The Divestiture of Conoco by DuPont - Case Study Example

The purpose of this paper is to examine the 1998 spinoff of Conoco. This will be accomplished by analyzing the transaction itself. In orderto put the transaction in perspective I will compare one of the potential alternatives to the actual long term impact of the sale as it occurred. The next step of the analysis is to decide and recommend which option would be better for the company based on long term benefits and the revenues that DuPont would generate from its ownership of Conoco. Originally DuPont purchased Conoco in 1981. At the time the union was the largest merger in corporate history. One of the reasons that DuPont acquired Conoco was to obtain a source of petroleum feed stocks for its fiber and plastics operations. Conoco was also attractive to the company because one of its wholly owned subsidiaries profitably manufactured commercial petroleum products and coal. Introduction Spinoffs have been used a lot in recent times in corporate America to improve the numbers reflected in the income statement and balance sheets of the companies. The use of this strategy has proven to be an effective way to get rid of unprofitable divisions and to raise capital. The money obtained from these spinoffs can be used by companies to make strategic acquisitions, pay off debt, repurchase stocks, or to invest in new projects that will bring the company greater profitability. After the occurrence of a spinoff companies can get back to concentrating on their core business activities. In 1998 DuPont complete the divesture of Conoco as a way to raise capital for the company. Back in 1981 when DuPont purchased Conoco the price of the barrel of oil was $35, but by 1998 oil prices had dropped to under $20 per barrel. Despite the fact that the activities of Conoco positively contributed towards DuPont revenues, the executive management team of the company believed that the petroleum segment had peaked in profits largely in part due to oil’s lagging prices. The fact that Conoco was involved in different aspects of the oil industry sheltered DuPont against sudden drops in the price of oil. In order to realize or determine if the spinoff was the best course of action for the company you had to look at the situation from the eyes of the CFO. The situation will be analyzed taking into consideration possible alternatives and the actions that took place. The goal is to determine if the spinoff was a prudent action in the long term or if the alternate solution would have been better. Strategies of DuPont The price of crude oil in 1998 declined severely to under $20 per barrel which represents a steep decline considering that crude oil is reached highs of $37 during the 1979 Iran embargo. Conoco was somewhat protected against a fall in price of crude oil because the firm was an integrated producer that obtain profits from all aspects of the industry including drilling, refining, transportation and production. The fact that Conoco had a diversified operation within different segments of the oil industry helped it reach consistent profits, but those profits were not as high as DuPont expected. DuPont bought the company partly because they thought the acquisition would help the firm hedge against the supply of oil becoming squeezed as a consequence of upwards movement in the price of crude oil. At the time many chemical producers were utilizing similar strategies. This approach was implemented in hopes of increasing the profit margin of the firms in an exponential manner. Many executives of DuPont saw the divesture strategy as an opportunity to increase the working capital while at the same time exiting a business that was suffering from lower profit margins despite the fact that during the time DuPont owned Conoco the earnings of both companies increased. The final decision of the company was to divest Conoco in a two step process. The first sale of the company occurred through an IPO in 1998 in which the firm sold 20% of its equity. The remaining 80% was sold at a later date through a secondary offering. The motivation of the executives of the company for this transaction was to get as much working capital as possible. In comments made to the media in regards to the transaction the CEO of the company said, “An IPO gives us maximum flexibility. DuPont will have access to cash from the IPO and, at the same time, will benefit from Conocos ongoing financial contribution as we consider the options for divestiture.” The strategy from the perspective of a CEO made sense. The fact that the company was so willing to sell indicates that the company did not think about the long term consequences of not having Conoco as a subsidiary of the firm. Due to the fact that the price of crude oil had fallen significantly with no signs of price recovery in the near future, this situation made DuPont feel that Conoco was squeezing their profits margin. The perspective of the company was that the acquisition of Conoco had failed and that it did not achieve the objective of providing protection of rising energy prices. Based on this presumption many executives of the company began to question the merits of the acquisition transaction despite the fact that it had helped the company increase its profits in ten years from $9.7 billion to $15.24 billion. The company began to ponder the possibility of a divesture. On the surface when DuPont got rid of Conoco it seemed like a prudent transaction. Since that time the petroleum market has not only recovered, but the price of the oil barrel reached new all time highs of $150 a barrel. DuPont ended up selling Conoco prior to the recovery of the oil market and subsequent increase in price, thus the company never realized the full value of keeping Conoco as a subsidiary. The company was not patient or willing to ride out the lagging oil price. Had they been patient DuPont would have obtained increasing profit margins. DuPont would have had the opportunity to sell Conoco in the future when oil prices hit all time highs. Possible Alternatives A potential alternative for DuPont was a partial spin off of Conoco. Based on this scenario the company would make a concentrated effort to sell those stocks to its shareholders. This alternative would have allowed the company the ability to raise working capital, while at the same time maintaining control of Conoco. DuPont would have had the ability under this scenario to raise its ownership of Conoco ever further. The growth of emerging economies such as China and India increase the demand for fossil fuels and began an upward trend in the prices of crude oil after 1998. As a consequence the supply of crude oil began to decline which led to the rising prices of this commodity in the following decade. The new reality of the market meant that if DuPont had kept Conoco the value of their investment would have increase in a dramatic manner. The company could have spun-off Conoco as an independent corporation, while at the same time maintaining a majority stake in the firm. To accomplish this strategy the company could have had two separate stock sales. Instead of selling 100% ownership of Conoco, a better strategy would have been to sell only 25% to 30% of the company. If the company had pursued this strategy their earnings would have increase a lot more than by divesting. Conoco was acquired within three years of being spun-off by Phillips Petroleum. Phillips Petroleum received a higher boost in earnings from owning Conoco than DuPont. If DuPont had maintained their ownership in Conoco over the long term their earnings would had been a lot higher. In 2010 DuPont obtained total revenues of $32.7 billion, a figure which is much smaller than the $179 billion in revenues that Phillips Petroleum obtained. These results are evidence that the company made a mistake by getting rid of Conoco. It is clear that had DuPont maintained control of Conoco they could have received the same earnings boost that Phillips Petroleum enjoyed. Recommendations If we analyze knowing now what occurred with the oil market it is clear that the decision to completely spin-off Conoco by the management of DuPont was a mistake. The rising demand for oil of emerging markets such as India and China have been steadily pushing the price of petroleum upwards. The Conoco-Phillips merger which occurred in the aftermath of DuPont selling Conoco has been extremely successful and this company has enjoyed greater revenues and valuation than DuPont has without Conoco. A better strategy for DuPont would have been focusing on reducing their ownership in Conoco by selling a small percentage to raise working capital, while maintain a majority stake ownership in Conoco. If the company had chosen this approach it would have been able to shield itself against rising prices in raw materials of petroleum derivatives. The potential benefits over the course of time would have been greater stock prices, earnings per share, and dividends. The best option would have been to partially sell Conoco in separate stages started with 10% to 20%. A second sale should have occurred when the price of oil rose to obtain maximum valuation for the company. This strategy would have ensured that the company maintained a majority stake in Conoco which would have allowed DuPont to enjoy earnings increase as the price of oil rose after 1998. A potential risk of this exit strategy was that the oil prices remain low at below $20 per barrel for a long period of time. If that were to happen the company would not have been affected that much as the operating margins of the firm would have continued to increase. The reason that the company would not be affected too much by lower oil prices was that Conoco was involved in a wide variety of operations within the industry including production and refining. The decision to sell Conoco ended up being a major mistake and error of judgment by the managerial staff of DuPont. The managers of the company were blinded by the short term benefits of the move which included obtaining an infusion of cash for working capital. In the long term DuPont would have benefited a lot more from keeping Conoco since oil prices skyrocketed. The firm would have obtained higher revenues, greater profitability, and a better valuation in the market had they kept Conoco. Read More