In order to help you value Gulf, use the following inputs:

WACC = 17.69%

Tax rate = 50%

How do I attach the case file here?

1. What is Gulfs Operating Cash Flow in 1983? Use OCF, rather than UCF, to value the firm in Question 2.
2. At the end of 1983 what is the value per share of Gulf Oil Alive, without future growth as a perpetuity? Assume that Gulf will perform each year in the future exactly as it did in 1983, including the actual tax rate implied by their 1983 tax figure. We must rely on OCF data since we do not have enough information to calculate UCF. Label each number that you used in your calculations. You can assume that Gulfs OCF will be a level perpetuity to make your calculation
3. Assume the SoCal purchased Gulf and will then slowly kill off Gulf by harvesting its reserves. It will save cash on exploration costs for the next 8 years. That is, Gulf will not explore for oil in 1984 or going forward. Gulf will produce from its reserves each year into the future. Calculate the OCF for each of the next 8 years going forward using this assumption. Label each number used in your calculation. Keep in mind that SoCal will not incur expensed nor capitalized exploration costs for the next 8 years. See Exhibit 8 from the case to understand why I am mentioning them separately and for the next 8 years.
4. At the end of 1983 what is the value per share of Gulf Oil Dead or in full harvest mode?
5. What do you think should be the real value per share of Gulf Oils stock when firms are bidding for Gulf Oil on March 5, 1984?

Exhibit 5 Financial Performance: Gulf Compared with Industry Exhibit 7 Trading Prices and Volumes, Gulf and Socal Note: The industry consists of seven major producers: Exxon, Gulf, Mobil, Shell, Standard Oil California, Standard Oil Indiana, and Texaco. aGulf's U.S. production as percentage of U.S. production of the seven major companies. barnings per share as percentage of the seven-company average. Exhibit 6 Results of Proxy Vote on Reincorporation Proposal a An abstention is essentially a vote against the proposal. atal volume for week. All dates shown are Fridays. Volume is shown in 100-share lots. For the week ending 8/5/83, Gulf volume is 1.66 million shares. 10 This document is authorized for use only by Sampath Mahankali in FIN 540 taught by Milagros Schrader. Arizona State University from Sep 2023 to Mar 2024. This document is authorized for use only by Sampath Mahankali in FIN 540 taught by Milagros Schrader, Arizona State University from Sep 2023 to Mar 2024. In response to these changing fundamentals, Lee trimmed exploration expenditures significantly in 1983. Even at this reduced level, however, spending for exploration in real terms equaled or exceeded that of every year before Lee's arrival except one (see Exhibit 2). In addition to investing in discovering new sources of oil and gas, Gulf management began using the company's sizable cash flow to repurchase shares. From mid-1981 to March of 1983, Gulf purchased 30 million shares of the 195 million outstanding. At that point, Lee said, "I have no philosophical problem with another bite if everything is as it is now and if our stock is as good a buy as it is now.".10 Keller's Decision George Keller was fully aware of Gulf's showing on most measures of financial performance (see Exhibit 5). Indeed, the possibility for improvement was the chief attraction. The only uncertainty facing Keller on the morning of March 5 was not whether to bid but how much to bid to be sure the opportunities didn't get away. Exhibit 1 Results of 1983 Operations Compared (\$ in millions) 10 Quoted in Gulf Oil Corporation Appraisal, John S. Herold, Inc., 1983, p. 349. 5 6 document is authorized for use only by Sampath Mahankali in FIN 540 taught by Milagros Schrader, Arizona State University from Sep 2023 to Mar 2024. Exhibit 3 Selected Market Prices 28505377 Exhibit 2 Exploration and Development Data for Gulf and Socal Wncludes88millionbarrelsacquiredfromKewaneeIndustries,Inc. G. S. Herold estimates that 725 million barrels in West Africa are not recoverable due to expropriation, which reduces the recoverable reserves to 2,313 million barrels. a Composite amounts represent crude oil, natural as liquids, and natural gas on a per-barrel basis. Natural gas volumes are converted to crude oil equivalent barrels using a conversion ratio of 5.7 thousand cubic feet per barrel. Exhibit 4 Pro Forma Balance Sheet-Gulf and Socal Combined ( $ in millions) 8 This document is authorized for use only by Sampath Mahankali in FIN 540 taught by Milagros Schrader, Arizona State University from Sep 2023 to Mar 2024 The share purchases were totally unexpected. Mesa Petroleum was a small company compared with Gulf (see Exhibit 1). If Pickens intended to acquire control of Gulf, the deal would require borrowing at least $10 billion dollars-many times the magnitude of Mesa's net worth. To put the effort in perspective, four years earlier the largest takeover was $1 billion, and that involved the conglomerate, United Technologies. What contributed to the surprise was the opinion of many that the time for oil megamergers had passed. Within a few years' time, Occidental Petroleum had acquired Cities Service; U.S. Steel had bought Marathon Oil; DuPont had taken over Conoco; and Elf Aquitane had gained control of Texasgulf. The political sentiment was that these takeovers, costing tens of billions of dollars, were not in the public interest. Senator Bennett Johnston (D., Louisiana) put the principle forcefully: When a few merge, it's one thing, but when a whole industry is consolidating, it's a very different matter. One's a glass of wine with Christmas dinner, the other, a six-month binge. 4 After the shock subsided, Gulf's response to the Investors Group was one of indignation and outrage. The chairman of Gulf, James Lee, described the group led by Pickens as "corporate raiders" who are "cannibalizing" the company. Harold Hammer, the chief administrative officer of Gulf, said, "We've got to roll up our sleeves and hit him where it really smarts." 5 Meanwhile, the Investors Group raised its share in Gulf to 13.2%. Pickens stated that his immediate objective was to put himself on the board of directors, where he could effect changes in Gulf policy. Pickens said he was particularly interested in forcing Gulf to spin off its domestic oil and gas properties into a royalty trust-a device he popularized and perfected at Mesa. 6 To thwart this, Gulf sought to move its corporate charter from Pennsylvania to Delaware, where Pickens would need a majority vote of the shareholders to elect alternative directors. This move, which occurred on January 18, 1984, followed a long and acrimonious proxy battle over the reincorporation. Gillf won that battle with 53% of vote in its favor. In that contest, Gulf was heavily supported by individual investors, most of Wnom were personally lobbied by Gulf executives (see Exhibit 6). After winning the proxy contest, Gulf felt confident that the reincorporation would deny the Investors Group, with limited capital at their disposal, their only means of access to the boardroom. On February 22, 1984, Pickens announced a partial tender offer at $65 per share. This price was within the range that the Gulf Investors Group estimated the royalty trust shares would trade if the proposed reorganization took place, according to their December 30 presentation to the Gulf board of directors. The offer price represented a significant premium over the closing price of $525/8 on the day before. To make the offer, Pickens had to borrow $300 million from Penn Central Corp., using securities of Mesa Petroleum as collateral. Even with this capital infusion, the Investors Group could afford to purchase only 13.5 million shares, which would leave them far short of a majority-with 21.3% of the stock. The Pickens group, however, had hoped that this show of strength would enable them to attract further financial backing. 4 Fortune, April 2, 1984, p. 22. 5 New York Times, November 5, 1983. 6 The principal advantage of a trust was the elimination of a second layer of taxation on distributed earnings and the tax savings from the step-up in the basis of the properties. However, some past tax deductions were recaptured in the process, and the shareholders had to pay capital gains rates on the difference between the trading value of the trust units and their basis in the corporation's stock. The arrangement worked well if the corporation had a high dividend-payout ratio and stockholders had a high tax basis. The motives of the Pickens group were widely impugned by those sympathetic to Gulf's management. On the day of the tender offer, for instance, a local Pittsburgh paper editorialized: Mesa chairman T. Boone Pickens, Jr., expects primarily to cash in on Gulf's golden eggs, which are in the form of vast amounts of oil and gas. After obtaining the revenue there, he plans to slaughter the goose. 7 Mesa's tender offer precipitated a crisis at Gulf. Seeming to sense the inevitability of the outcome, Gulf decided to seek a liquidation on its own terms. James Murdy, an executive vice president of Gulf, said in a retrospective interview: Now all of this attention put enormous speculative pressure on our stock. We saw that and we knew we had to do the best job for all shareholders while at the same time saving as much as possible for employees and others with a stake in Gulf. So when Mesa finally launched its unfair partial tender offer, our board was willing to consider selling the company to a strong merger partner rather than see Mesa steal the company. 8 Having made the decision to liquidate, Gulf contacted several firms-including Allied, ARCO, Socal, Sohio, and Unocal-and invited them to Pittsburgh for the unprecedented sale. Gulf's Situation, 1975-1984 In 1975 Gulf lost a large portion of its reserves when Kuwait and Venezuela canceled Gulf's oil concession. In the years that followed, total reserves declined, reaching a record low in 1981. In that year, James Lee became chairman. Lee enunciated a clear, twofold strategy to reverse the decline in Gulf's competitive position. First, he would concentrate Gulf's efforts on oil. (In the past, Gulf had developed into an energy conglomerate through acquisitions of coal mines, uranium mines, and synthetic fuel plants. In the future, Gulf intended to de-emphasize these ventures, which were not notably successful.) The second part of the strategy arose naturally from the first. In keeping with the renewed emphasis on oil, Lee would continue a policy of increased expenditures on exploration and development. As a result of this policy, outlays for exploration more than doubled between 1978 and 1982, and the long decline in reserves was finally arrested and reversed. Lee was quite explicit about his policy. In his own words: "Gulf's number one priority is to replace our domestic reserves of hydrocarbons through discoveries and acquisitions." = The key phrase in Lee's statement of purpose was "discoveries and acquisitions." In 1982 Gulf made.an effort to acquire Cities Service. Ironically, Gulf's attempted acquisition of Cities Service involved a confrontation with Mesa Petroleum that almost cost Mesa its corporate life. The takeover of Cities Service collapsed at the last minute, however, when the Federal Trade Commission raised several objections and Gulf withdrew its offer, causing many arbitrageurs to lose heavily. Lee's business plan underwent a mid-course correction as a result of developments in the oil markets. Beginning in 1982 and continuing throughout 1983, the real price of oil and natural gas declined (see Exhibit 3). As 1984 began, almost all experts were in agreement that, in constant dollars, the price of oil would not change for the next 10 years. Even the oil ministers of Saudi Arabia and Qatar shared this opinion. 7 Pittsburgh Post Gazette, February 23, 1984. 8 Energy Bureau Seminar, October 3, 1984. 9 Gulf Oil Corporation, 1981 Annual Report, p. 3. 4 9285053 The most direct way of accomplishing this debt reduction was to sell some of Gulf's assets. REV: DECEMBER s, 19 s Another way, Keller felt, was to make use of the funds Gulf currently spent on exploration and development. 1 These funds amounted to over $2 billion in 1983 (see Exhibit 2). The only question was whether, by using funds that had been earmarked for the search for more oil, the long-run viability of the new enterprise would be sacrificed at the expense of financial expediency. After all, if investing in new sources of oil was worthwhile before Gulf's acquisition, it would be just as worthwhile afterwards. An opposite point of view, however, was that if Socal purchased Gulf, its reserves would be so large that Gulf's contribution to the exploratory effort could safely be discontinued. Gulf Oil Corp.-Takeover On the morning of March 5, 1984, George Keller of the Standard Oil Company of California (Socal) still did not have his mind made up about how much to bid. The stakes were high. For sale was Gulf Oil Corporation-one of the original Seven Sisters. But the price was high as well. Gulf management made clear that it would not consider any bid below $70 per share-a considerable premium over the $43 price at which Gulf had traded during the close of 1983 when the sale of Gulf was a remote possibility. Bidding against Keller in this confidential auction in Pittsburgh were some who were willing to pay $70 and more. Among them were members of the Atlantic Richfield Company (ARCO) and bankers from Kohlberg Kravis Roberts \& Company. Keller felt that the bid from Kohlberg Kravis was the one to beat, since it came essentially from Gulf itself. The proposal from Kohlberg Kravis, specialists in leveraged buyouts, allowed Gulf to become a private firm by tendering for the shares of its public stock. The undeniable attraction of the offer lay in its preservation of the name, the assets, and the jobs of Gulf Oil until management found a long-term solution. Keller knew that if ARCO offered more than $75 per share, its debt to total capital ratio would have exceeded 60%-a historically high level. In contrast, Socal's debt to total capital ratio was so low that the banks were queuing up to lend money. So anxious were the banks to lend Socal $14 billion that the potential loan was oversubscribed by 30%. The profusion of bank credit meant that Keller could safely bid $79, $80, or even higher. The opportunities created by the acquisition would be enormous but so were the risks of betting the whole company on them. With one stroke, Socal could assure itself access to vast quantities of highquality light oil. Overnight, Socal could virtually double its reserves and give the next generation of management something to work with. An appraisal of the value of the opportunities offered by the Gulf deal required, of course, an idea of how the two companies would perform as a unit. A pro forma balance sheet (Exhibit 4) showed that the combined firm would have a considerable amount of financial leverage. While manageable in the short run, the debt would have to be reduced over the next few years. Note: Advice concerning the tax aspects of the Gulf takeover was provided by the law firm of Simpson Thacher \& Bartlett of New York. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright (\$ 1994 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbspharvardedu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means-electronic, mechanical, reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any photocopying, recording, or otherwise-without the permission of Harvard Business School. Besides how to reduce the takeover debt, there was another issue: the tax cost of the acquisition. Although the tax considerations were complex, it was felt that the tax benefits and costs nearly offset each other. 2 The decision, therefore, of how much to bid depended solely upon the economic benefits of the acquisitions. At times those benefits seemed almost incalculable. As Keller said: "It's like a 100year mining project. A straight rate-of-return analysis would prevent you from doing it. The decision has to be a little glandular." =3 Background on the Takeover of Gulf Although the takeover of Gulf had been a subject of speculation for years, the event that precipitated the emergency meeting in Pittsburgh in March 1984 was far more recent. The decision to sell the company was made in response to a takeover attempt by Boone Pickens, Jr., the chief executive officer of Mesa Petroleum Company. Boone Pickens had a long string of successes in targeting undervalued oil companies, beginning in 1969. In 1982, the year prior to its attempt on Gulf, Mesa tendered for two companies-Cities Service and General American Oil of Texas. In both cases, Mesa failed to gain control but made a substantial profit in reaching an accommodation with the target. In the case of Cities Service, Mesa sold back the stock it acquired through the tender for a gain of $31.5 million. In the case of General American, Mesa received $15 million for withdrawing its tender and another $42.4 million when it sold the shares accumulated in open-market purchases to a higher bidder. On August 11, 1983, Boone Pickens and a consortium of experienced investors began purchasing shares of Gulf Oil for $39. Two months later, the Gulf Investors Group, as the consortium called itself, had spend $638 million and had acquired about 9% of all the Gulf shares outstanding at an average cost of approximately $43 per share. 1 Exploration and development is considered a time-consuming effort. For an onshore site, it generally takes 4 years from the time the lease is acquired until the field comes onstream. Having been developed, the field is productive for another 7 to 10 years. 2 It was expected that the acquisition would be structured as a "liquidating sale" of Gulf's assets. Under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), the treatment of such a sale held both benefits and drawbacks for the acquiring company. On the positive side, no gain was recognized to the acquired company on the sale of its assets. More important, the acquiring company was allowed to step up the assets to their fair market value, thereby realizing future tax benefits through higher depreciation and depletion deductions. On the negative side, certain tax deductions taken in the past by the acquired company became "recaptured" and had to be repaid immediately upon liquidation. For example, since Gulf used the LIFO method to account for petroleum inventories, the difference between the FIFO and LIFO valuations had to be treated as ordinary income and taxes paid accordingly. Also recaptured and treated as ordinary income was any depreciation in excess.of the straight-line amount on real property and certain accelerated drilling costs. 3 Fortune, April 2, 1984, p. 22. 2