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case_study.pdf
________________________________________________________________________________________________________________ HBS Professor William E. Fruhan and Professor Wei Wang, Queens University, Kingston, Ontario prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. Although based on real events and despite occasional references to actual companies, this case is fictitious and any resemblance to actual persons or entities is coincidental. Copyright © 2014 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.
W I L L I A M E . F R U H A N
W E I W A N G
Newfield Energy
In early September, 2013, Miles Griffin, CEO and chairman of the board of Newfield Energy, was considering a package of proposals prepared by his CFO. Griffin had to present the proposals to the board of directors for final approval the following day. The proposals included: (1) a press release outlining that the company was planning to divest several natural gas projects immediately, probably at significant book losses; (2) a significant reduction of common stock dividends; and (3) an exchange offer under which the company would exchange up to 20% of its common stocks into newly issued preferred stocks. Griffin recognized it would require both careful financial analysis and some shrewd decision-making to make the best of a bad situation.
Company Background
Newfield Energy, based in Houston Texas, was a large independent energy company primarily engaged in the exploration, development, and production of crude oil, natural gas, and natural gas liquids (NGL). Newfield was founded in 1982 by Miles Griffin with a focus on crude oil exploration and development in Texas and the Gulf of Mexico. The company experienced stable revenue in the 1990s, followed by a period of accelerated revenue growth between 2002 and 2008 (Exhibit 1 and Exhibit 2). Supported by the accelerated growth in revenue and earnings, Newfield was able to increase its dividend dramatically in 2007. Its stock price soared from $20 per share in 2003 to about $70 in 2007 (Exhibit 3).
Gas prices had risen rapidly between 2002 and 2005 (Exhibit 4) and, believing that the uptrend would continue, Griffin decided to enhance the company’s exposure to natural gas exploration and production in 2005. Between 2005 and 2008, the company aggressively sought acquisitions and consolidated a significant amount of natural gas assets, mostly unconventional1 (Exhibit 5). By the end of 2008, the company had about 80% of its production in natural gas (Exhibit 6).
1 Unconventional natural gas is essentially the same as conventional natural gas with the main differences being it is riskier, costlier, and requires more complex drilling techniques as it has low “permeability” or high “tightness” (referring to the hardness of the rock). There are three types of unconventional gas: coalbed methane, shale gas, and tight gas sands.
9 - 9 1 4 - 5 4 1 F E B R U A R Y 2 5 , 2 0 1 4
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Both crude oil and natural gas prices reached a peak in the middle of 2008 and crashed shortly afterwards. Natural gas prices experienced a prolonged decline in 2009-2012, partly due to technological innovations in exploring and developing unconventional gas. After observing a divergence in prices between crude oil and natural gas during this period, Griffin started to lose confidence in the profitability of Newfield’s natural gas operations and also considered the tradeoffs between having focused vs. balanced energy production within its asset portfolio. In 2011, he began a major restructuring plan to divest some of the natural gas assets that the company had acquired and to purchase several oil and NGL assets. He planned to continue investing in liquids-rich assets and shift Newfield back to a liquids-focused producer. Given the depressed natural gas prices in 2011, Newfield divested several natural gas assets at considerable book losses. Though the company had been transitioning to more liquids-focused assets, it suffered a continued decline in earnings from 2010 to 2012, partly due to restructuring charges and the impairment of oil and natural gas assets.
Industry Background
There were more than 8,000 U.S.-based oil and gas companies in 2013. The large companies in the industry experienced an average per year revenue growth of 15% from 2002 to 2012. The majority of the large companies were involved in a balanced production of oil and natural gas. A few of them, like Newfield, made major acquisitions during the decade to switch their focus to unconventional natural gas. Given the prolonged weakness of natural gas prices after 2008, many of the firms divested natural gas assets to increase the proportion of oil in their asset mix.
Prior to 2007, the U.S. natural gas market was characterized by scarcity, high prices, and import dependency. After 2008, however, technological innovations made possible the extraction of natural gas from increasingly difficult geological formations, notably shale rock, and this technical revolution made the U.S. the world’s largest natural gas producer. Oversupply resulted and, combined with the effects of a lingering economic recession, drove natural gas prices to a decade low in 2012. Many energy companies with extensive natural gas assets were forced to divest. From 2011 to 2013, eight large public companies in the oil and gas industry had to cut their dividends. These firms experienced large negative reactions from the stock market when they announced their dividend reductions.
The Newfield Proposals of 2013
In August, 2013, Griffin reaffirmed to the board Newfield’s long-term commitment to oil and NGL.2 Newfield’s overexposure to dry natural gas led to declines in earnings from depressed natural gas prices. The company needed to divest additional unconventional natural gas assets while investing significantly in oil and NGL operations. Griffin planned to have Newfield’s natural gas production reduced from 60% of total production in 2012 to below 40% by fiscal year 2014. During 2011 and 2012 the company had divested five natural gas assets that it acquired between 2005 and 2008, realizing considerable losses on these investments. It planned to put three more assets up for sale immediately. Meanwhile, Newfield acquired several assets in oil and NGLs during 2011 and 2012.
Newfield was facing a heavy debt load and weakening earnings in 2013 primarily due to its debt- financed acquisitions being much less profitable than expected. Its share price had dropped from $68 at the end of 2007 to about $44 at the end of August, 2013. Griffin felt that Newfield should reconsider
2 NGL had historically tracked the prices of crude oil better than natural gas.
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Newfield Energy | 914-541
HARVARD BUSINESS SCHOOL | BRIEFCASES 3
its financial policy, including its dividend policy, as part of the company’s restructuring efforts. In fact, the company paid dividends in excess of net income in both 2011 and 2012. The company would be able to conserve cash by reducing its dividend from $2 to $1 per share. Newfield maintained its $2 dividend per share since the last dividend cut in 2009. Griffin recalled that the dividend cut in 2009 did not trigger an immediate drop in Newfield’s stock price because Griffin had alluded to the possibility of a dividend reduction well ahead of the announcement. However, he felt that the company faced a different situation in 2013. Newfield had not indicated to investors that the company might cut the dividend in the near future, but two consecutive years of dividends in excess of earnings might have signaled the likelihood of a dividend cut anyway.
Newfield’s twenty largest institutional investors held over 65% of the company’s 382 million shares. These investors included commercial banks, investment banks, large corporations, mutual funds, pension funds, and asset managers. Of these institutional investors, five fund managers and three corporations, who together owned 20% of the outstanding shares, clearly indicated dividend yield to be their primary investment objective in holding Newfield’s shares. Those investors might sell their Newfield shares quickly if Newfield reduced its dividend without offering them other forms of cash income. Griffin asked Newfield’s CFO to consider steps that the company could take to prevent the dividend reduction from driving down the stock price.
The CFO proposed that Newfield offer to exchange a maximum of 76.4 million common shares on a 1-to-1 basis with new preferred equity. The newly issued preferred stock would pay cumulative quarterly dividends of 50 cents ($2 each year) accrued from December 1, 2013 to December 1, 2016 on the same dividend payment dates as its common stock. Common stock holders would see their dividends reduced to 25 cents per share each quarter. Newfield would redeem the preferred stocks on December 1, 2016, at which time the CFO hoped to be in a position to increase common share dividends. Early redemption was possible only in special situations such as a takeover. Preferred stock holders would receive one common share for every preferred share if the price of the common stock was less than or equal to $60.50, or $60.50 worth of common stock per preferred share if the common stock was above that price on the redemption date. The CFO noted the option-like features embedded in the preferred stock. The CFO proposed to impose two restrictions on the common dividend payment. First, Newfield would not be able to pay its common dividend at any time when its preferred dividend was in arrears. Second, Newfield would not pay a common shareholder a dividend of $1.25 or more per share per year until the preferred shares had been redeemed.
The company’s stock closed at $44.25 per share on August 30, 2013. Exhibit 7 shows the closing prices of Newfield’s call options as listed on the Chicago Board Options Exchange on that date. One- year U.S. Treasury Notes were paying 0.12% interest per year at the time.
Griffin felt that sophisticated institutional investors would probably have no trouble understanding the new security. However, he would need to convince his colleagues on the board that the offer would be fair to all shareholders of the company, and that the ability to swap common for preferred should be appealing to those institutional investors who desired a high dividend yield. Furthermore, he was considering the consequences of announcing three simultaneous corporate decisions. Might the breadth and complexity of the package of proposals cause investors worry instead of comfort?
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For the exclusive use of K. Kothari, 2016.
This document is authorized for use only by Krish Kothari in Finance taught by David C. Ketcham, Bryant University from January 2016 to July 2016.
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914-541 | Newfield Energy
6 BRIEFCASES | HARVARD BUSINESS SCHOOL
Exhibit 3 Stock Price Performance, 2003–2013
Year
Closing price at
year end
Shares outstanding
(million) Market cap
(million) S&P 500
index
2003 $20.45 324 $6,626 1111.92 2004 $24.54 328 $8,049 1202.08 2005 $28.98 329 $9,534 1248.29 2006 $40.24 330 $13,279 1418.30 2007 $68.12 331 $22,548 1468.36 2008 $48.21 338 $16,295 903.25 2009 $52.71 349 $18,396 1115.10 2010 $50.22 342 $17,175 1271.87 2011 $39.27 374 $14,687 1257.60 2012 $41.24 382 $15,754 1426.19 2013* $44.25 382 $16,904 1632.97
* The price in 2013 reflects the closing price on August 30, 2013. The historical volatility of Newfield stock was 27.5% per year over the previous six month and 31.6% per year over the previous 12 months.
Exhibit 4 Crude Oil Prices (West Texas Intermediate) and Natural Gas Prices (NYMEX)
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Newfield Energy | 914-541
HARVARD BUSINESS SCHOOL | BRIEFCASES 7
Exhibit 5 Newfield’s Major Acquisitions and Divestitures of Natural Gas and Oil Assets, 2005–2012
Assets Buyer/Seller Deal Year
Deal Value (millions)
South Texas oil and gas assets from Sinclair Energy Buyer 2005 $580 Sixteen natural gas producing properties in the Appalachian Basin Buyer 2005 $1,150 Oil and gas properties in Nebraska and Virginia from NGX Energy, LLC. Buyer 2006 $600 Oil and gas properties in Permian Basin from Harrison Energy Partners Buyer 2006 $950 River Ranch Natural Resources LLC Buyer 2006 $1,400 Southeastern Energy Corporation LLC Buyer 2006 $760 Natural gas assets from One Energy Inc. Buyer 2007 $1,970 Midcontinent natural gas assets from Oklahoma Natural Gas LLC Buyer 2007 $820 Pan-American Energy Resources Inc. Buyer 2007 $2,600 Barnett shale gas assets from First Reserve Energy Buyer 2008 $1,640
Sixteen natural gas producing properties in the Appalachian Basin Seller 2011 $950 River Ranch Natural Resources LLC Seller 2011 $1,100 Pan-Pacific Energy LLC Buyer 2011 $920 Meridian Oil Co. Buyer 2011 $1,250 Southeastern Energy Corporation LLC Seller 2012 $420 Midcontinent natural gas assets from Oklahoma Natural Gas LLC Seller 2012 $600 Barnett shale gas assets from First Reserve Energy Seller 2012 $1,120 DBA Energy Corp. Buyer 2012 $1,380 Gulf of Mexico oil properties Buyer 2012 $850
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9 8 .1
5 ,0
0 1 .5
6 ,2
8 0 .4
3 ,8
1 8 .8
4 ,0
2 0 .4
2 ,8
0 3 .0
1 ,9
1 0 .3
N
G L
2 6 4 .5
3 2 4 .6
4 9 4 .9
7 2 8 .6
6 9 6 .6
5 3 1 .1
5 6 1 .2
5 5 2 .1
8 3 5 .9
1 ,2
4 7 .8
T o
ta l
2 ,2
9 1
2 ,9
8 7
4 ,3
7 5
6 ,1
1 4
8 ,4
8 4
9 ,6
6 3
7 ,0
8 4
7 ,5
2 6
7 ,8
8 8
8 ,0
4 5
% n
at u
ra l
g as
i n
t ot
al r
ev en
u e
4 1 %
4 3 %
4 2 %
4 1 %
5 9 %
6 5 %
5 4 %
5 3 %
3 6 %
2 4 %
M a rk
e ti
n g
, g
a th
e ri
n g
a n
d c
o m
p re
ss io
n
1 0 0 .2
1 8 9 .2
1 1 3 .4
2 6 6 .2
1 9 9 .8
1 7 4 .0
2 0 9 .7
4 1 .5
1 7 7 .7
2 2 3 .2
O
il fi
e ld
s e rv
ic e s
2 4 .5
3 2 .6
4 6 .0
6 5 .3
8 9 .0
6 4 .7
7 4 .7
7 6 .4
8 2 .3
2 3 4 .2
O
th e r
3 1 .8
4 7 .1
6 0 .5
8 4 .9
1 2 8 .9
7 0 .8
9 9 .5
8 4 .2
8 6 .0
1 0 8 .4
T ot
al r
ev en
u es
2 ,4
4 7
3 ,2
5 6
4 ,5
9 6
6 ,5
3 1
8 ,9
0 3
9 ,9
7 3
7 ,4
6 8
7 ,7
2 9
8 ,2
3 4
8 ,6
1 1
*T o
ta l
sa le
s fo
r e a
ch c
a te
g o
ry i
n cl
u d
e r
e a
li z
e d
o r
u n
re a
li z
e d
g a in
s a
n d
l o
ss e s
fr o
m d
e ri
v a
ti v
e s.
For the exclusive use of K. Kothari, 2016.
This document is authorized for use only by Krish Kothari in Finance taught by David C. Ketcham, Bryant University from January 2016 to July 2016.
Newfield Energy | 914-541
HARVARD BUSINESS SCHOOL | BRIEFCASES 9
Exhibit 7 Newfield Call Option Trading Information on Chicago Board Options Exchange (Closing Prices), August 30, 2013
Calls
Strike Price September October November
$40.00 $4.37 $4.66 $4.89 $42.50 $2.24 $2.68 $3.12 $45.00 $0.79 $1.31 $1.79 $47.50 $0.18 $0.56 $0.85 $50.00 $0.02 $0.17 $0.41
*Each contract represents an option on 100 shares. These contracts expire at the end of the third Friday of the maturing month.
For the exclusive use of K. Kothari, 2016.
This document is authorized for use only by Krish Kothari in Finance taught by David C. Ketcham, Bryant University from January 2016 to July 2016.
