australia, and several others. The company's main activities involve the exploration, production, transportation, and marketing of crude oil, bitumen, natural gas, liquefied natural gas (LNG), and natural gas liquids. As of 2023, ConocoPhillips had proved reserves of 6,758 million barrels of oil equivalent, with significant production in the United States, Norway, Canada, and Australia. The company also holds a prominent position in the industry, ranking 156th on the Fortune 500 and 83rd in the 2023 Forbes Global 2000. Additionally, ConocoPhillips has been acknowledged for its diversity and employment practices.

However, despite its achievements, the company was ranked as the 14th most polluting company in 2019, responsible for 0.91% of global industrial greenhouse gas emissions from 1988 to 2015.

Segments include: Crude Oil (69.76% of LTM “Sales and Other Operating Revenues,” Ended 1Q24); Natural Gas (14.85%); Natural Gas Liquids (4.70%); where Other composed 10.69% of these revenues. Geographically, the company derived these sales from: United States (80.25% LTM “Sales and Other Operating Revenues,” Ended 1Q24); Canada (5.62%); Norway (4.32%); and Libya (3.37%); UK (2.95%); Malaysia (1.75%); China (1.75%); Other Foreign Countries (0.01%).

Marathon Oil Corporation (NYSE: MRO) based in Houston, Texas, is an independent (E&P) company focused on significant oil-rich resource plays in the U.S., including the Eagle Ford in Texas, Permian in New Mexico, STACK and SCOOP in Oklahoma, and the Bakken in North Dakota. The company also has a world-class integrated gas business in Equatorial Guinea. Marathon Oil had estimated proven reserves of 972 million barrels of oil equivalent as of December 31, 2020, with 86% in the U.S. and 14% in Equatorial Guinea. In 2020, it sold 383 thousand barrels of oil equivalent per day. The company emphasizes environmental, social, and governance (ESG) issues and communicates its sustainability efforts through its annual sustainability report.

Segments include: Crude Oil & Condensate (82.22% of LTM “Revenues from Contracts with Customers,” Ended 1Q24); Natural Gas Liquids (10.22%); Natural Gas (7.26%); Other (0.30%).

Geographically, the company derived these sales from: Eagle Ford Shale (39.07% LTM “Revenues from Contracts with Customers,” Ended 1Q24); Bakken Shale (35.83%); Permian (Northern Delaware Basin, TX) [11.98%]; Oklahoma (8.09%); International (Equatorial Guinea) [4.08%]; Other US (0.96%). As such most of their oil comes from Eagle Ford (Texas) and Bakken (North Dakota).

The financial models used in this report aim to describe and track the forecasted development of COP and MRO sales revenues, expenses and profits, within the context of this merger. These models describe both companies at a quarterly level, out to FY 2026. At the end of 4Q24, COP will acquire MRO. Beginning 1Q25, the companies are set to start merged operations.

NEWSFLOW: This report marks the beginning of coverage of the merged entity. On May 29, 2024, in their press release upon this issue, “ConocoPhillips (NYSE: COP) and Marathon Oil Corporation (NYSE: MRO) announced today that they have entered into a definitive agreement pursuant to which ConocoPhillips will acquire Marathon Oil in an all-stock transaction with an enterprise value of $22.5 billion, inclusive of $5.4 billion of net debt. Under the terms of the agreement, Marathon Oil shareholders will receive 0.2550 shares of ConocoPhillips common stock for each share of Marathon Oil common stock, representing a 14.7% premium to the closing share price of Marathon Oil on May 28, 2024, and a 16.0% premium to the prior 10-day volume-weighted average price.”

We understand this to mean that at the time of the merger, ConocoPhillips will issue however many shares of (NYSE: COP), such as to achieve a ratio of 0.255 COP/MRO. What this means is that for every single share of MRO outstanding on that date (the “Effective Time”) (some time in 4Q24, as we’ll later see – “The transaction is expected to close in the fourth quarter of 2024.”), ConocoPhillips will issue 0.255 shares of stock in order to fund the deal whereby they will effectively acquire Marathon Oil, and it will be merged into the operations of ConocoPhillips as a subsidiary of ConocoPhillips. Mathematically, we will assume a closing date at the end of 4Q24, so effectively December 31, 2024, for the intents and purposes of our analysis.

This occurs when Marathon acquires Puma Merger Sub Corp., which is a wholly owned subsidiary of ConocoPhillips. By this mechanism, Marathon effectively takes the place of Puma Merger Sub Corp., and becomes, itself, a wholly owned subsidiary of ConocoPhillips. The funding for the merger is provided by issuance of ConocoPhillips stock, as we’ve described, in an all-stock deal.

GUIDANCE/MERGER FORECASTS: Over the fiscal quarters, 1Q18 through 1Q24, we saw compound quarterly growth rates (CQGRs) in COP’s key business segments of the following: Crude Oil (CQGR = 3.24%); Natural Gas (-1.64%); Natural Gas Liquids (4.60%); Other (1.11%). With regard to the growth in their geographic segments, we saw the following: United States (3.05%); Canada (1.62%); China (-0.10%); Libya (2.51%); Malaysia (-1.14%); Norway (-0.25%); United Kingdom (-2.86%). Over the same period, we saw the following for MRO: Crude Oil and Condensate (-0.18%); Natural Gas Liquids (NGLs) [1.59%]; Natural Gas (0.48%); Other (-3.47%). With regard to their geographic segments, we saw the following: Eagle Ford (0.76%); Bakken (1.62%); Oklahoma (-1.80%); Permian (Northern Delaware Basin, TX) [5.26%]; Other U.S. (-5.50%); International (Equatorial Guinea) [-5.14%]. See financial models included for forecasts.

With regard to Total Revenue, ConocoPhillips exhibited a compound quarterly growth rate of 2.02% from 1Q18 to 1Q24.

Marathon, on the other hand, has demonstrated a compound quarterly growth rate of -0.46% on Total Revenue from 1Q18 to 1Q24. As such, we can see that ConocoPhillips is the faster-growing company. However, interestingly, Marathon does offer a compound quarterly growth rate of 5.26% (1Q18 to 1Q24) on their sales from the Permian Basin, as such that is their main growth area.

With the acquisition of MRO, COP will gain a fast-growing footprint in the Permian Basin (Northern Delaware Basin, in Texas), coupled with an increased focus on crude oil, by percentage of sales, overall. With this merger, we even see improvements to the combined company’s margins. Within 1Q25, we may expect to see Gross Profit Margin go up by 1.98%; Operating Profit Margin go up by 1.45%; EBITDAX Margin go up by 1.57%; EBITDA Margin go up by 1.51%; EBIT Margin go up by 2.48%; Earnings Before Tax Margin go up by 2.90%; and Net Profit Margin increase by 2.19%.

Overall, Marathon is a smaller, but much more profitable company than ConocoPhillips, so in addition to buying a faster-growing footprint in the Permian Basin, they are buying profitability.

Thus, we can infer a dual rationale for undertaking the merger, these reasons being: (1.) Increase ConocoPhillips’ concentration on crude oil, especially in the Permian, (2.) Buy improved margins.

Independent of the merger, we see $61,334.3M (+4.71% YoY) in Total Revenue in 2024E, $68,797.3M (+12.17%) in 2025E, and $74,696.4M (+8.57%) in 2026E. Considering merger effects, these forecasts are the same in 2024E, but boosted upward to the following in 2025E and 2026E: $75,664.3M (+23.36%), $81,806.4M (+8.12%). Considering that merged operations begin in 2025E, we forecast diluted EPS of $10.25 for 2024E, merger or not. For 2025E and 2026E, we see diluted EPS of $15.73 and $19.35, demonstrating an accretion in EPS of +$1.24 and +$1.12, respectively.

VALUATION: Using DCF (specifically the Perpetuity Growth Method, with a 10-year growth period, and perpetuity formula to summarize value past the 10 years modeled here), we value ConocoPhillips at $81.26 per share; Marathon at $89.75. Furthermore, after performing the merger analysis, we value the combined company ConocoPhillips/Marathon at $115.88, a 42.60% increase over the standalone DCF of ConocoPhillips. The deal is slightly accretive to EPS as well, but from a valuation perspective, it’s most accretive to the DCF value of the company; and we see potential for additional growth in crude oil re-fracking, as well as a greater focus on the Permian Basin. We find the purchase price per share, ~ $27.41 at a major discount to the DCF valuation.

The only thing to watch for, in terms of the merger’s impact to valuation, is where the price of MRO will be by 4Q24. Since the deal is structured in terms of a ratio of shares of the acquirer to shares of the target company, such that ConocoPhillips is paying 0.255 shares of COP per each share of MRO, the price is variable, and not set by the terms of the deal. This could result in a more or less favorable deal for ConocoPhillips, and thereby more or less accretion to EPS, Net Income, and DCF, according to how many shares they eventually have to issue in order to fund the merger.

THE MERGER: Here we’ve provided special coverage of the COP/MRO merger deal: On May 29, 2024, ConocoPhillips announced its intent to acquire Marathon Oil for $22.5 billion in an all-stock transaction, including debt, expected to close in the fourth quarter of 2024. Currently, we do not see a $22.5B price for the deal, but since the deal is fixed in terms of the ratio of shares of the acquirer to shares of the target company, such a price is possible, given a certain level of price appreciation in the MRO stock, before the 4Q24 closing date.

Below, we have considered the deal under current prices, as at 8/1/2024.

As the prices converge to their final values before the deal closes, we will continue to update these data and print a few more revisions of the analysis.

Purchase Price and Acquisition Multiples:

Taking the median of these values, from 2024E to 2027E, we see roughly the following: EV/Revenue = 2.98x; EV/EBITDAX = 4.36x; EV/EBITDA = 4.42x; EV/EBIT = 8.02x; Purchase Price / Net Income = 8.64x; Purchase Price / EPS = 6.59x.

Accretion / (Dilution) Analysis: Considering that the merger is set to close in 4Q24, we begin combined operations in 1Q25. Within that first quarter, we anticipate a likely accretion of $0.21 per share, $0.33 in 2Q25, $0.34 in 3Q25, and finally $0.36 in 4Q25.

Quarterly, as well as annual, results are shown below.

Segment Revenue Forecasts (COP, MRO, Merged Company): Forecasts were determined by the use of a proprietary time series forecasting algorithm built in MATLAB.

Standalone financial model (COP): This model presents near-term forecasts on COP alone, independent of the merger with MRO.

Standalone financial model (MRO): This model presents near-term forecasts on MRO alone, independent of their acquisition by COP.

Merged Operations: This model presents near-term forecasts for COP/MRO, considering the merger, which is modeled to occur at the end of 4Q24.

Merged Cash Flow Statements: The following Cash Flow Statements describe the operations of COP before the acquisition, then combined operations out to 2026E.

Merged Balance Sheets: The following Balance Sheets describe the operations of COP before the acquisition, merger adjustments occurring at the time of transaction, and operations thereafter.

CONCLUSION: While ConocoPhillips is the larger and faster-growing of the two companies examined here, we can understand their implied rationale for buying Marathon Oil. It appears that they are buying the company to achieve a larger presence in crude oil, a larger presence in the Permian Basin, higher margins, and also faster Permian-Basin-specific growth. It has been cited in the media also that the company intends to re-frack some of the existing wells acquired in this deal, and with better technology, additional and better results could be achieved from such drilling.

Under our analysis here, we have, however, not included either Revenue or Cost synergies. They are possible, and ConocoPhillips reports that (1.) The deal will be immediately accretive to earnings and FCF per share, (2.) It will offer $500M in annual savings, (3.) They will increase share buybacks from $5B to $7B after the close of the deal. While these are good upside targets, and they may in fact materialize, we have focused so far on only the combination of both companies, based on a “business as usual” base case scenario. Under this scenario, we rate MRO BUY and COP HOLD.

VALUATION: Discounted Cash Flow Analysis (DCF) was used to value the companies. The specific method of DCF was a two-stage growth model, by the Perpetuity Growth Method (PGM), 10-year growth period, using the yield to maturity on the 10-Year US Treasury as the risk free rate (Rf). Valuations provided at the end of this report.

Time Series Forecasting: Time series forecasting is a technique for examining a "time series" of any piece of data. Time series data like quarterly revenue or expenses obey certain properties. They typically move according to a general trend, which can be modeled by a moving average, and they exhibit repeating seasonal highs and lows associated with the quarter of the year in which the data occur. Revenue and expense forecasts were aided by this technique (MATLAB).

Contact: Franklin Monzon ([email protected]) was the founder of Finance Study Group, which first began its work as a Facebook group dedicated to studying corporate valuation, for the specialized education of students pursuing careers in investment banking. The group sought to improve upon the work of notable thinkers in finance like Aswath Damodaran, with the use of the tools of data science. Work began with developing materials to study valuation by DCF, then Comparable Companies Analysis, and finally data science tools like web-scrapers for downloading stock price data, systems to convert the data to formats more amenable to analysis, and other systems to examine the betas of stocks as well.

The publicly available works of this software/research study group can be found at Finance Study Group. Beta values determined in the DCF portion of this report were determined using this tool: Equity Beta Calculator. Prices can be reviewed again here: Equities.

DISCLAIMER: While this article presents an analytic opinion based on the available data, common techniques used in investment banking, and data science software that I have overlayed upon the problem we face, it does not say "Buy this." Suffice it to say, this is an opinion based on the available data, and is some sense, a case study.

It is not a cheat code; it is not financial advice, but rather, an analysis of a scenario.