12 Mesa Petroleum Company (C) 589 12. Mesa Petroleum Company (C) 15 . 2 l . . 16—19. -*. 1. T. Boone Pickens, Jr. , chairman of Mesa Petroleum, didn’t seem to agree with the way major companies in...

12 Mesa Petroleum
Company
(C)

589

12. Mesa Petroleum Company (C)

15 . 2 l .
. 16—19.
-*.
1.






















































T. Boone Pickens, Jr. , chairman of Mesa Petroleum, didn’t seem to agree with the way major companies in America were being run.
“People talk about fiefdoms in the Middle East, in these Arab countries. What do you think you have in these chief executive offices in these companies in the United States? I mean they’ve got everything in their command. I do. Hell, I could order this airplane down and load it up with girls and go to Las Vegas,” commented Pickens. “But you’ve got to have discipline to run it like it should be run, and it should be run for the stockholders,” continued Pickens. “These people are caught up in their empire. Look at a guy like Lee [Gulf’s CEO). Where do you think a guy like Lee can get another job for $800,000 a year? He’s not articulate. He’s not knowledgeable. Hell, he’s about as attractive as yesterday’s toast.” '
Certain of Pickens’ contemporaries had definite opin- ions on his takeover ploys and his claims to be working in the shareholders’ interests.
“He’s only after the almighty buck, he’s nothing but a pirate,” said G. C. Richardson, formerly of Cities Service.
²

This case was written by Mark Rich and Francis C. Stiff, research assistants, and Robert R. Gardner, associate director of the Maguire Oil and Gas Institute, under the direction of Professor M. Edgar Barrett, director of the same institute. It is designed to serve as the basis for class discussion and is not intended to illustrate either effective or ineffective handling of an administrative situation.
Copyright " 1985 by M. Edgar Barrett. Reproduced with
permission.
This case is available in looseleaf form from Lord Publish- ing, Inc. , One Apple Hill, Natick, Mass. 01760.
'“Playing for Keeps,”
Westward Magazine, Dallas Times

Herald,
March 25, 1984.

²
High Times for T. Boone Pickens,”
Time,
March 4, 1985,
pp. 52—64.
“My only objection to Pickens is the aura he tries to create when he says he is for the small shareholder. That’s just a lot of crap,” remarked Harold Hammer, head of Gulf Oil’s defense effort.
Senator Howard Metzenbaum (D—Ohio) commented, “Pickens makes a crusade out of what he is doing because he can make a lot of money.’’^
Pickens’ critics regularly hurled invectives, calling him a raider, a greenmailer, and a waster of corporate assets. These criticisms, however, rarely came from Mesa Petroleum’s shareholders and partners.
PETROLEUM INDUSTRY IN THE EARY 1980s
The oil and gas industry entered the 1980s riding a boom of at least a half dozen years of immense prosperity. The boom quickly, and surprisingly to many, turned sour in late 1981 . By 1982, the industry found itself heading into a severe recession. Oil and gas firms in 1985 were still deeply mired in this recession and showed few signs of a near-term recovery.

The Boom.
After the OPEC oil embargo in 1973, world crude oil prices rose steadily through the 70s, peaking at $35 per barrel in 198 l (Exhibit 1). Expecta- tions by many in the industry were for crude prices to reach $60—$100 per barrel in the next decade.
As the “boom” fever spread, investors poured liter- ally billions of dollars into oil and gas deals. Oil company stock prices became “hot’’ plays as their prices pushed upward. Oil and gas syndicates also became popular among investors seeking tax benefits and earnings potential. Bankers competed fiercely to loan money for both oil and gas production and oil field equipment.

³Ibid.
^Ibid.
‘
590

Part VI Strategic Management: Cases


EXHIBIT
1 Refiner Acquisition Price per Barrel of Crude
$40
35
30
@ 20
10

1972 1974
1976 1978 1980 1982 1984

Within the industry itself, drilling activity began to rise dramatically as exploration and production compa- nies spent the dollars flowing in from increased produc- tion revenues and from new investors. Increased activity by established drilling contractors was complemented by a substantial number of new drilling companies attracted by the profits to be earned. According to
Reeds Rig Census,
there were 3,100 rigs capable of drilling to 3,000 feet or better in operation as of December 1979. By December 1981, the same count had grown to 4,800 rigs. The number of working rigs at the peak of demand was 4,530 at the end of 1981. At that time new rigs were coming on-line at the rate of 2.5 rigs per day.’
As drilling activity increased, so did the demand for oil field equipment. Prices on rigs, pipe, and related products moved up sharply. Increasing costs, rather than
discouraging drilling, seemed only to add to fhe frenzy, as investors and bankers viewed the oil field equipment industry as another “hot’’ play.

The Bust.
Meanwhile, in the face of the boom, demand for refined products was slowing. Gasoline consumption was down due to the switch to more fuel-efficient cars (average mpg had risen from 13.2 in 1973 to 24.6 in 1982), and reduced driving in general (down 107c between 1978 and 1982).
⁶
The combined effects led to a decrease in gasoline consumption by 1 million barrels per day between 1978 and 1983.’
In addition to gasoline, the demand for middle distil- lates was also down. In the industrial and utility sectors,
a massive e5i was paying falling s industries steel indu› r-. the pulp arse period.' Cor.- by industrir _
began in 19›
While dee continuing

Scorecard
-.”

nol,
July ñ, I •
12 Mesa Petroleum Compan iC
591

EXHIBIT
2 Oil Use per Dollar of GNP

	47
46
45
44
43
O	42
41
40
39
38
37
E	36
35
34
33
32
31
30
1972	1974	1976	1978	1980	1982	1984

Source: “Big Oil Starts Thinking Smaller,’ ’
The New York Times , M
arch
17, 1985, p. 1,
sec.
3.

e frenzy, uipment
a massive effort at conservation and fuel substitution was paying off. Oil consumption per dollar of GNP was falling steadily throughout this period (Exhibit 2). Heavy industries led this trend, with oil consumption in the steel industry down 807o from 1979 —84 and oil use by
The turn from boom to bust in the industry became apparent on the order books of drilling contractors by late 1981. Land-based contractors were booked solid through the end of the year, but had little or no backlog of orders for 1982. By April of 1983, the number of rigs .e boom,
the pulp and paper industry falling 50% during the same
in operation had fallen to 1,807.'° Gasoline
tyt¢
period. Contributing to the decrease in oil consumption by industrial users was the economic recession that also
At the same time, investors began to cool toward oil and gas plays. A major factor was the Income Tax n13. 2 in
began in 1981.
Reform Act of 1981 . This act reduced the top tax bracket c general
While demand was falling, production had been
from 709o to 509a, thus reducing the value of immediate combined
continuing at a record pace. OPEC countries had
tax reductions and, hence, the appeal of many drilling ation by 1
reached a peak in production of 32 million barrels of oil
ventures. 13.
per day (bopd) in 1979 and were still producing at very
Decreased demand for oil ultimately led to falling Idle distil-
high levels.
prices. As E&P companies had borrowed heavily to ry sectors ,
“Scorecard for the OPEC Meeting,”
The Wall Street Jour-

nal, July 3, 1985, p. 6.
“Energy,” p. 75.
finance their operations, the fall in prices placed these
“‘ ‘Oilfield Drillers and Services,”
Forbes,
January 2, 1984,
p. 84.


592

Part VI Strategic
Management.
Cases


companies in a severe cash bind. With a loss of revenues due to falling prices, and a decline in investor interest in oil and gas plays, hundreds of operating companies were forced into bankruptcy.
The refining and marketing segment of the industry was also hard hit. The fall in demand left the industry with significant overcapacity. Competition at the gas pump combined with already low refinery utilization rates led to very poor profitability throughout the re- fining and marketing industry. Despite closure of more than a hundred refineries, the industry in 1985 was still saddled with overcapacity and thus, poor profitability (Exhibit 3).

()Utl00k.
The near-term outlook for the oil industry as of 1985 was not encouraging. With the control of much of the world’s oil production in the hands of foreign- exchange-hungry governments, the prospect of reducing the oversupply of oil through production cuts appeared unlikely. OPEC’s production had fallen to 16 million bopd and many members of the cartel were either cheating on their production quotas or selling oil below set prices.'’ Saudi Arabia, in turn, threatened cheating OPEC countries with a price war that could flood world markets with oil and drive prices below $20 per barrel.'
²
Analysts did not look to demand increases to bolster prices, even with a strong economy. Said Raymond
Mason, Charter Co. president,
Even if the economy keeps expanding, pressures will continue to push oil prices down."
Fred Singer, of George Mason University, remarked,
Consumption in the transportation sector may increase slightly if gasoline prices fall; for other sectors, gas and coal prices will adjust downward and provide competition. The big item in demand (short run) may be inventories; will oil stocks be built up at $24 (per barrel of oil)? I don’t think SO."
'' “Scorecard for the OPEC Meeting.”
'
²Ibid.
““Energy,” p. 74.
'^“Scorecard for the OPEC Meeting.”
Boone Pickens summed up the outlook for the indus- try as follows:
Of all the wells that have been drilled in the world, 80 percent of them have been drilled in the Lower Forty-eight. So, while you’ve got a limited number of good prospects in the U.S. , you still have more rigs running than the rest of the world does. You also have natural gas markets that are weak, and oil markets that are uncertain. That’s a
very sobering set of fundamentals the industry is , facing.’
Adding to the dilemma of many major oil companies was the current trend in the financial markets of low valuation of conglomerates. Many major oil companies found themselves ‘ ‘undervalued” by the market, both because of the poor outlook of the oil industry and because of Wall Street’s current disenchantment with multibusiness firms."
Development of spot markets for both crude and refined products was a new addition to the industry in the 1980s. This new feature served to establish a world market for oil and refined products, and reduced some of the advantages of integration in the oil industry. The long-term effects of this addition were still unclear.
MESA PETROLEUM COMPANY: 1981—1985¹⁷

By early 1981 , Mesa was a reasonably good-sized oil and gas exploration company. Based in Amarillo, Texas, it had reported revenues in 1980 of $200 million and net income of $95 million. Mesa was primarily a domestic E&P firm with approximately 909c of its revenues generated by its exploration and production operations. Its oil and gas reserves in 1980 were estimated at 25 million barrels of oil and 858 billion cubic feet (bcf) of
““Interview: T. Boone Pickens, Wildcats on Wall Street,”

Planning Review,
July 1985, p. 6.
“Splitting Up,”
Busi'ness Week,
July 1, 1985, p. 50. "For background data on the firm- from its inception until
1980, see
Mesa Petroleum Company (A)
and
(B), {not
included in this publication].












since




rate the:



12 Mesa Petroleum
Company (C)


593


EXHIBIT
3 Number of U.S. Refineries*

320


310


300


290












270


260


250


240


230

220
210
1972 1974 1976 1978 1980 1982 1984
*Many of the refinery closures illustrated here were the result of the Reagan administration’s elimination of entitlement cross-subsidies in 1981. The majority of these closed refineries were small, “teakettle” operations.
Source: “Big Oil Starts Thinking Smaller,’ ’
The New
y«i
Times,
March 17, 1985, p. 1. sec. 3.

gas, with production of 3 million barrels of oil and 106 bcf of gas during the year.
Mesa’s finding costs had risen fairly dramatically since 1979. According to
Petroleum Outlook,
it cost Mesa $15.06 to find a barrel of oil in the United States in 1981. By comparison, Mesa’s finding costs were
$13.80 a barrel in 1980 and $5.43 a barrel in 1979.'
Though Mesa had exhibited a healthy earnings growth rate through 1981, this was partially a function of the firm’s accounting practices. A 1979 FASB ruling had allowed the capitalization of certain interest costs related to developing properties. Since 1979, Mesa had been
''“A Nicely Coppered Bet,”
Forbes,
July 5, 1982, p. 40.
capitalizing an increasing percentage of its interest costs. In 1979, Mesa had capitalized $6.2 million, or 119c of its interest costs. By 1981, the firm was capitalizing $70 million, or 709c. Had that interest been expensed, 1981 earnings would have been reduced by some $38 million."
Mesa’s capital expenditures during the early 80s peaked in 1981 Iduring the industry boom) and thereaf- ter declined steadily. Expenditures in 1985 were pro- jected to be $85 million. Recent reductions in capital spending were due in part to the general slowdown in the industry and in part to a change in strategy at Mesa. Sid
"Ibid.
594
Part VI


Strategic Management.‘ Cases


Tassin, assistant to Mesa’s financial Vice President David Batchelder, recalled when the initiative to change strategy began:

1980 1459o 80^.. 1981 154 87 1982 117 70 1983 80 81 1984 65

Pickens said it wasn’t enough to just hunker down like a bunch of groundhogs; get rid of a little fat; accept a little less cash flow, lower reserves and less

TABLE
1 Reserve Replacement Percentage

Percent of Mesa Replaced (excluding
net income, and next winter come out of the hole. He said it was time to take a fresh look
at our own business.
The “fresh look” that Pickens took resulted in a change in strategy and a restructuring of Mesa’s operations. The changes included reducing the work force by one third,
selling overseas interests, halting the issue of company

Year


CQ H OHS












cars, and holding exploration costs at less than $10 per barrel.
²' Early in 1984, Mesa reduced the number of its vice preidents from 10 to 3. Mesa’s employees in 1985 averaged 36 years of age, with all of Pickens closest advisers being below 35 years of age.
Despite Mesa’s leaner operations, the firm continued to perform well. Oil and gas revenues rose steadily through the 80s, reaching record levels. Total assets and shareholder’s equity of the company, after a fall in 1982, grew strongly through 1984. The net amount of Mesa’s debt also declined from 1982 to 1984 by about $60 million. In addition, Mesa was able to remain at or above the industry average (excluding acquisitions) of replacement percentage (Table 1)." Including acquisi- tions, the replacement percentage was higher in later years. Mesa also continued to introduce innovations into its operations. Examples of these included running wells by wind chargers and reducing obsolete inventory by trading with other companies.
²" Exhibits 4-6 summa- rize Mesa’s recent financial and operating history.
Mesa continued its policy of spinning off oil and gas properties into tax shelters for its shareholders. In 1982, Mesa transferred a 90% net overriding interest in 10 offshore, partially developed properties into the Mesa Offshore Royalty Trust. The trust was somewhat unique

²"‘ Mesa’s Style Is Lean and Unorthodox,”
Los Angeles Times,
April 22, 1985.
2 ' Replacement percentage is the amount of new reserves discovered divided by the amount of production in the period It should be noted that Mesa tended to book its reserves just
Source: “Mesa’s Style Is Lean and Unorthodox,”
Los Angeles Ti-. :

April 22, 1985.

TABLE 2 Year	Mesa’s Capital Expenditures
1980	$397
1981	420
1982	332
1983	223
1984	105

1985 g5
Source: ‘‘Mesa's Style Is Lean and Unorthodox,’ ’
Los Angeles Tirr.r.

April 22, 1985.
in that the properties transferred were only
partial!’.
developed and would require significant expenditures tc complete development. The development expenditure- meant that no distributions from the trust would take place in 1983, and only a minimal distribution was likel in 1984.
before they were brought into production. Therefore, reset e increases shown in a given year in the 1980s could, in fact.

²’“Mesa’s Style Is Lean and Unorthodox.”
12 Mesa Petroleum Compan y (C)
595
Cifing a lack of economically drillable prospects, ing to take over companies with assets valued below Pickens, during this period, diverted a portion of Mesa’s appraised value. The details of Mesa’s ventures in this resources away from oil and into other opportunities. area, specifically the attempted takeovers of Cities One activity was the purchase of undervalued reserves Service, General American Oil, Superior Oil, Gulf Oil, from other oil companies. Generally, this meant attempt- Phillips Petroleum, and Unocal, are presented in the
EXHIBIT 4

Revenues:
MESA PETROLEUM COMPANY

Income Statement Years Ended December 31

($ in thousands)

1984 1983 1982

Natural gas ...... .... $ 279,317 $262,620 $264,776 Oil and condensate . . 115,807 112,618 96,342 Natural gas liquids .... ........... 14,829 13,084 13,766 Other . 3,536 2,812 1,497 413,489 391,134 376,381 osts and expenses: Lease operating...... 51,628 48,850 50,353 General and administrative ... 21,476 20,235 19,440 Production, federal excise and other taxes 30,516 26,472 29,798 Depreciation, depletion and amortization ......... 155,137 137,070 124,226 258,757 232,627 223,817 perating income ..... 154,732 158,507 152,564 ther income (expense): Gain on sale of securities and assets..... . 403,549 89,221 63,967 Interest income ..... ....... ...... ..... 87,748 19,524 23,942 Interest expense, net of amounts capitalized. . ... (184,192) (77,513) (40,299) Dividend income 22,403 10,108 4,943 Other .. .. ... (8,649) (102) (9,613) 320,859 41,238 42,940 ncome before income taxes . .. 475,591 199,745 195,504 Provision for income taxes ... (205,407) (73,835) (65,600) et income ...... 270,184 125,910 129,904 Preferred stock dividends. . (16,333) (11,019) (13,959)

C
O O










I N
Net income available for common shares Net income per common share ...
Weighted-average shares outstanding. .











EXHIBIT 5
Current assets:
MESA PETROLEUM COMPANY

Balance Sheet as of December 31 ($ in thousands)


Assets


1984

1983


EXHIBi

Funds p Cash and short-term investments ...
$ 550,946 $ 22,722
Net ii Accounts and notes receivable .. .................. ........ . .
Marketable securities... ...
136,926 t26,630
338,507
Depre Defen Inventories . ...
Prepaid expenses and
other.........
.... ... . ...

Total
current assets..... . . ..

Secured installment note ............ .......... . ........... 796,007 F Term royalty 185,273 222,232 Other fu Other 22,274 22,248 1,003,554 244,480 MarLc

Long-term receivables:
12,524
18,325
1,057,228
31,644
2,885
183,881
Gain i Intern
Uniea


Marketable securities..... .... ... .. .... . .......
Property, plant and equipment (using full cost accounting):
249,051
637,220

Oil and gas properties, wells and equipment ...... ...... ............ ......... .. 2,191,833 1,599,888 Oil and gas properties not yet Evaluated 45,582 64,074 Transportation, office and other properties . . 53,896 54,425 2,291,311 1,718,387 Less—Accumulated depreciation, depletion and amortization . ....... ........ .. .... 664,116 491,706 1,627,195 1,226,681 eferred charges and other assets . ... 18,923 13,383

Fundsp
Longs Issuan
D
$3,955,951 $2,305,645


Liabilities and Stockholders’ Equity

Fuo Current liabilities:
Current maturities on long-term debt .
$ 27,670 $ 54,745
Funds ut Re:
debt repaid in 1985...
350,000
Capita

ou:.,g , a db Ap A bilities:	58,561	80,375
, e :„'	21 ,935	17,619
Other	8,790	5,217
Total current liabilities . .	466,956	157,956 Cash c
Long-term debt, net . .	1,625,009	1,248,878
Subordinated variable rate notes. ..	500,000	Resultin°

Deferred revenue and other 115,478 42,532 Deferred income taxes ...... .. .. 422,914 227,774 Changes Contingencies Cash a 7 'o redeemable preferred stock . . 84,000 126,000 Accou Stockholders’ equity. MarLa

Common stock, $1 par value; authorized 100,000,000 shares; outstanding 66,959,000 and 66,904,000 shares, respectively 66,959 66,904 Capital surplus ........ .... 163,412 162,852 Reinvested earnings. . 530,500 290,032

Invenii

Unrealized loss on marketable securities ... (19,277) (17,283) Accoui Total stockholders’ equity . 741,594 502,505 otal liabilities and stockholders’ equity $3,955,951 $2,305,645

Revol
T
Source: S
Source: Mesa Petroleum Company, Annual Reports. EXHIBIT 6

MESA PETROLEUM COMPANY

Statement of Changes in Financial Position Years Ended December 31
($
in thousands)


1984 1983 1982

Net income . . $ 270,184 $ 125,910 $129,904 Depreciation, depletion and amortization ... 155,137 137,070 124,226 Deferred income taxes .. ... 194,971 66,753 59,432 Gain on sale of securities and assets (403,549) (89,221) (63,967) Interest capitalized (7,263) (10,831) (57,323) Unrealized foreign exchange loss 11,298 1,659 10,255 Funds provided by operations . 220,778 231,340 202,527 Other funds provided: Proceeds from sale of securities and assets, net . . 1,099,451 284,383 330,839 Marketable securities classified as current assets ..... 335,507 Increase in deferred revenue and other liabilities ..... 72,946 23,121 — Other . (4,627) 5,525 (7,003) Other funds provided 1,506,277 313,029 323,836 Funds provided by (utilized in) financing: Long-term borrowings . 1,789,470 631,544 305,864 Issuance of subordinated notes 500,000 Retirements of long-term debt .. . (1,386,909) (104,765) (430,832) Decrease (increase) in long-term receivables . (770,372) 25,044 (6,002) Redemption of preferred stock (42,000) (42,000) (42,000) Funds provided by (utilized in) financing ..... ... 90,189 509,823 (172,970) Funds utilized: Capital expenditures— Purchase of Mesa Royalty Trust units . . 507,068 — — Oil and gas properties and other, net .. . 109,278 235,989 314,495 Purchases of marketable securities ....... .. ...... 606,835 801,192 62,225 Cash dividends. 29,716 24,385 27,315 1,252, 897 1,061,566 404,035 Resulting in an increase (decrease) in working capital of.... $ 564,347 $ (7,374) $ (50,642) —_ Changes in working capital: Cash and short-term investments $ 528,224 $ 8,603 $ (978) • Accounts and notes receivable. . 10, 296 (10,609) (60,572) Marketable securities 338,507 — Inventories, prepaid expenses and other .... (3,680) (26,644) (5,455) “ - Current maturities on long-term debt. . 27,075 (20,730) 3,698 ‘ Revolving credit debt repaid in 1985. (350,000) — Accounts payable and accrued liabilities ... 13,925 42,006 12,665 ,‘- $ 564,347 $ (7,374) $ (50,642)

Funds provided by operations:































598
Part VI Strateg ic Management: Cases


following sections. Although a great deal of Mesa’s net income was attributable to these activities, Mesa’s oil and gas operations also remained relatively profitable during the 1981 to 1984 period.
MESA’S ATTEMPTED ACQUISITIONS AND MERGERS: 1982 AND 1983
In early 1982, Pickens offered his assessment of the market for oil and gas securities, an appraisal that foreshadowed a series of mergers and attempted mergers that he would initiate over the next two years. Stated Pickens,
The company remains committed to the replacement and enhancement of its reserves, the depletable assets of the shareholders. . Oil and gas assets are currently undervalued in the security
markets. . [Mesa] will actively evaluate and pursue opportunities to enhance its shareholders’ investment through acquisitions and financial innovations.°’

Cities Service C•0.
Pickens did not delay in moving actively and aggressively to capitalize upon apparent opportunities. In May of 1982, Pickens lined up partners to help finance a tender offer for 51 to of Cities Service Co. at $45 per share. The stock of Cities Service, the nation’s 20th largest oil company, was then selling at approximately $35 per share. Cities Service was a much larger company than Mesa, with 1981 revenues of $8.56 billion versus Mesa’s $407.7 million.
Learning of the proposed offer, Cities Service’s management surprised Wall Street by making a preemp- tive offer of $17 per share for 519o of Mesa’s 73.8 million outstanding shares. Mesa responded by offering
$50 per share for 51to of Cities’ 80.7 million shares outstanding. Pickens made the offer to Cities Service’s board as a proposed “friendly” merger. Explaining his reason for wanting to merge with Cities Service, Pickens voiced a theme he would return to often, “We had a feeling we needed to do something about our invest-

“Mesa Petroleum Comp any 1981 Annual Report,
p. 5.
D ‘‘
°''1

TABLE
3 Gains on takeover Attempts (in millions, pre-tax gain)
Supron (1982) $ 22.3
Cities Service (1982) 31.5
General American Oil (1983) 43.6
Superior Oil (1983) 31.6
Gulf Oil (1984) 760.0
Phillips Petroleum (1985) 89.0
Unocal (1985) 83.0*
Total $1,061.0
*Estimated after-tax gain from
Theh
all Street Journal,
July 3, 1985.
Source: “High Times for T. Boone Pickens,’ ’
Time Magazine,
March 4, 1985, p. 55.
ment, because Cities Service management was deplet- ing the company’s reserves and not replacing them.”"
Many industry analysts felt there was good reason to take Mesa’s offer seriously despite the disparity in the companies’ sizes. As one executive stated, “This man is definitely who Cities fears most. He is a cool and calculating gambler, the arch stereotype of the West
Texas poker player.
²7 Pickens’ uncanny financial abil-
ities had earned the respect of much of the investment community. “He has made a lot of people a lot of money by doing what he says he is going to do,” said a Houston-based analyst. “I suspect that 99 percent of the world loves Boone Pickens.””
When Cities’ board did not respond to his merger offer, Pickens made a tender offer directly to the shareholders. The offer was for 12. 1 million shares at
$45 per share. Pickens’ apparent objective
was to
strengthen his bargaining position by proving that Cities’ shareholders were eager to sell.
On June 8, after rejecting Mesa’s offer, Cities’ board made its second offer—a “friendly” bid to purchase all

²’“ Cities Service Heats up Battle with Mesa via Fraud Suit. -
Legal Pressure on a Bank,”
The Wall Street Journal,
June 3. . -
1982.
“” The Man Cities Service Fears, ”
Dallas Time.s Herald.

June 6, 1982, p. 2.
2“‘Mesa’s Founder Takes on Big Foe,”
The New York Times.

June 7, 1982, p. D— 1. _
12 Mesa Petroleum Compan y
(C)


599

of Mesa for $21 per share. This offer was, in turn, rejected by Mesa’s board.
During the following week, Mesa and Cities were each tendered approximately 459c of the other’s shares. Attempting to thwart Cities Service’s takeover, Me- sa’s board voted for two antitakeover measures. The first measure was a “super-majority” provision, requiring a 759c shareholder vote to approve a change in the control of Mesa. The second measure removed from Mesa’s bylaws a provision that gave anyone holding at least one third of the shares the right to convene a special
shareholders meeting.
On June 17, Gulf Oil Corp. announced a $63 per share bid for Cities Service, a total purchase price of $5 billion. Gulf’s chairman, James E. Lee, acknowledged that the large jump in bidding (from Mesa’s $45-a-share offer to Gulf’s $63-a-share offer) was designed to prevent a bidding contest with any other potential suitors.
Three-way negotiations involving Mesa, Cities, and Gulf ensued, eventually resulting in Mesa selling its 4.1 million shares of Cities back to Cities for $55 a share. As part of the peace agreement, Mesa agreed that for a period of five years it would not purchase Cities stock or seek to influence the affairs of Cities. The total pre-tax gain to Mesa was said to exceed $30 million.
With Mesa out of the way, the road seemed to be paved for Gulf to proceed with its bid for Cities. The potential for antitrust objections still threatened to derail the acquisition, however. [Cities Service ultimately merged with Occidental Petroleum in a $4.05 billion transaction.]
Just days after accepting the Gulf deal, Pickens made it clear he was not through dealing in the securities market. “We’ve got to come up with some other deals, because this industry is in for some rough sledding.
As long as the costs of finding oil and gas reserves stay high, 1982 will be a shakeout year in this industry, especially if companies keep depleting their reserves.
²’

General American Oil (GA0).
In an effort to take control of Dallas-based General American Oil Co . of Texas, Mesa, in December of 1982, offered $40 a share
for a majority of GAO’s stock. GAO was primarily an exploration and production firm operating in Canada, the United States , the Gulf of Mexico and the North Sea. Mesa and GAO were roughly of equal size in terms of reserves and undeveloped acreage.
Mesa had purchased 7.59c of GAO’s stock in 1976. Subsequently, Mesa issued debentures exchangeable for most of the GAO shares it had accumulated."
In a surprise reaction to Mesa’s hostile bid, GAO made a $50-a-share offer for nearly a third of its own outstanding shares. The strategy behind the move ap- peared to center on GAO management’s control of a large block of its shares held in a foundation and two trusts set up by GAO’s late founder. Should a third of GAO’s shares be repurchased and retired, the management-controlled block of shares which remained would constitute a clear majority.
At the probation deadline several days later, Mesa’s hostile tender offer for control of GAO was heavily oversubscribed.
In a move similar to the ending of the Cities Service deal, Phillips Petroleum Co. stepped in and purchased GAO for $1.14 billion. As a part of the deal, Mesa dropped its hostile bid; in return, GAO paid Mesa $15 million for tender offer expenses. Mesa further agreed not to purchase GAO securities for five years.
Mesa’s pre-tax gain on its holdings of GAO stock amounted to $43.6 million.

Superior 0Ïl CO.
In early March, 1983, Pickens spoke in Dallas. ‘‘You’ve got to replace your reserves or you are liquidating the assets,” said Pickens. “We have to ieplace those reserves because we’re on record for five years now saying that if we have back-to-back years of down reserves we’11 sell out.”’'
Within a week, Mesa’s latest play for oil became public. On March 14, the financial press announced that Mesa had purchased 2.5 million shares (or nearly 29o) of Superior Oil Co. , the nation’s largest independent oil company. Like Cities Service, Superior was a much larger company than Mesa. In 1982, Superior earned
$223.4 million on revenues of $2.04 billion. At the time

600

Part VI Strategic Management: Cases


of Mesa’s purchases, Superior’s stock was selling for about $35 per share. Analysts placed the company’s liquidation value at $57 per share.
Many oil industry analysts quickly stated that they doubted whether Mesa intended to actually take over Superior. “I don’t believe Mesa Petroleum wants to acquire Superior,” said one analyst. “I think Pickens sees a company that’s undervalued and the majors might want to get in there and do a deal. He’s just an opportunist.’ ”°
Mesa’s purchases helped give visibility to a resolution that was scheduled to come before Superior’s annual meeting. The resolution was sponsored by Wilametta Keck Day, daughter of the company founder and sister of retired chairman Howard M. Keck. The resolution called for certain above-market offers for at least 459o of Superior’s shares to be submitted to a committee of three independent directors. Unless the committee found the offer unfair it was to recommend that the full board approve it. Mrs. Day’s spokesman stated that she had submitted the resolu- tion because “if an offer is submitted, she thinks the shareholders ought to know about it.”"”
Mesa raised its stake in Superior to 39c over the summer. In September, Superior and Mesa reached an agreement, with Mesa selling its 3.98 million shares back to Superior for $42 a share, a 109c premium over its market value. The buyback resulted in a $32 million profit for Mesa.
Criticism was immediately directed at Superior. One industry observer derided the buyback as “the ultimate bailout.” He continued, “To bail out a 3 percent small stockholder for a 10 percent premium above the market is going to get a lot of criticism from stockholders.”°’
Added another analyst,
It’s been a no-lose proposition for him. He takes a position in a company, the speculation takes over from that point and the company bails him out or a white knight comes in. He’s making more money that way than turning the [drill] bit.”
Big institutional investors were also incensed. Port- folio managers were angry that Superior did not offer to buy them out at the same premium. In the weeks following the buyback, Superior officials admitted they had received many calls from upset investors. Many of the big institutions showed signs of worry. “Major institutions are increasingly anxious to sell, and might
not hold out for top dollar,” warned one portfolio manager.’6
In March 1984, Mobil Corp. announced it had agreed to acquire Superior for $45 a share, a total of $5.7 billion. It would be the fifth largest takeover in history.

I(N Energy Inc.
Mesa’s attempt in the fall of 1983 to take over KN Energy Inc. was short lived. KN Energy operated a 16,000 mile natural gas pipeline system, and held various oil and gas interests. Mesa, it was said, was primarily interested in the firm’s natural gas reserves.
In September, Mesa had offered to purchase all of KN’s outstanding shares at a price of $54. 25 per share. A month later, Mesa backed down, declining to press for an unfriendly takeover after KN directors rejected Me- sa’s earlier bid.
Mesa’s reticence to persevere in the takeover attempt fueled speculation that Pickens was considering bigger plays.

STALKING BIG GAME: MESA

VERSUS GULF

In August of 1983, a Mesa-led group of investors had, in fact, begun quietly to purchase shares of Gulf Oil Corporation. The increased trading was soon noticed in Pittsburgh by Gulf executives who had been worried about what they perceived to be the low market valua- tion of the firm’s common shares.

Problems at Gull.
When James E. Lee became Gulf’s chairman in 1981 , he took over a company that many considered to be the weakest of the Seven Sisters. Gulf had been shaken by political payoff scandals in the


fact.
howe er. mid-1970s, and had not appeared to move decisively
the mar•.

" “The Takeover Game Isn’t over at Superior Oil,”
Business

Week,
September 19, 1983, p. 103.
shares c





since. This apparent passivity was accompanied by a steep decline in proven reserves.
Lee moved rapidly to implement a plan to return Gulf to long-term health. His program had four major thrusts: i 1) reduction of Gulf’s work force, (2) repurchase of Gulf shares, (3) consolidation and elimination of many downstream operations, and (4) refocusing Gulf’s ex- ploration efforts on domestic, high-risk, frontier (arctic, offshore, etc.) ventures.
Gulf began the implementation of Lee’s strategy with a repurchase of 10 million Gulf shares (out of 195 million shares then outstanding) in the latter half of 1981. Despite the repurchase, Gulf’s share price fell 197c during 1981 . Moreover, although Gulf had signif- icantly increased new project spending in 1981, the tirm’s domestic reserves continued to fall. Gulf had, in fact, been unable to replace its reserves since 1972.
In an effort to improve the profitability of its market- ing operations, Gulf concentrated on increasing market share on the East Coast, where it was the second-largest marketer with an 89c share. While Gulf’s gasoline sales still decreased 39o that year, the drop was less than the 4.59c decline seen industrywide.
During 1982, Gulf continued to emphasize domestic oil and gas exploration and production. The company widthdrew many of its refining, marketing and chemi- cals operations overseas. Write-offs during 1982 totaled 5200 million. The remaining worldwide refining, mar- keting and chemical operations produced an operating loss of more than $250 million during the year. As part of the employee reduction program, Gulf in 1982 removed some 129c of its work force from the payroll. Though the firm’s total revenues in 1982 remained at about the previous year’s level, earnings fell by 27 to.
Gulf’s net margin improved somewhat in 1983, a fact management attributed to its recent cost-cutting moves. Throughout 1983, Gulf had stepped up the pace of its restructuring by closing all European refining and mar- keting operations, closing domestic retail outlets, reduc- ing companywide employment by another 17%, and repurchasing more of its outstanding shares.
With both prices and demand for oil products falling, however, Gulf’s strategy by mid-1983 was not impressing the markets. By August, Gulf’s market capitalization"











”Market Capitalization
is defined here as the number of shares outstanding times the price of the firm’s stock.

12 Mesa Petroleum Compan y (C)

601

had fallen to $6 billion on 166 million shares outstanding— a drop of almost 509o since 1980.

Mesa Closes ln.
As heavy trading in Gulf stock continued into the early fall, Gulf’s board began to consider possible antitakeover provisions. On October 11, the board, spurred by the trading of almost 2 million Gulf shares the previous Friday, proposed abolishing cumulative voting for directors and other charter amend- ments designed to reduce the threat of a takeover. A shareholders meeting to vote on the proposals was set for December.
On Monday, October 17, a Mesa-led investor group revealed that it held 14.5 million shares of Gulf (8.759c of the then outstanding shares). Mesa itself held 9.6 million of the total. The partners joining Mesa were Canada’s Belzberg family, Wagner & Brown (a Mid- land, Texas independent), Harbert International Inc. (a privately held Birmingham, Alabama construction and real estate firm), and Sunshine Mining Co. of Dallas. The announcement stated that the group had spent $630 million to purchase the stake. The group had decided that Mesa would coordinate future purchases and have exclusive power to vote the group’s shares through September 30, 1984.
In its SEC filing, the investor group intimated that it would like to restrucmre Gulf to increase returns to shareholders. The filing stated, “significant recapitaliza- tion transactions and assets restructurings” could be used to increase shareholders’ returns. Possible methods de- scribed included, “repurchases of shares and distributions of assets to shareholders in the form of independent Operating entities, royalty trusts or limited partnerships.^„38

Gulf’s senior management responded with criticism of
the restructuring idea, and a defense of company policies. “We’ve looked at royalty trusts . and all the ideas that are included in the filin The royalty trust concept had been rejected because it would mean increased tax ex- penses for owners. “We’ve been doing many of these things over the past two years,” said a Gulf official. “All our actions are directed at ... returning value to our shareholders.””










“ ‘ “Mesa Petroleum Group Discloses Gulf Oil Holding,”
The

Wall Street Journal,
October 18, 1953, p. 3.
”Ibid.


602

Part Vt Strategic Management: Cases


Yertical Integration, Cash Returns and Market Valuation.
In the fall of 1983, large oi1 companies’ vertical integration strategies were under attack by the investment community. Integrated companies were be- ing valued at 409c or less of their asset value, while small E&P companies were valued at an average of 909o.^°
Many analysts and oil industry consultants were advocating the breakup of integrated companies to allow earnings from oil and gas production to flow directly to shareholders. “There is a fundamental restructuring taking place,” said one consultant. “You’re going to see more and more of the traditional integrated companies broken up.”” An investment banker stated, “Certainly there are efficiencies with integration. But that doesn’t mean we need 20 integrated oils. ^²

Arguing against breakups and concepts such as the royalty trust, many majors contended that they needed to retain their cash flow to search for future supplies of oil and gas. In the past, the high cost of exploration had often been cited as a reason for high oil prices. Many oil executives felt that distributing profits from high-priced oil, rather than reinvesting to assure future energy supplies for America, would anger consumers and bring on new government regulations. As a government en- ergy analyst put it, “Corporate strategy in cash-rich oil companies is a public policy matter.”°’
In November 1983, Gulf’s chairman, James E. Lee, defended the integrated companies’ strategies in an
successfully replacing our reserves and the only way we can continue even to hold the level of oil production is to reinvest to replace reserves.” ^‘
Countered Pickens,
Over the period 1978 to 1983 Gulf Oil only replaced about 43 percent of the oil and gas produced. . Over that five-year period, they actually lost 634 million [equivalent] barrels off their reserve base. Do you think the stockholders knew anything about that?”
Pickens and his supporters argued that cash flow was being wasted on increasingly risky exploration projects that wouldn’t pay off and on unprofitable downstream operations. Therefore, they wanted to force oi1 company managements to return more cash to investors. Pickens contended that this would force managers to abandon marginal exploration. In support of this viewpoint, an oil analyst remarked, “Full replacement of domestic reserves by domestic companies has become an all but unrealistic and impossible objective.””
Pickens often asserted that oil companies could there- fore “liquidate efficiently” by sending cash flow di- rectly to shareholders. Spinning off assets to sharehold- ers, according to Pickens, would both make it easier for a company to replace remaining reserves and force the market to value the company at closer to its true value.
Gulf
Defense Mechanisms.
Immediately after the
the c.

G. P’.:K’_- H.

interview. Answering a question concerning Pickens’ philosophy he stated, “I see a mutual interest in increas- ing shareholder value. We may have a difference of opinion as to how best to do that.” . . Articulating his disagreement with the royalty trust concept, Lee stated, “If you’re going to be an oil and gas company, every- thing still indicates that it’s the natural resource base that really determines the value the market places on the company . . we decided to focus our technology, our capital, toward the U.S. , the frontier areas, because that’s where we think we have the best probability of
^ “Boone Pickens, Company Hunter,”
Fortune,
December
26, 1983.
°'“Restructuring Big Oil,”
Business Week,
November 14,
1983, p. 139.
^‘Ibid.
"Ibid. , p. 146a.y
Mesa group’s announcement that it was behind the - - activity in Gulf’s shares, Gulf officials began to analyze
possible defenses. To prepare for any contingency, Gulf
lined up a $5 billion line of credit with 38 banks. At the ’‘* - “ - same time, Your of the banks backing the Mesa group
withdrew. Pickens charged that Gulf pressured the
institutions , a charge Gulf denied. -
Gulf had numerous possible defenses, each with its
own perils. The first defense was simply to convince — ** Gulf shareholders that Gulf’s long-term strategy would
provide a better return than Pickens’ short-term plans.
Unfortunately for Gulf, approximately one third of its -. -.- shares were held by institutions who might not only find
“Ibid. , p. 143.
° “Interview: T. Boone Pickens,” p. 8.
°‘Ibid. , p. 139.
12 Mesa Petroleum Compan y
(C)


603

the idea of a quick pay-off appealing, but whose fiduciary responsibility might lead to a decision to sell. The second possible defense was attacking Pickens personally—the “low road” approach. Gulf had already run ads attacking Pickens’ record of attempted take- overs, portraying him as a hit-and-run artist, an oppor-
tunist unconcerned with shareholders.
Other plausible defenses were financially oriented. Gulf could buy back the investor groups’ shares. This move risked provoking other shareholders who were not offered the same opportunity.
Gulf could also buy Mesa Petroleum and depose Pickens. Pickens had foreseen this possibility, however. His investors had agreed that in this event, voting control of the entire block would pass to the private firm, Harbert International. In addition, as pointed out by a Texan close to the investor group, this option would “make Boone several hundred million dollars richer, (with his options on millions of Mesa shares), and he’d still be around advising the group.”*’
A further option for Gulf was to purchase reserves in the market, an approach advocated by Pickens himself. This would have defused Pickens’ liquidation argument. But, there was no guarantee Pickens would not then argue for a bigger royalty trust.

October: Mesa’s Growing Stak8.
By the end of October, the Mesa investor group had increased its share of Gulf to 17.9 million shares. The investors also made a filing under the Hart-Scott-Rodino Act. This act required a filing if a securities purchaser may have intentions other than investment. This filing barred the Mesa group from making further purchases until the government determined that there were no antitrust problems. On the final day of October, Mesa filed with the SEC for permission to seek proxies at Gulf’s December meeting and named Lehman Brothers Kuhn Loeb Inc. , as their financial advisor.

November: The Royalty Trust.
By November, the battle had begun to focus on the possible shareholder value of a Gulf royalty trust. Mesa disseminated a book detailing possible Gulf trusts which would distribute
" “Future of Gulf Oil Hinges on Proxy Fight Led by Mesa Chairman,”
Thr Wall Street Journal,
November 2, 1983, p. 18.
from 107c to 759c of Gulf’s U.S. oil and gas production revenues. The report predicted that the frust units would have a significantly higher market valuation than equiv- alent Gulf shares. It contended that the trust units would trade at 8 to 10 times cash flow, versus Gulf’s current stock price of 2 to 3 times.
As expected, Gulf officials took issue with Mesa’s report. “Contrary to the proponents’ assertions, the capital markets are sufficiently sophisticated to know that one plus one equals two,” asserted a Gulf spokes- man. “Thus, except for an initial flurry of excitement the distribution of [units] has resulted in a drop in
the distributing company’s stock price that reflects the value attributed to the royalty trust units.”"'
Gulf’s management also rebutted the traditional ar- gument for tax savings due to the elimination of double taxation by creating a royalty trust. They claimed that tax credits and deferments gave Gulf approximately an 89c effective tax rate."⁹
In addition, they pointed out that Gulf shareholders would have to pay taxes on the initial distribution of trust units. This distribution would be treated as a dividend. Gulf officials stated that many individual shareholders would have to sell shares to pay the tax bill.
James Lee hit hard on this last point: “It’s certainly clear Mr. Pickens doesn’t care a hoot about the huge unnecessary tax bite that would hit most of our shareholders.”"' Pickens responded to this issue by stating that when shareholders make money they should expect to pay taxes.
On November 22, Mesa was cleared by the SEC to purchase more Gulf shares. The investor group imme- diately began to increase its holdings. By the December
2 meeting, the investors had purchased another 1, 963,200 shares for $87. 1 million.

Attempted Takeover.
In the first round of Pickens’ bid to restructure Gulf, Pickens was soundly beaten. Gulf’s management won a December proxy fight that
“‘“Gulf Oil Royalty Trust Plans Are Outlined by Mesa and Partners, Raising Questions.”
The Wall Street Journal,
Novem- ber 9, 1983.
“'“Future of Gulf Oil.”
' °“Pickens Says He Wouldn’t Break up Gulf, Pledges Not to Sell Stake Back to Oil Firm,”
The Wall Street Journal,
November 11, 1983, p. 10.
12 Mesa Petroleum Compan y
(C)


605

Onboard a Mesa corporate jet headed for New York, Pickens received the news from an aide in Amarillo. “Shucks,” he said, “I guess we lost another one.””
It was later reported that Mesa's investor group would report a pre-tax gain of $760 million on the purchase of Gulf by Socal. Mesa Petroleum’s share of the investor group’s profit was said to be about $500 million.” Pickens personally received a cash bonus of $18.6 million for his performance in 1984 as Mesa’s CEO. The bonus was to be drawn from a $20 million pool set up to reward certain Mesa executives for their roles in the battle to acquire Gulf Oil. Pickens’ bonus was thought to be the largest ever given to an executive of a public company.’"
BUY-BACK 0F THE MESA ROYALTY TRUST

In a move that took most industry observers by surprise, Mesa, in May of 1984, made a $570 million cash tender offer for the 16.3 million outstanding units of its own Mesa Royalty Trust. The buy-back offer for the trust Mesa had established in 1979 marked the first time an oil company had sought to repurchase oil and gas interests it had earlier spun-off to shareholders.
According to Pickens, his main objective in making this unusual move was to acquire high-quality producing oil and gas properties at a reasonable price. “We’re buying gas in the ground for 92 cents [per thousand cubic feet],” said Pickens, “and that’s cheaper than we can find it.. . Gosh. Just think. We didn’t make anyone angry on this deal.”’”
Mesa’s offer of $35 per unit represented a 259c premium over market price. Throughout the year, the stock price for the trust had ranged from a high of
$29.875 to a low of $24.625 and had closed at $27.5 the day before the announcement was made.
” “Why Gulf Lost Its Fight for Life,” p. 76.
““Mesa Chiet Pickens Is Awarded Bonus of $18.6 Mil-
lion,”
The Wall Street Journal,
March 21, 1985. “Ibid.
”“Raiding Mesa Discovers Target Right at Home,”
Dallas


Morning New's,
May 16, 1984, p. lD.
Analysts were quick to ascribe motives to Pickens’ surprise move. The most plausible explanation con- cerned certain political moves being made by the Kansas legislature. The majority of the Mesa Royalty Trust properties were located in Kansas’ Hugoton Field. Kansas officials, said analysts, were on the verge of reducing the spacing between gas wells. If such infill drilling were allowed, the underlying asset value of the Mesa Royalty Trust could rise to as high as $60 to $70 a unit." It was the apparent belief of Mesa officials that investors would be willing to tender to receive a sure price immediately rather than speculate on the future.
Other observers suggested that the buy-back offer was designed to quickly bolster the firm’s reserve position. It seemed likely that Mesa would fail to replace all of its reserves for the second year in a row. Still others viewed the offer as an easy way for Mesa to boost its own value—just in case Mesa should become the target of a hostile raid.
The buy-back offer was ultimately an unqualified success. By the end of June, approximately 889c of the outstanding units had been tendered and accepted for payment.
MESA VERSUS PHILLIPS In December of 1984, Pickens announced that Mesa and its partners had acquired a 5.79o interest in Phillips Petroleum and that they intended to acquire a controlling interest in the company. Their first step in the acquisition was a tender offer for an additional 15°7o of the company at $60 per share. At $60 per share, the total value of Phillips would be $9. 3 billion. Pickens made it clear in the early going that his group was opposed to “green- mail” and would not sell their stock unless all share- holders got the same price.
¹

At the time, Phillips Petroleum was the nation’s 1 lth largest oil and gas firm, with total assets in 1983 of $13 billion, revenues of $15 billion, and net income of $721 million. The company’s significant reserves of crude oi1 and natural gas are shown in Table 4. Although the
"Ibid.
' ‘‘Phillips Novel Solution,’’
The New York Times,
Decem-
ber26, 1984 606
Part VI Strategic Management.- Cases




TABLE
4 Phillips Petroleum Reserve Base

Crude Natural Gas


(millions (billions of


Year of barrels) cubic feet)

1979 1,023 7,741
1980 834 6,778
1981 749 6,776
1982 737 6,677
1983 969* 7,646*
*Includes reserves from the purchase of 119 million barrels of oil and 487 billion cubic feet of gas from Aminoil.
Source: “The Attractions
of
Phillips,”
The New York Times,
Decem- ber 6, 1984.
appraised value of Phillips stock was $76 per share, it had only been trading in the mid-40s prior to the bid. Said George Baker, energy analyst for Smith Barney, “At $60 per share, Phillips Petroleum is a bargain.’’⁶²
According to analysts, Phillips met almost all of Pick- ens’ requirements for restructuring—it had “an above average dividend, managers that were not pushing to maximize shareholder wealth, and a lackluster record at replacing oil and gas reserves.”
Phillips quickly rejected Mesa’s offer and sought to block the takeover bid. Their most effective tactic was a suit against Mesa citing a breach of a non-takeover contract with General American Oil (GAO). The GAO standstill agreement called for Mesa not to try to acquire GAO “directly or indirectly’ ’ for five years. Phillips claimed that Mesa’s attempted acquisition of Phillips, as it was an indirect attempt to acquire GAO, violated this earlier contract. Despite the opinion of many analysts that Mesa would eventually win the suit, Mesa was forced to postpone the beginning of its tender offer due to legal uncertainties.
On Sunday, December 22, after a weekend of tough
negotiations, Phillips and Mesa came to an agreement ending Mesa’s takeover bid and adopting a plan to ‘put more value” in Phillips stock. The agreement was a part
“ “The Attractions
of
Phillips,”
The New York Times ,

December 6, 1984, p. 33. ”’Ibid.
of a recapitalization plan for Phillips. Under this plan Phillips would:

1. Repurchase 389o of Phillips’ 154 million outstanding shares using debt with an intended market value of

$60 per share. This would amount to approximately
$3.5 billion for 58.8 million shares. The recapital- ination would raise Phillips’ debt/equity ratio (de- fined as long-term debt to total stockholders’ equity) from 359c to approximately 709c.

1. Spend an additional $l billion buying stock on the open market, approximately 20 million shares.


2. Issuance of 32 million shares to the Phillips em- ployee stock ownership plan (ESOP). The ESOP could borrow money for these shares at low rates due to favorable tax laws. The ESOP would end up owning approximately 389c of Phillips.


3. Arrange for Mesa to sell its shares of Phillips for a minimum of $53 per share.


4. Phillips would sell approximately $2 billion in assets."

Although many of the individual actions in the recap- italization plan were relatively common ones, the pack- aging of them was somewhat unique. Sources involved in the negotiations said that each part of the plan was designed to please individual groups without hurting the company." Alan Edgar, analyst for Schneider, Bernet and Hickman Inc. , remarked on the significance of the plan:
It’s a lot more important than just a partial success for Boone Pickens. It has some far-reaching ramifications. There are other companies out there that are going to get exposed to this blueprint, either voluntarily or involuntarily.6 ‘
Pickens later boasted that Mesa had, over time, developed an in-house financial group that could com- pete with anyone. “Look at the Gulf and Phillips deals,” said Pickens. “Gulf and Chevron paid $64 million to investment bankers. We paid $8.5 million. In the Phil- lips deal—they paid $35 million to investment bankers; we paid zero.
⁶’
‘*“Phillips Novel Solution,”
The Ne York Times,
December
26, 1984.
“Ibid.
“Ibid.
"“Interview: T. Boone Pickens,” p. 11 .
MESA

The El. Picker - acqufi-e. annoi:r:: Fred He mam.n










"“H.-
cal’s Fr:—fi P 1
fibiJ


16, 19
12 Mesa Petroleum Compan y (C)

607
MESA VERSUS UNOCAL The Mesa-Unocal battle began in February of 1985 when Pickens announced that Mesa and its partners had acquired a 7.99o stake in Union Oil of California. Mesa announced the purchase was for investment purposes. Fred Hartley, chairman of Unocal, commended Mesa on making a good investment. It was not until the end of March that Pickens, now with 13.6'fo or 23.7 million shares of Unocal, announced that Mesa was considering a takeover or restructuring of Unocal. Shortly thereafter, Mesa announced a cash tender offer of $54 per share for just over 509o of Unocal. The other 509c would be purchased later for an equivalent $54 per share in notes, bringing the total offer to approximately $8. 1 billion.
⁶⁸
After the bid, Pickens announced that close to $4 billion in financing had already been arranged. A Unocal adviser commented on this announcement,
All of us were just shocked when Boone came up with that money. . Think of it! That’s green for half the company.
⁶’
Unocal was the nation’s 12th largest oi1 company. It had the sixth lowest finding costs in the industry, and ranked second in terms of reserve replacement.’°
Excluding the rash of name-calling in the press, the takeover battle was being fought over two basic issues. The first of these was over the date of the Unocal annual meeting. The Mesa group sought to delay the meeting so that it would have a chance to put together a slate of directors to run against the Unocal directors. Unocal strongly opposed this proposal in an effort to deprive Mesa of the opportunity to gain control of the board of directors. As Unocal had recently added several anti- takeover provisions to its charter, attempting a takeover at any time other than an annual meeting was very difficult. Due to an intense effort, Unocal was able to win the proxy fight and block Mesa’s bid to delay the meeting.
A second major battle, meanwhile, was being fought in the Delaware courts. Unocal had initially counterat-
““How Mesa’s Boone Pickens Finally Met Match in Uno- cal’s Fred Hartley,”
The Wall Street Journal,
May 24, 1985,
“Ibid.

⁷’“ Unocal Chairman Digs in,”
The New York Times,
April
16, 19 .
tacked the Mesa offer with a defensive tactic designed to shake Mesa’s financing. Under this plan, Unocal would tender for its own stock for $72 per share. The offer would commence only when the Mesa group got 51to of the company. Mesa would then acquire a company with a long-term debt to the total shareholders’ equity ratio of 609c, as opposed to l69o. Unocal later changed this strategy, instead offering a straight repurchase of 299o of the company’s securities for $72 per share. Under the new offer, Unocal would not accept any of the Mesa shares for repurchase. It was this issue which caused Mesa to seek redress in the Delaware courts. The courts initially ruled in favor of Mesa on two occasions, but later reversed themselves. The Delaware Supreme Court ovemiled the lower courts and allowed the targeted repurchase to continue. Analysts expected the SEC would move quickly to block future repurchases of this type.
The two sides got together for the first time the day
after the Unocal annual meeting. Although the results of the proxy fight to delay the annual meeting were not official, it was believed that Mesa had lost. At the time of the meeting, Mesa had won the initial decision in the Delaware courts and analysts expected the Delaware Supreme Court to rule in Mesa’s favor. The meeting itself seemed to go well, with Pickens commenting at the end of the day,
Fred, I think we did pretty damn good today. I didn’t call you arrogant, and you didn’t call me an idiot once.’'
Despite having made progress toward a solution, the next day the two sides found themselves far apart. Sources said that the Unocal team had decided that there was no reason to make any concessions. The Unocal draft of the solution worked out the previous day was, according to a Pickens aide, “ . the most ridiculous deal you ever saw. It went backwards from where we were the day before. ’
²
Pickens and his staff walked out of the meeting and returned to Amarillo.
After losing their bid to postpone the annual meeting, the Mesa Group’s primary hope of success hinged on the tender offer. Assuming Unocal lost in the Delaware courts, Mesa planned to tender its shares in the Unocal
' “How Mesa’s Boone Pickens Finally Met Match.”
’^Ibid. 608
Part VI Strategic Management.’ Cases

EXHIBI $72 offer and use the proceeds to finance the rest of the takeover bid. Shortly after the surprise ruling by the Delaware Supreme Court, Mesa lawyers contacted Un- ocal and the negotiations for a final settlement began. Hartley was said to be anxious to end the battle, due to worries about what the Pickens group would do next. Pickens’ advisers, meanwhile, were concerned that fur- ther attempts to make cash tender offers for Unocal could be stymied if Unocal continually outbid the Mesa group while saddling the company with more debt.”
The final agreement called for Unocal to include 7.7 million of Mesa’s shares in the repurchase and to spin off a large proportion of its domestic oil and gas reserves into master limited partnerships (MLPs) (MLPs are larger, more complex versions of the more traditional limited partnership arrangement. The shares, or “depos- itory receipts,” of an MLP are publicly traded and therefore liquid). Despite Pickens’ claims that the Mesa shareholders would not lose any money, analysts pre- dicted that the settlement would cost Mesa from $80 to
$110 million.
On June 2, Mesa reported an $83 million
gain
as a result of the Unocal takeover bid. The gain came from an income tax rule that allowed Mesa to report the gains it received from the settlement as dividends and not
”Ibid.

1979 1980 1981 1982 1983 1984 Mesa $ 5.43 $13.80 $15.06 $17. 13 $12.89 $ 6.06 Phillips 9.04 9.85 12.56 6.12 7.77 6.72 Unocal 8.87 10.64 13.43 12. 86 6.38 10.09 Gulf 16.47 15.84 19.23 16.00 9. 11 Superior 43.92 10.75 14.52 15.69 Industry average 11.74 10.07 12. 18 1 l . 93 8.97 7.73

EXHIBIT
7 Domestic Finding Costs (dollars per barrel)
Source:
Petroleum Outlook,
June 1985,
Petroleum Outlook,
June 1984.
capital gains. Mesa was also able to take a write-down of
$305 million on the Unocal shares it had to hold as a part of the settlement agreement. This write-down offset gains from previous takeover attempts.
STOCK REPURCHASE In July of 1985, Mesa’s board approved a plan to purchase up to $100 million worth of Mesa’s own 67 million outstanding shares.
’‘We believe that our shares represent an attractive reinvestment opportunity,” explained Pickens. “Mesa constantly evaluates alternatives to maximize values for Mesa shareholders, and we believe that share repur- chases meet the criteria at this time.”’°
Company officials stressed that the offer should not be interpreted as an antitakeover effort. “It’s not of the size that would have any antitakeover type intent,” said Mesa Vice President David Batchelder. “It’s really a matter of having undervalued assets in the form of Mesa common stock, which we find an attractive investment. We’re able to buy reserves for $4 a barrel.””
’"“Mesa Approves Plan to Buy Back $100 Million Worth of Shares,”
Dallas Morning News,
July 9, 1985, p. lD.
”Ibid.
Standard Reset e- Future Future
opt




Future Di
Discs , Fu:.




Chances
Stand.
























Sales Sale. Pres‘-










Net . Stan.
Note:
Discc
Fum-
prO














EXHIBIT
8 Mesa Petroleum Reserve Recognition Accounting (in thousands)


Standardized Measure of Future Net Cash Flows of Proved Reserves (unaudited):

1984


Years Ended December 31


1983 1982

Future cash inflows. . Future development and production costs:	.$ 4,594,130	$ 3,629,048	$ 3,439,222
Operating costs and production taxes ....	(924,386)	(984,801)	(826,489)
Federal excise tax on oil and condensate .......	(34,345)	(57,278)	(96,338)
Development and abandonment costs ..........	(129,836)	(151,349)	(177,052)
Future net cash flows before income taxes........	. 3,505,563	2,435,620	2,339,343
Discount at 109c per annum................................................................................................... (1, 755, 174)	(1,160,910)	(1,041,935)
Discounted future net cash flows before income taxes 1,750,389	1,274,710	1,297,408
Future income taxes, net of discount at 109c per annum................................................................................................... (319,999)	(265,461)	(252,879)

Standardized measure of future net cash flows of proved oil and gas reserves .
Changes in the Standardized Measure funaudited):
.$ 1,430,390
$ 1,009,249 $ 1,044,529

Standardized measure at beginning of year ..... .	.$ 1,009,249	$ 1,044,529	$ 1,036, 113
Revisions of reserves proved in prior years: Net changes in prices and production costs .	(33,387)	25,454	46,868
Net changes due to revisions in quantity estimates . .	105,656	11,618	(10,577)
Net changes in estimates of future development costs	483	(205)	(22,816)
Accretion of discount	127,471	129,741	129,032
Other, primarily timing of production .. ..	13,917	(73,984)	(54,401)
Total revisions .	214,140	92,624	88, 106
Extensions, discoveries and other additions, net of future
production and development costs	81,942	119,508	310,581
Purchases of producing properties .	515,532	34,801
Sales of oil and gas produced, net of production costs. . .. Sales of producing properties Previously estimated development and abandonment costs	t332,l52) (27,628)	(316,411)	(298,497)
incurred during the period	23,845	4 780	31,892
Distribution to Mesa Offshore Royalty Partnership ... .	(124,991)
Net change in income taxes . . (54,538)	(12,582)	1,325
Net changes in standardized measure 421,141	(35,280)	8,416
Standardized measure at end of year......................................................................................................... $ 1,430,390	$ 1,009,249	$ 1,044,529

Note:
Discounted future net cash flows before income taxes are calculated by discounting such cash flows at 109o per year, compounded monthly, over the expected period of realization.
Future income taxes are computed by applying the statutory tax rate to future net cash flows less the tax basis of the properties and net operating loss and investment credit carryforwards as of each year end; permanent differences and tax credits applicable to future oil and gas producing activities are also considered in the income tax computation.
Canadian reserves have an insignificant effect (less than 3') on either the standardized measure or the results of operations. Undiscounted future income taxes totaled $1.1 billion in 1984, $746 million in 1983, and $668 million in 1982.
Source: Mesa Petroleum Company, Annual Reports.



‘ ’ ' '°‘ '
EXHIBIT
9 Mesa Petroleum Marketable Securities

°°"

’°

!’

'°”'

1984 1983 1982


Non- Number Percent Non- Non-


Current current of shares of class current current ($ in thousands)

Income attributable to the company’s investment in marketable securities for the three years ended December 31, 1984, was comprised of the following ($ in millions):

1984 1983	1982
Gains on sales .	$ 403.5	$ 62.7	$ 64.0
Dividend income . .	22.4	10.1	4.9
Interest expense .	(40.6)	(24.1)	(18.6)
385.3	48.7	50.3
Income taxes ................	(172.6)	(13.0)	(7.5)
Income from securities................... $ 212.7	$ 35.7	$ 42.8
Source: Mesa Petroleum Company, Annual Reports.

EXHIBIT 10
ben-Year Sumniary of’ Mcsa I’ctrtilcuin’s k'inancia1 l9ata (in thousunds cxcc}›l per sliarc slitta)

Years ended December 31 (not covered b› auditors’ report)

1984	19R3	1982	1981	1980	1979	1978	1977	/ 976	1975
Oil and gas revenues	$ 413,489	$ 391, 134	$ 376,3S1	$ 367,552	$ 332, 193	$ 266,941	164,748	$139,257	$ 96,527	$ 63,426
Operating income.	154,732	$ 158,507	$ 152,564	$ 171 ,633	$ 143, 900	$ 122,545	$ 84,568	$ 79,439	$ 53,677	$ 31, 714
Other income (expense) and
taxes: Gain on sale of securities
and assets	403,549	89,221	63,967	1,730	15, 931	346,012
Interest income.	87,748	19,524	23,942	33,075	40,608	14,519	781
Interest expense, net	(184,192)	(77,513)	(40,299)	(29,332)	(32,655)	(49,601)	( 18,301)	(8,840)	(3,384)	(3,705)
Dividend income and
other .	13,754	10,006	(4,670)	8,683	(7,359)	1.710	9f›8	541
Provision for income
taxes	(205,407)	(73,835)	(65,600)	(70,740)	(65,189)	(149,563)	(26,270)	(30, 100)	(20,100)	(9,37?)
Net income .	270, 184	125,910	129, 904	115,049	95, 236	285,622	41,76ó	41,299	30, 734	19, 170
Preferred stock
dividends	(16,333)	(1 I ,0 19)	(13,959)	(8,670)	—		(2,394)	(4,899)	(3,288)
Net income available for
common $	253,851	$	114,891	$	115, 945	$	106,379	$	95, 236	$	285, 622	$ 41, 766	$ 35,905	$ 25,835	$ 15,582
Net income per common
share $ 3.75	$ 1.72	$ 1.72	$ 1.54	$ 1 . 38	$ 4.43	$ .66	$ .64	$ .48	$ .31
Cash dividends per common share $ . 20	$ . 20	$ . 20	$ .12	$ .0525	$ .0975	$ . 11	$ .0625	$ .025	$ .0125

Cash and short-term investments, marketable securities and
interest-bearing receivables
Long-term debt, including
à2,119,835 $ 882,426 $ 294,506 $ 556,072 $ 41 S ,668 $ 398,951 $ 87,204 $ 71,S7ó à 48,247 à 12,495

current maturities, subordinated notes and redeemable preferred
stock ....	$2,586,679	$1,429, 623	$ 924, 114	$1,094,780	$ 661 , 968	$ 626,551	$451,233	$321,453	$224,571	$150, 730
Total assets at year end ....	$3,955,951	$2,305,645	$1,667,230	$2,069,355	$1,426,850	$1, 2h8,459	$974,963	$800,210	$614,627	$496,897
Stockholders’ equity	$ 741 ,594	$ 502,505	$ 416,901	$ 595,445	$ 509,775	$ 400,181	$315,044	$337,223	$300,483	$276,47 6

Source: Mesa Petroleum Company, Annual Reports.