At press time, Unocal Corp., El Segundo, Calif., (NYSE: UCL) was considering a counter-proposal from CNOOC Ltd., (NYSE: CEO) an affiliate of China National Offshore Oil Co., to acquire the company for US$67 per share. The all-cash offer values Unocal at approximately US$18.5 billion-some US$500 million more than the Chevron Corp. (NYSE: CVX) offer. The date of the Unocal stockholder meeting to vote on the Chevron offer was in August, but Unocal intends to commence discussions with CNOOC. The Unocal board's recommendation that Unocal stockholders accept Chevron's bid remains in effect. Unocal agreed to be acquired by Chevron in April for US$65 in cash or 1.03 CVX shares or a combination per Unocal share. The ratio is 75% stock and 25% cash. The offer places an average value per Unocal share at $62. Chevron would issue approximately 210 million CVX shares and pay approximately $4.4 billion in cash, plus assume estimated net debt of $1.6 billion. CNOOC chairman and chief executive Fu Chengyu has written to Unocal's chairman that the offer is friendly and CNOOC is seeking a consensual transaction. Acquiring Unocal would more than double CNOOC's production and increase its reserves nearly 80% to approximately 4 billion BOE. Approximately 70% of Unocal's proved reserves are in Asia and the Caspian region. The merged company would have a balanced mix of total reserves: 53% oil. "For our shareholders, there is a strong business rationale for the combination, as CNOOC and Unocal would form one of the leading international E&P companies and become one of the premier players in the Asian energy market," says Chengyu. "It would rebalance our portfolio to include more natural gas reserves and strengthen our regional presence by combining with Unocal's complementary Asian asset base. I am confident that the merger will increase shareholder value." Chevron reports that it stands behind its agreement with Unocal, which both companies' boards have approved. Chevron says its transaction is likely to close, while the CNOOC proposal must undergo an extensive regulatory review process in the United States and elsewhere. Chevron and Unocal's combined production would average about 3 million BOE per day in 2006. Unocal has 1.75 billion BOE of proved reserves, which would boost Chevron's year-end 2004 proved reserves about 15%. The Unocal assets are complementary to Chevron's portfolio in the Asia-Pacific region, the Gulf of Mexico and the Caspian. Deutsche Bank analyst Paul Sankey calls the counter-bid a "high-level political decision that makes little sense on a corporate level by Western conventions unless another of our theories, that CNOOC is getting itself into bargaining position with Chevron, is correct. The two really need to be negotiating over Asian gas, not fighting, and this may yet end with a handshake." "Friendly" hostile deals have never been the norm in the E&P patch, says Merrill Lynch analyst John Herrlin. "We can't recall a comparable situation in the energy business in our careers in which a hostile overture was made post-an-already-agreed-upon merger." Herrlin says the difference between the two offers for Unocal-excluding price-is that the Chevron offer includes continued participation on an equity basis and reduced tax exposure, as opposed to a rigid cash deal. "The Chevron deal has a greater certainty of merger closure, and Unocal did reiterate the board's reaffirmation of the Chevron merger plan," Herrlin says. Despite these affirmations, Sankey says Chevron's reaction to the counteroffer is key. "This is not a knock-out blow from CNOOC, but the tacit entrance of the Chinese government means that Chevron has gone from fighting David to fighting Goliath. It is crucial that the company does not enter a bidding war. "We believe that the best thing for Chevron is to throw all its financial muscle into aggressively stepping up its buyback in order to increase the value of its offer into a July Unocal shareholder vote. Allowing for the time value of money, with CNOOC's bid likely to take at least a year to clear... effectively CNOOC's all-cash offer is closer to $65.50." Sankey has a Buy recommendation on Chevron stock with a target price of $67. There has been a bit of a buzz about U.S. regulatory interference in the counterbid, but Bernard Picchi, Foresight Research Solutions senior managing director, says he doubts the rumors of regulatory scrutiny carry any real weight with CNOOC. "In fact, the Chinese probably welcome an intense U.S. government review of the Unocal bid as a kind of clarifying exercise that will set firm policy regarding Chinese direct investment in the U.S.," Picchi says. He adds that there are three factors that will determine who the bid winner will be: the Unocal board, the reactions of the bidders and Unocal shareholders. "Privately, board members might want Chevron to win, but CNOOC's bid is $6 per share superior to Chevron's and it's in cash. If the board acts properly, we believe, it will stop the clock on Chevron's fast-track merger timetable, open discussions with CNOOC, evaluate all options, consult legal and financial experts, and probably try to coax Chevron into raising its bid." Both bidding companies are after Unocal's Asian and Caspian assets. As Chevron is experiencing production declines, losing out on Unocal would cripple its efforts to snag opportunities in Indonesia, Vietnam, Bangladesh and Azerbaijan. "One compromise would be for Chevron and CNOOC to jointly acquire Unocal, thus owning and developing some or all of its Asian assets together-we believe the North American assets will be sold regardless of the winner," Picchi says. "We admit this is a long shot, but it is not out of the question." He adds that his rationale is based on the fact that a key development project in Chevron's global portfolio is its Gorgon/Barrow Island LNG project on Australia's Northwest Shelf. As Chevron plans to market that LNG to China, offending the most likely buyer should be avoided. Picchi says that while Chevron is the likely winner, it may have to raise its offer to match CNOOC's bid. He does not foresee CNOOC suddenly deciding to withdraw unless the U.S. government blocks the bid. At press time, there was an unconfirmed report that CNOOC will increase its offer. This deal may have inadvertently set the stage for other Chinese companies with global appetites for acquisition to compete more directly with U.S. energy companies. Picchi says, "That would make sense, since both cash flows and cash levels in the world energy industry have risen out of proportion to the growth of the industry's reinvestment opportunities. Further consolidation seems inevitable."

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