In corporate battles, as in life, it helps to have a sugar daddy willing to fork over big bucks to help you buy what you want. And it's the Sugar Daddy Factor that explains how a tiny company like CNOOC Ltd. of China can hope to outbid a giant firm like Chevron Corp. of California for Unocal Corp.
CNOOC (pronounced SEE-nook) is only about one-twentieth the size of Chevron, No. 6 on the Fortune 500. Chevron's profits last year were almost double CNOOC's total revenue. Yet as of Monday's stock market close, CNOOC's all-cash offer of $67 a share comfortably topped Chevron's pending stock-and-cash takeover, valued at $60.51.
The secret? CNOOC's sugar daddy: its 70 percent stockholder, China National Offshore Oil Co. This company, which we'll call Big CNOOC, is wholly owned by the Chinese government -- and there's the rub. Baby CNOOC's bid is being bolstered by a multibillion-dollar subsidy from its parent -- which means the Chinese government is indirectly subsidizing Baby CNOOC's offer.
"It's an unfair playing field," Chevron Vice Chairman Peter J.Robertson complained. "If any foreign government can do that, their companies can not only buy Unocal, but any company they want."
There's nothing illegal about this, of course. Governments help their companies all the time, directly and indirectly. If I were a Unocal shareholder, I'd want the highest price I could get for my shares, regardless of where it came from. And if I owned stock in Baby CNOOC, I'd happily accept Big CNOOC's subsidy. The point here isn't to demonize the Chinese government or CNOOC -- it's to show how Baby CNOOC has come up with the firepower to take on Chevron.
Baby is counting on $7 billion of ultra-cheap loans from its parent to fund its $19 billion Unocal offer. That includes a $500 million breakup fee to Chevron, whose offer will be voted on by Unocal holders next month. Baby would borrow the rest of what it needs from its two U.S. investment banks and a commercial bank owned by the Chinese government.
If Baby CNOOC were to borrow everything in arm's length transactions, it would have so much debt and such heavy interest obligations that analysts would rate it a junk credit. Lenders would probably charge at least 8 percent a year for the $7 billion, which would be ranked the riskiest portion of Baby's borrowings.
But Big CNOOC is cutting Baby a huge break by lending it $2.5 billion for two years at zero interest and $4.5 billion for 30 years at a very low 3.5 percent. Take the difference between those rates and 8 percent, and the interest subsidy amounts to about $400 million annually for two years, then $200 million for 28 more years. Run those numbers through a spreadsheet program and discount them at 8 percent, and the subsidy is worth around $2.6 billion in today's dollars. That's about $9.50 per Unocal share -- more than the amount by which Baby CNOOC's offer tops Chevron's.
Even if you reduce the assumed interest rate to a low 7 percent, the subsidy is worth about $2.3 billion, more than $8 per Unocal share.
CNOOC won't talk, but people close to the company say my logic and numbers are wrong. They say that the $2.6 billion subsidy number is far too high, because Baby CNOOC plans to repay the subsidized loans quickly with money raised by selling stock to investors. The less time the loans are outstanding, the smaller the interest subsidy will be.
These people also argue that even though Big CNOOC is owned by the Chinese government, Big CNOOC subsidizing Baby somehow isn't the same as the government subsidizing Baby.
The Chevron-CNOOC battle will probably heat up this week, when Unocal's board is scheduled to meet and hears about the company's recent conversations with Baby. Wall Street is betting on a higher offer. How do I know that? Because Unocal closed Monday at $65.97. That's way above Chevron's offer. And it's more than Baby's $67 offer is worth, once you adjust for the serious uncertainties involved and the time it would take for such a deal to be completed.
It's hard to see, from the numbers, how Baby can afford a cash bid much higher than $67. But when you've got a big enough sugar daddy willing to write a big enough check, nothing may be out of reach.
Sloan is Newsweek's Wall Street editor. His e-mail address is email@example.com.