M&A Corner: Exxon's XTO Deal Launches Energy's Next Mega-Trend

The U.S. oil industry has experienced a variety of mega-trends over the past century and a half: The massive consolidation of John D. Rockefeller's Standard Oil in the 1870s and 1880s; the era of diversification deals in the 1960s and 1970s; the period of hostile takeovers in the 1980s; and the era of large mergers in the late 1990s.
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Now it looks like the industry is poised to experience yet another mega-trend, triggered by ExxonMobil's (XOM) $41 billion purchase of XTO (XTO). It's a clear sign that future growth in the extractive energy realm will come from sources other than oil -- sources such as natural gas.

Founded in 1985, XTO saw an opportunity to build a thriving business by purchasing under-appreciated energy properties. Its strategy had three parts: acquire, exploit and discover.

It worked extremely well. Currently, XTO is one of the largest owners of domestic natural gas reserves.

XTO also owes some of its success to investments in science and operational efficiency. The company now possesses sophisticated technologies that can extract -- on a cost-effective basis -- natural gas from shale rock. That has been a game-changer.

The Resources Exxon Brings to the Table: Size and Money

In light of this, why did XTO sell out? It has been in a brutally difficult situation since the recession hit in 2008. Commodities prices are well off their highs, and credit is still tough to get. Moreover, XTO has a heavy debt load, which makes it difficult to capitalize on the opportunities now available.

But by adding its technology and reserves to the scale of ExxonMobil, XTO can truly realize its ambitions. Essentially, XTO is a platform that can be implemented across the globe. This is critical since the unconventional energy sources XTO aims to tap appear to be in plentiful supply in the world's politically stable regions. That contrasts to oil, the reserves of which are in far-off regions where populations tend to be hostile to American interests.

At the same time, natural gas fits within the nation's long-term focus on greener energy. While natural gas is far from a perfect fuel, it is still releases far less carbon into the atmosphere when burned than oil or coal.

Yet, as with any deal of this scope, the risks are significant. Given the technology aspects, Exxon will need to work hard to retain key employees. Just look at the ConocoPhillips (COP) deal for Burlington Resources, which is a stark reminder of the real dangers of such acquisitions.

A Blueprint for Future Deal-Making

But it looks like Exxon is already taking steps to deal with the culture issues. For example, the transaction is an all-stock deal, which gives the XTO employees an incentive to perform. What's more, Exxon's global operation for unconventional resources will be housed at XTO's headquarters in Forth Worth, Texas.

Exxon's deal is likely to be a blueprint for future dealmaking by the other supermajors such as BP (BP), Royal Dutch Shell (RDS.A) and Chevron (CVX). Over the next couple years, expect to see more deals with natural gas and unconventional sources -- whether in terms of acquisitions or joint ventures. Some possible targets include Chesapeake Energy (CHK), EOG Resources (EOG), Anadarko Petroleum (APC), Petrohawk Energy (HK), EnCana (ECA), Devon Energy (DVN) and Ultra Petroleum (UPL).

Finally, keep in mind that the purchase of XTO is Exxon's biggest deal since it acquired Mobil in 1999. That deal was a risky, but it was based on solid analysis that fossil fuels would not go away. And that deal too, was a harbinger of things to come; it was followed by Chevron's purchase of Texaco, and BP's acquisition of Amoco.

But this time around, the dealmaking will need to be about more than just slashing costs. Instead, it will involve moving large organizations into new categories and technologies. The stakes are high. But if the supermajors want to grow for the next decade, they will have to make some big bets.

Tom Taulli is the author of a variety of books, including
The Complete M&A Handbook. His website is Taulli.com.
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