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ConocoPhillips' CEO Addresses the Elephant in the Room

Matthew DiLallo, The Motley Fool

The oil industry has been buzzing over the epic battle for control of Anadarko Petroleum (NYSE: APC) and its prime position in the Permian Basin. Oil titan Chevron (NYSE: CVX) initially beat out rival Occidental Petroleum (NYSE: OXY) in that fight by settling on a $33 billion purchase price. Undaunted, Occidental Petroleum brought in investing titan Warren Buffett to help it seal a $38 billion deal for Anadarko, leaving Chevron to walk away with a $1 billion breakup fee.

This headline-grabbing fight has many investors speculating which companies might jump into the M&A arena next. That led ConocoPhillips' (NYSE: COP) CEO Ryan Lance to address this topic head-on during the company's first-quarter conference call.

Two people shaking hands with oil pumps in the background.

Image source: Getty Images.

Understanding the buckets

Toward the end of his prepared remarks, CEO Ryan Lance shifted gears and stated, "I'm going to take another issue head-on and that's M&A." He did this to avoid the likely barrage of questions from analysts on whether his company might get into a bidding war for Anadarko or some other company. He then spent several minutes running through how his company views mergers and acquisitions. He started by stating:

As you've heard from me many times, we think of M&A in three buckets. First, incremental fence-line transactions that add value such as additional working interests, royalty interests, or coring up our acreage. We're going to do these things, under the radar day in, day out.

As Lance points out, the company is continuously making small deals around existing assets. These activities include increasing its stake in a drilling project or buying up acreage around a focus area.

Next, Lance stated:

The second bucket consists of high-return bolt-on assets or acreage deals, and they could be larger in size. They also make good sense. We're always on the lookout for these kinds of opportunities and we executed a few last year.

These transactions are more strategic. Last year, for example, the company made two acquisitions to bolster its position in Alaska. In one deal, it bought out Anadarko's 22% interest in their Western North Slope joint venture for $400 million, giving it full control of that asset. It also traded a 16.5% interest in the Clair Field in the U.K. North Sea to BP (NYSE: BP). In exchange, ConocoPhillips acquired BP's 39.2% interest in Alaska's Greater Kuparuk Area, as well as its 38% interest in the Kuparuk pipeline. Those deals boosted ConocoPhillips' ownership in those assets to around 95%.

Finally, Lance said:

But I'm sure the bucket people seem focused on now is the third one, bigger corporate transactions that require premiums. Of course, we pay attention to what's out there. However, we've always said the bar is very high for these large transactions and that's still the case. We're focused on returns and we won't do transactions that are not in our shareholders' best interest.

As Lance points out, he's aware that large-scale M&A draws attention, which has been the case in the battle for Anadarko. However, he also notes that those deals require paying a massive premium for control. Occidental Petroleum had to outbid Chevron by several billion dollars to win over Anadarko, and that's on top of the near-40% premium Chevron had agreed to pay.

A closeup of a calculator with stacks of coins next to it.

Image source: Getty Images.

We'd like to get bigger, but...

Those comments frame ConocoPhillips' thoughts when it comes to reviewing M&A opportunities. While the company would also like a bigger position in the fast-growing Permian Basin, Lance stated at ConocoPhillips' recent shareholder meeting that "it has to be competitive in the portfolio and that's a high bar."

This bar is tough to get over because of the substantial premiums needed to make a significant corporate acquisition. That makes deals hard to do according to Lance, especially since "those [premiums] are destructive to value. They're destructive to returns." That's the opposite of what the company wants to do since it aims to enhance shareholder value and grow returns.

Because of that, the company will focus its energy on filling up the first two M&A buckets. That means doing small deals to buy neighboring properties in that region and completing larger bolt-on transactions when those make sense.

Shopping in the value isle

ConocoPhillips' CEO has directly addressed the elephant in the room by walking investors through how the company views M&A. While investors tend to get excited by attention-grabbing corporate M&A deals, those transactions come at a high cost. That's why the company likely won't make a big, splashy acquisition. Instead, it will focus its attention on smaller purchases that can create value rather than destroy it. The company believes that this strategy will create far more value for shareholders in the long run.

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Matthew DiLallo owns shares of ConocoPhillips. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.