The skirmishing has just begun in what could turn out to be one of the most interesting takeover fights of 1978, Occidental Petroleum Corp.'s billion-dollar bid to acquire Mead Corp., an Ohio-based paper products company.
Both firms are awaiting clearance from the Securities and Exchange Commission before they may start appealing directly to the hearts, minds and pocketbooks of Mead shareholders either to turn in their shares for new Occidental securities or to stick with current management.
But the materials filed with the SEC already provide outlines of the battle to come between Occidental, a $6 billion, Los Angeles-based oil and natural resources company with a buccaneer reputation, and Mead, and old-line, heartland industrial company that had sales in 1977 of $1.8 billion.
There are a number of significant features to the proposed Occidental bid.
First, there is its size. Valued at nearly $1 billion, it would be the largest hostile tender offer ever undertaken. There have been larger mergers in recent years -- General Electric's acquisition of Utah International or Mobil's takeover of Marcor, for example --basis (though some not so friendly negotiations may have preceded the announcements).
It is also another attempt by an oil company to diversify by gobbling up other natural resource companies. In its prospectus, Occidental cited the need to diversify domestically to cushion its large foreign operations, and it noted that "Occidental's oil and gas operations are based on resources of a depletable nature, while the resource on which Mead's forest products business is based is replenishable."
Meanwhile, the Justice Department's Antitrust Division has announced that it is conducting "a full-fledged civil investigation" into possible anticompetitive aspects of the proposed merger. The division has been at pains to point out that this goes beyond the routine once-over that the department or the Federal Trade Commission gives to every large deal.
Frustrated in recent months by their inability to impede the parade of large conglomerate mergers, the government's trustbusters have been looking for a good case to signal a tougher attitude. And they are trying to decide whether to make a stand on Occidental-Mead.
Another significant aspect to the proposed deal is that Occidental is offering Mead shareholders paper -- in the form of new preferred and convertible preferred securities -- rather than cash for their shares.
Most of the takeover bids in the current acquisition wave, which commenced in 1975, have been for cash on the barrel.
Occidental's financing gambit for a deal this size recalls some of the conglomerate acquisitions of the late 1960s when companies were scooped up through the use of all kinds of fancy paper instruments. If this deal succeeds, "It could set off a wave of paper offers that would make 1969 look pale by comparison," commented one merger lawyer.
Occidental proposes to issue 0.28 share of a new $10 cumulative preferred stock and 0.07 share of a new $7.50 cumulative convertible preferred stock for each Mead share.Acquiring the 28 million Mead shares outstanding would entail issuing about $800 million of the $10 preferred and $200 million of the $7.50 convertible preference stock.
The annual dividends on this mass of new paper would come to $95 million. But with Mead earnings this year estimated to approach $110 million, the acquisition would in effect be self-financing, leaving Occidental an extra $15 million in cash profits and possession of a $2 billion company without having made a real cash outlay of its own. Purchase of Mead also would allow Occidental to utilize some of its $100 million in unused investment tax credits, providing the oil company with further benefits.
While the arithmetic is difficult, Wall Street estimates are that each Mead share on conversion would be worth about $35 (compared with the $22 it was trading at several weeks ago).
In a letter that it plans to send to shareholders urging them to reject the Occidental offer, Mead concentrates at some length on the financing method and Occidental's already leveraged balance sheet with $1.7 billion in long-term debt in order to cast doubt about the merger proposal.
"If the occidental proposal were accepted, we believe the ratio of earnings to fixed charges and preferred dividend requirements would be extremely low, and we believe such ratio is already low," Mead comments.
It also asserts that if Occidental succeeds in acquiring Mead on its terms, "The resulting company would be so financially leveraged as to impair the ability of the resulting company to grow." And it conjectures that if Occidental issues this much new preferred stock, it "might have an adverse effect on the market for such paper."
Wall Street analysts who follow Occidental are quick to dismiss the financing argument.
"It's a red herring," said Bruce Lazier, a petroleum analyst with Paine Webber Mitchell Hutchins, who noted that Occidental's fast-increasing cash flow -- primarily from its North Sea oil stake -- is expected to exceed $800 million this year, more than enough to absorb the additional fixed charges for the new preferred stock.
But because preferred stock is a hybrid instrument between the debt and equity, how it is treated on a balance sheet is somewhat controversial. Although a preferred stock trades somewhat like a bond, going up and down with interest rate trends, it nevertheless is considered equity rather than debt on a company's balance sheet. And to issue $1 billion in new preferred stock actually improves Occidental's debt-equity substantially.
But in the view of some accountants, preferred stock that is scheduled to be retired through a sinking fund over a set period, like Occidental's $800 million in $10 cumulative preferred, is little different from a bond and therefore should be labeled debt rather than equity.
The SEC is considering this question, and a decision to treat such preferred stock as debt could significantly alter an evaluation of the capital structure of a company such as Occidental.
Another drawback to preferred stock is that dividends paid on it are not tax deductible, unlike the interest on bank loans, making it an expensive way to finance an acquisition.
"In view of the fact that interest payments on debt are deductible for tax purposes, the company that treats preferred stock dividends as a fixed obligation finds the explicit cost to be rather high," notes Stanford Business School Prof. James Van Horne in his text, "Financial Management and Policy."
So why didn't Occidental just borrow the $1 billion to take over Mead's shares for cash?
"If they add debt, it could affect their debt credit rating and add to the cost of future financing," said Phil Dodge, an analyst with Merrill Lynch, Pierce, Fenner & Smith. "In that situation, preferred stock looks like a cheaper form of financing. They've been reducing their debt ratio as a matter of policy over the past couple of years, and they would like to have it at a 2-to-1 ration. if they used debt to finance Mead, theyhd be back above it."
Dodge, noting that "Occidental has a history of attempted acquisitions that have not gone through," said he also was skeptical about the prospects for the Mead acquisition. "The antitrust aspect of it is the main hurdle," he added.
Elsewhere on Wall Street, opinion is widely divided on Occidental's prospects for success, and there is considerable speculation that Mead is searching for an alternative merger partner, or "White Knight," to avoid the clutches of Occidental.
Because of Mead's size, and the interest that has been expressed by other oil companies in diversifying into the forest-products area, speculation has centered on another petroleum giant coming in and topping Occidental's offer.
"If Oxy can make an offer, there's no reason one of the other 'seven sisters' can't do the same -- and they might have cash," commented Irving Haass, an analyst with David J. Greene & Co. who has followed Mead for some 15 years.
"I don't want Occidental's paper, I don't want a taxable deal, and if I have to have a taxable deal, then I wouldn't consider liquidating my position for less than $50 a share. I don't want to trade Mead's prospects, which I consider very good, for this third-rate paper in a company I don't know anything about," said Haass.
Lazier of Paine Webber takes a contrary view and says that if he "were a shareholder of Mead, I would be suing them. I can't see how the Mead board can sit there and tell the shareholders that they rather should see the company stay independent then to get $35 for each of their shares. There's probably no other company that is going to pay this king of money."