In reality, markets are neither perfectly efficient nor completely inefficient. All markets are efficient to a certain extent, some more so than others. Large and sophisticated stock markets, such as the UK and US stock markets, respond efficiently to new information, and only exhibit inefficiencies in some areas, particularly at the strong-form level. It is reasonable to conclude that they are substantially efficient and it is rare that a non-insider can outperform the market. We also have seen how many of the semi-strong inefficiencies, from bubbles to underpricing low PER shares. Since such cases are small in number when compared with the total value of business in the market as a whole, and since legislation has been introduced to control the practice of insider dealing. Therefore we may conclude that stock markets are efficient, particularly in the UK and US.
The hypothesis of foreign exchange market efficiency assumes that (1) all relevant information is quickly responded in both the spot and forward exchange markets, (2) transaction costs are low, and (3) instruments denominated in different currencies are perfect substitutes for one another. (Eiteman, Stonehill and Moffett, 2001)
Tests of foreign exchange rate efficiency have abounded. The first approach is to test exchange rates in an arbitrage context to determine whether they are out of parity with interest rates or other exchanges rates. If a profitable trading scheme can be developed due to exchange rate mispricing, the conclusion is that market inefficiency exists in the currency. The second approach to efficiency testing relates to the ability of forward exchange rates that predict corresponding future spot rates. If the forward rate is found to be a biased predictor, even after considering potential risk premiums, profitable trading schemes may be developed to take advantage of exchange rate mispricing. Therefore, market inefficiency is also said to exist. The third approach to exchange rate efficiency testing is to examine exchange rates as a time series to determine whether or not they follow a random walk. If exchange rates do not follow a random walk, the profitable trading schemes could be possible if the pattern detected is economically significant. The UK Pound and the US Dollar exchange markets are two of the most active foreign exchange markets in the world. Thus they do not reject the random walk hypothesis and provide evidence that exchange rate markets can be efficient. (Smoluk, Herbert, Vasconcellos, Geraldo, Kramer, Jonathan, 1998) Furthermore, the US and the UK both belong to independently floating exchange rate regime. That means 'the exchange rate is market-determined, with any foreign exchange intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it'. (Eiteman, Stonehill and Moffett, 2001) Therefore we also can get similar conclusion about the foreign exchange market efficiency with the stock market efficiency. Some mature and large foreign exchange market, such as the UK and US foreign exchange markets, can be regards as efficient in most time.
The Market Positions and Background of BP Amoco and ARCO Prior to The Acquisition1
BP Amoco p.l.c. (BP Amoco) is a United Kingdom corporation with headquarters in London, England. BP Amoco is one of the world's top three petroleum and petrochemical groups on the basis of market capitalization with a wide operational and geographic scope. The BP Amoco Group has well-established operations in Europe, North and South America, Australia, Asia and parts of Africa.
BP Amoco's main businesses are exploration and production of crude oil and natural gas including refining, marketing, supply and transportation, and manufacturing and marketing of petrochemicals. The BP Amoco Group provides high quality technological support for all its businesses through its research and engineering activities. Although relatively small in comparison to its main business, the BP Amoco Group also contains one of the world's leading solar businesses - BP Solarex.
Atlantic Richfield Company (ARCO), the seventh largest oil group in the US, is a Delaware corporation with headquarters in Los Angeles, California. ARCO is a worldwide oil and gas enterprise. Its turnover for the year ended 31 December 1998 was approximately $10.3 billion and its gross assets at that date were approximately $25.2 billion. It operates in two segments: exploration and production, refining and marketing.
Exploration and production develops and produces oil and natural gas worldwide. Areas in which it has operations include Alaska, the Gulf of Mexico, China, Indonesia and the United Kingdom North Sea. The largest element of ARCO's operations in the Lower 48 States of the United States is held by ARCO's 82 per cent owned subsidiary, Vastar.
Refining and marketing is primarily responsible for petroleum refining, marketing and transportation. ARCO's refining and marketing operations are primarily in the western United States. These operations include two west coast refineries and over 1,700 branded retail gasoline outlets in six western states of the United States and British Columbia in Canada.
The Motives for The Acquisition of BP Amoco and ARCO2
The Boards of BP Amoco and ARCO believe if the two companies' complementary oil and gas assets around the world are combined they will have a stronger strategic position, and will enhance efficiencies and cost competitiveness, and will create significant opportunities for growth. Furthermore BP Amoco periodically reviewed strategic initiatives for the improvement of its competitive position in the worldwide oil and gas industry, including possible business combinations, joint ventures and other significant transactions.
Therefore the motives of the acquisition of BP Amoco and ARCO considered by the BP Amoco Board are the following:
? Alaskan oil and gas
The combined Alaskan oil assets of BP Amoco and ARCO will provide BP Amoco with opportunities for significant cost reductions and motives for new investment. Significant Alaskan gas interests of ARCO and BP Amoco will bring Alaskan North Slope gas deposits into production.
? Refining and marketing
In the US, leading position of ARCO in refining and marketing on the west coast with BP Amoco's substantial position in the rest of the US will enable the combined group to compete on an equal footing with other major coast-to-coast marketers of gasoline.
? Global gas assets
The addition of ARCO's gas production and reserves will enable BP Amoco to become the second largest non-state owned gas producer in the world. The combined group will have significant potential for further growth in production. In Southeast Asia ARCO will bring current gas producing assets in China and Indonesia to BP Amoco. Some undeveloped growth interests in the Thailand/Malaysia joint development zone and in Indonesia's world-class Tangguh field will be available for BP Amoco as well.
Synergies were created through this acquisition. 'The combined company is expected to achieve an annual rate of pre-tax cost savings of approximately $1 billion during the second full year after the Effective Date of the transaction, with anticipated pre-tax cost savings of approximately $600 million to be achieved during the first full year.' The estimated cost savings are expected to come from the following:
? Organisational efficiencies, including reductions in staff and corporate overheads;
? More focused exploration efforts through the use of shared technology to reduce the risk of unsuccessful wells;
? Standardisation and simplification of business processes;
? Rationalisation of operations.
'The anticipated cost savings are expected to be offset by restructuring charges and transaction expenses of approximately $1 billion in the first year after the Effective Date, including approximately $400 million in UK stamp duty to be incurred on the issue of BP Amoco ADSs to ARCO Common Shareholders. BP Amoco expects to reduce the worldwide staff of the combined company by approximately 2,000 positions as a result of the Combination.'
There are also some additional factors the BP Amoco Board considered.
? The opinion of Morgan Stanley show that the Exchange Ratio was fair from a financial point of view to BP Amoco at 30 March 1999;
? The combination would be subject to acquisition accounting under UK GAAP, resulting in on-going additional depreciation and amortisation charges;
? The transaction would produce significant increased cash flow through reduced cash costs due to the targeted synergies and reduced capital expenditure through the application of BP Amoco capital efficiency targets to all of the combined company's assets;
? The growth opportunities in ARCO's current asset base could contribute up to 300,000 barrels per day in oil or oil equivalents of new production by 2010.
After the consideration of these various factors relevant to evaluation of the acquisition, the BP Amoco Board made the decision to combine with ARCO. All above these motives were shareholder oriented and for maximizing shareholders' wealth. The acquisition of BP Amoco and ARCO will make BP Amoco the largest non-state owned oil producer in the world and the largest oil and gas producer in both the US and the UK. ARCO will bring BP Amoco distinctive assets that will diversify its portfolio of international assets, extend its strategic position in key areas, and significantly increase its opportunities for growth.
The Reasons Why ARCO Accepted The Bid
In 1998 Arco's sales dropped from Dollars 14.3bn to Dollars 10.3bn, while net income, which was distorted by write-offs and disposal gains, fell from Dollars 1.77bn to Dollars 452m.3 At that time some ventures, particularly in the international arena, had absorbed cash and failed to produce as much profit as had been expected. Outside the US, by contrast, Arco's record is poor. Much of its US cash flow has been wasted on digging dry wells. In 1998 it wrote off Dollars 629m in exploration expenses more than the Dollars 500m analysts project for BP Amoco in 1999, which is a company three times bigger.4
At the same time because of the large drop in crude oil prices in late 1997 and significant industry consolidation during 1998, ARCO Board and management determined to run its strategic plan of focusing on its core oil and gas businesses as an independent company, ARCO should explore a strategic combination with another company in the oil and gas industry. After the consideration of the possible merits of a combination with each of the three largest integrated oil and gas companies by market capitalisation and transaction costs and risks, ARCO's management determined that the greatest opportunities for synergies and enhanced shareholder value would be created by a combination of ARCO and BP Amoco. As a result, ARCO contacted BP Amoco to discuss options for closer co-operation between the two companies.
Furthermore, Mike Bowlin, Arco chairman and chief executive, will leave Arco with $3.2 million in salary and bonuses plus another $29.3 million in exercisable stock options, according to estimates by Executive Compensation Advisory Services based on Arco's proxy statements. Probably it was also another element to boost this deal.5
The Methods Were Used to Finance The Acquisition6
On April 1, 1999 the Board of BP Amoco announced that it had reached agreement on a proposed combination with ARCO of Los Angeles. BP Amoco agreed to buy ARCO for more than $31-bil, which is this company's second audacious acquisition in eight months.
The aggregate value of the consideration that was paid by BP Amoco for the acquisition calculated on the basis of the per share price of £12.20, which was the closing middle market quotation for BP Amoco Ordinary Shares as derived from the Daily Official List on 9 July 1999, multiplied by 1,672 million (the estimated maximum number of Consideration Shares to be issued, which included the number of BP Amoco American Depositary Shares, ADSs, which may be issued in respect of outstanding ARCO options and contingent stock and on conversion of ARCO Preference Shares) less the expected consideration receivable on the issue of shares under option ($605 million) is approximately $31 billion (£20 billion) after applying an exchange rate of $1.5515: £1.00 (the Noon Buying Rate on 9 July 1999).
The combination terms described as follow:
? 'Under the terms of the Combination, ARCO Common Shareholders (other than BP Amoco, ARCO or any subsidiary of BP Amoco or ARCO) will be entitled to receive, for each ARCO Common Share, 4.92 BP Amoco Ordinary Shares in the form of BP Amoco ADSs or, if they so elect in a timely manner, BP Amoco Ordinary Shares (each BP Amoco ADS will represent six BP Amoco Ordinary Shares and in consequence ARCO Common Shareholders will receive 0.82 of a BP Amoco ADS in exchange for each ARCO Common Share they own at the Effective Date). If the Subdivision is approved at the EGM and is completed prior to the Effective Date, ARCO Common Shareholders will be entitled to receive 1.64 BP Amoco ADSs or, if they so elect, 9.84 BP Amoco Ordinary Shares for each ARCO Common Share they own at the Effective Date.
? ARCO Common Shareholders who would otherwise have been entitled to receive a fraction of a BP Amoco ADS (including any odd lot of less than six BP Amoco Ordinary Shares representing such a fractional interest) will receive, in lieu thereof, cash (without interest and rounded to the nearest cent) equal to (a) the amount of that fractional interest multiplied by (b) the average closing sale prices for BP Amoco ADSs on the New York Stock Exchange for the ten trading days ending on the fifth complete trading day prior to the Effective Date, as reported in the Wall Street Journal.
? ARCO DSC II, a subsidiary of ARCO, will be exchanging the ARCO Common Shares it holds for BP Amoco Ordinary Shares in the form of BP Amoco ADSs prior to the Effective Date under the Share Exchange Agreement.
? Upon the Effective Date, all employee options and other rights to acquire ARCO Common Shares will convert into options and other rights to acquire BP Amoco Ordinary Shares, in the form of BP Amoco ADSs, after adjustment to take account of the Exchange Ratio.'
Share-for-share offer was the major method to finance this acquisition. For ARCO's shareholders, an advantage of this method is that they still have an equity interest in the company that they originally invested in. Additionally, they did not need to spend the brokerage costs, and did not need to pay any capital gains tax liability arising from the disposal of their shares. A disadvantage to the shareholders of both BP Amoco and ARCO is that equity payments tend to work out as more expensive than cash offers.
The Analysis of Share Price Movement Before During and After This Acquisition
Figure 1 Actual Value
Figure 2 Rebased to the first
Absolute share price
BP Ordinary (GBp)
Start date: 01/01/1999 End date: 31/12/2000
(c) 1999-2003 BP p.l.c.
Figure 3 Compare with FTSE 1007
From Figure 1 we could see the movement trend of BP Amoco and ARCO's actual share price during the period from Jan 1st, 1999 to Dec 31st, 2000. Compare with ARCO, the share price of BP still kept stable during these two years. On the contrary, the share price of ARCO moved acutely in this period. There were two sharp drops of ARCO's share price during this period. The first obvious drop of ARCO's share price occurred in early March 1999. In March 3rd, 1999 the share price reached Dollars 53, which is the lowest point during last several years. The main reason that share price slid was the poor performance of ARCO, this was also probably the major reason that brought Arco into BP Amoco's sights and prompted talks about this acquisition of the seventh largest oil group in the US. During the rest of March the share price of ARCO rose steadily, because BP Amoco and ARCO were talking about the possibilities of their acquisition at that time. On April 1st 1999 ARCO's share price reached Dollars 73, when BP Amoco and ARCO announced the acquisition. The news of acquisition should be the factor that influenced the rise of ARCO's share price because of the good perspective of ARCO for investors after combination. Till July, ARCO's share price kept dramatically going up. During the next several months the share price still continued to increase. On Nov. 18, 1999 ARCO's share price got to Dollars 97, which was the historic new high price. After considerable criticism by the public, individual legislators and legal experts retained by the Merger Committee, the Governor Knowles announced an "Amended Charter Agreement" in early December. On Feb. 2, 2000 the US Federal Trade Commission (FTC) announces it will oppose this acquisition. In the lawsuit Governor Knowles intervened on behalf of BP Amoco. On Feb. 8, 2000, the Merger Committee rejected the Amended Charter Agreement because it did not require BP Amoco to divest a sufficient part of ARCO's assets to provide for competition.8 Due to the influences of these disadvantage information ARCO's share price went down continuously over this period. On Feb. 11, 2000 ARCO's share price went down to Dollars 64. Shortly thereafter, BP Amoco announced that it would sell all ARCO Alaska's assets to Phillips Petroleum. On April 16, 2000 BP Amoco and ARCO announced that they had received clearance from the FTC for the combination of the two companies and the combination was completed on April 18, 2000.9 During this period ARCO's share price rose again till the acquisition finished with the price of Dollars 77.
According to Figure 2, we can easily see the comparison of share price between BP Amoco and Exxon Mobil, the first largest oil group all over the world, by rebased the Exxon Mobil curve to the starting value of BP Amoco's. From the middle of March 1999, the share price of BP Amoco continued to outperform Exxon Mobil's. Till March of 2000, the share price of BP Amoco dropped sharply, because FTC blocked the acquisition at that time. However after the success of the acquisition, the share price of BP Amoco obviously performed better than Exxon Mobil's after April of 2000. From Figure 3, we also can see the influences of this acquisition to BP Amoco's share price. Before the announcement of the acquisition, BP Amoco's share price was lower than FTSE 100. The acquisition brought confidence to investors therefore, share price jumped up immediately and kept above FTSE 100 after the announcement. During February and March 2000, the share price dropped again because of the opposition of the acquisition by FTC. Nevertheless after the bid finished, the share price rose again and maintain higher than FTSE 100.
From the above analysis of both BP Amoco and ARCO before, during and after the acquisition, we could get the conclusion that this acquisition brought dramatic benefit to not only the BP Amoco's shareholders but also ARCO's.
Evaluation of BP Amoco's Performance in The Period Following The Acquisition
In 2000, the year following the acquisition, BP Amoco got excellent performance because of high crude oil and natural gas prices, a sharp rise in refining margins and its ARCO acquisition boosted earnings. The result for the year was $14,203 million, compared with $6,206 million in 1999. The result per share was 65.63 cents increased of 105% compared with 32.00 cents a year ago. The replacement cost operating result was $21,253 million. This figure was $10,080 million in 1999. Replacement cost profit before exceptional items was $11,214 million, compared with $5,330 million a year ago. The return on average capital employed (ROACE) was 23%, up 10 percentage points on 1999. Net cash inflow for the year was $3,743 million, compared with an outflow of $82 million in 1999. This resulted from an almost doubling of operating cash flow at $20,416 million, partially offset by higher tax payments and net cash outflows from capital expenditure, acquisitions and disposals. Disposal proceeds amounted to $11,362 million, including $6,803 million from the divestment of ARCO's Alaskan business. The group's net debt was $19,359 million at the end of 2000, an increase of $6,366 million over the year. Net debt of $6,579 million was acquired with ARCO and Burmah Castrol. Following the acquisitions, the group repurchased $960 million of outstanding debt in order to provide greater financing flexibility for the future. The net debt ratio was 27%, compared with 23% a year ago.
The total dividends announced for 2000 were $4,625 million, against $3,884 million in 1999. Dividends per share for 2000 were 20.50 cents, an increase of 2.5% compared with 20.00 cents per share in 1999. (BP Amoco's annul review 2000)
(BP Amoco's annul review 2000)
Every part of business contributed to the achievements of 2000. (See Figure 4) Exploration and production produced a record result. Higher gas production and the ARCO acquisition offset lower oil production. Gas and power made an improved operating contribution that partly offset increased business development costs. Refining and marketing had an outstanding year with record results and a highly competitive 22% return on fixed assets. Refining benefited from significantly higher margins and we saw strong growth in convenience sales, coupled with strong oil trading performance and cost reductions. The acquisition of ARCO gave BP Amoco coast-to-coast market access in the USA. Chemicals' demand was firm in the first half of the year, but then weakened in the final two quarters because the global economy was slow. Annual production rose 1% to 22.1 million tones. (BP Amoco's annul review 2000)
From the above performance of BP Amoco, we can easily draw a conclusion that the company got a great improvement in its business after the acquisition with ARCO. According to the comparison of share price with Exxon Mobil (See Figure 2) and FTSE 100 (See Figure 3), BP Amoco's share price performed good after the acquisition. The excellent performance in business and rise of share price both mean the growth of shareholders' wealth.
According to the theoretical analysis of rationale for international acquisitions or mergers, international merger or acquisition is a key strategy for companies, which plan to successfully expand their business globally. Through the analysis of stock market and foreign exchange market, particularly in the UK and US, they can be regarded as efficient. By the study of the acquisition of BP Amoco and ARCO, a successful combination is able to maximise shareholders' wealth in both sides.
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MN 414 INTERNATIONAL FINANCIAL MANAGEMENT