Professional Documents
Culture Documents
com
December 22, 2009
XTO Energy: Liquidity and Solvency Analysis
Anyone who has been even remotely cognizant of financial market events over the past week
should be aware that Exxon (XOM) has agreed to purchase XTO Energy (XTO) in an all stock deal
worth $31B (or $41B, depending upon whether you choose to categorize debt assumption as a
direct cost to Exxon). At first glance, the deal looks like a pure‐play home run bet on the natural
gas industry. After all, XTO's revenue has risen from less than $400M in 1999, to over $8B over
the trailing twelve month period. Net Income has risen from $46M to $2B over the same time
period.
http://TheValueatRisk.blogspot.com
December 22, 2009
The question though, is whether XTO has managed to achieve this level of growth with a debt
level that is manageable in the long term. I'll begin an attempt to answer this question by
looking at XTO's debt maturity profile, as stated in its most recent 10‐Q. All figures are in $MM:
The schedule above lets us know that XTO has several billion dollars worth of debt maturing in
the next 6 years; however, it may be more instructive to observe just how this debt has
affected the firm's balance sheet. To do so, I prepared a 10 year look at XTO's debt to equity
ratio:
http://TheValueatRisk.blogspot.com
December 22, 2009
The trend displayed by the chart above is encouraging; XTO's debt‐to‐equity ratio has declined
throughout the past decade, and the company is now financed by roughly a 1 to 1 mixture of
debt and equity. Yet another way of examining XTO's use of leverage is to take a look at its
Times Interest Earned (TIE) ratio, which measures EBIT as a multiple of interest expense:
In 2006, XTO's TIE ratio peaked at just over 14X, meaning that the company reported earnings
before interest and taxes that could have covered its annual interest expense 14 times. That
multiple has since decreased to ~6X, as interest has comprised an ever larger share of XTO's
EBIT. A possible explanation for this trend lies in TIE's numerator: EBIT. A rapidly growing
company like XTO will have large amounts of depletion expense that will adversely affect EBIT,
but not cash flow. To see whether this idea holds water, I'll look at operating cash flow as a
multiple of interest expense:
http://TheValueatRisk.blogspot.com
December 22, 2009
Once again, we see this measure trending downwards. Obviously, 3 data points doesn't create
an irreversible trend. However, its worth noting from a standpoint of how XTO's financial
performance is likely to affect Exxon in the coming years. Of course, Exxon may be able to
refinance XTO's debt at a far lower weighted average cost of capital.
Next, I think that XTO's liquidity should be examined using the current and quick ratio's:
http://TheValueatRisk.blogspot.com
December 22, 2009
Although you'd generally like to see both of these ratios at a level above 1, its worth noting that
over the past decade, XTO's current and quick ratios have stayed within a relatively stable band
(1.4‐0.8). If you look at XTO's balance sheet, you'll notice a relatively large current asset labeled
"Derivative Fair Value". According to XTO management, these derivatives are cash flow hedges
used to protect the company from major price swings in the natural gas market. Ultimately, the
hedges should be viewed as a prudent move that allows XTO to focus on the acquisition,
exploitation etc of new properties, and ignore short term noise in the price of natural gas.
In the end, XTO has to be considered a pretty remarkable growth story. There's clearly a strong
performance oriented culture at the company that has allowed it to expand as rapidly as it has.
My feeling is that post‐merger, Exxon would do best by allowing the XTO culture to remain in
place, at least in its core business operations. Exxon's true contribution to the marriage will be
in the economies of scale created by the combined venture; perhaps XOM should handle the
financing and hedging activities that XTO requires, and simply place some guard rails on the
acquisition strategy. XTO is definitely structured for growth; the problem is, it needs to be
managed properly, and with manageable levels of debt.
My last comment on the XOM‐XTO merger is it represents the potential for a brilliant strategy.
Exxon has poured too much money into share buybacks over the past decade, probably
because hostile foreign government run oil companies have kept Exxon from exploiting their
natural resources. The XTO purchase though, could provide a useful outlet for XOM's excess
cash. If XTO's acquisitions can be funded through Exxon's internally generated cash flow, and
http://TheValueatRisk.blogspot.com
December 22, 2009
the debt agglomeration trend can be halted, then Exxon could wind up being the largest owner
of natural gas property in the country ‐ and the US has plenty of natural gas.
*no positions
For additional analysis of financial markets and politics, or to view information about the author, please visit
http://TheValueatRisk.blogspot.com
The content contained within this newsletter, as well as The Value at Risk website, is provided as general information only and
should not be taken as investment advice. All site content shall not be construed as a recommendation to buy or sell any
security or financial product, or to participate in any particular trading or investment strategy. The ideas expressed on this site
are solely the opinions of the author(s) and do not necessarily represent the opinions of firms affiliated with the author(s). The
author(s) may or may not have a position in any security referenced herein. Any action that you take as a result of information
or analysis on this site is ultimately your responsibility. Consult your investment adviser before making any investment
decisions.