PEtroleum Corporation(A) 295029 were evaluating reserves and production operations. In addition to checking the independent both direct costs and overhead--would be an important determinant of MWs profitability costs- reserve estimates, they were looking for cost-saving opportunities. The ability to manage Structuring a proposal To take advantage of what they regarded as an attractive opportunity for growth, Apache's executives and advisors had to design a transaction that would satisfy Amoco's desire to sell MW at a good price; that would be profitable for Apache; and that could be financed externally with a large component of debt. This last requirement was expected to be especially difficult, given the large size of MW, the Ba3 rating of Apaches debt, and the current lending environment In 1991, the maximum loan-to-value ratio permitted by banks lending against oil and gas assets was typically 50% of the value of proved reserves. In addition, the credit approval process would require the analysis of a worst-case scenario, and loan terms would be set to protect the lender as much as possible in the worst case. The lending environment in 1991 was even tighter than these restrictions suggested, however, because U.S. banks were under pressure from regulators to improve the quality of their loan portfolios following losses on some highly levered transactions of the 1980s. Highly levered transactions were clearly out of favor, and some institutions were out of he market altogether, after the posting of reserves against bad loans had reduced their lending capacity. Consequently, there was a limited number of institutions among which to syndicate a There were several possible ways to make an MW acquisition more attractive to lenders One was to reduce its size, though both Amoco and Apache would oppose reducing it beyond a certain point. Another was to have Apache or MW issue equity either to Amoco, to the public, or to some other private investor. Both Amoco's and Apaches shares were traded on the New York Stock Exchange; historical stock price data for both companies is presented in Exhibit 9. Yet another possibility was for Amoco itself to lend to Apache, or to guarantee some part of Apaches external acquisition debt. Finally, Apache could expect to borrow more, the more it could reduce the banks'exposure to a worst-case scenario. Experienced lenders' prime concern was an unexpected drop in oil prices like the one that had occurred in 1986. In early 1991, with a war underway in the Persian Gulf, most experts foresaw higher rather than lower energy prices, though they varied a among the most conservative forecasters. Some had lent too aggressively follor. ugh, banks were great deal in their prediction of the near-term path of prices. Not surprisingly Despite the problems Apache had to overcome, in at least one respect the lending environment was favorable. Inflation in the United States had been low for nearly a decade and interest rates had been generally falling. Long-term treasury bonds offered yields of 8% to 8.25% and yields on B-rated debt had dropped more than 150 basis points in two months, despite the turmoil in the Middle East. Lower rates made whatever financing was available less expensive, and a lower opportunity cost of capital made long-term investments like MW more attractive Contemporary financial market data are presented in Exhibit 10DO NOT COPY MW Petroleum Corporation (A) 295-029 7 were evaluating reserves and production operations. In addition to checking the independent reserve estimates, they were looking for cost-saving opportunities. The ability to manage costs— both direct costs and overhead—would be an important determinant of MW’s profitability. Structuring a Proposal To take advantage of what they regarded as an attractive opportunity for growth, Apache's executives and advisors had to design a transaction that would satisfy Amoco's desire to sell MW at a good price; that would be profitable for Apache; and that could be financed externally with a large component of debt. This last requirement was expected to be especially difficult, given the large size of MW, the Ba3 rating of Apache’s debt, and the current lending environment. In 1991, the maximum loan-to-value ratio permitted by banks lending against oil and gas assets was typically 50% of the value of proved reserves. In addition, the credit approval process would require the analysis of a worst-case scenario, and loan terms would be set to protect the lender as much as possible in the worst case. The lending environment in 1991 was even tighter than these restrictions suggested, however, because U.S. banks were under pressure from regulators to improve the quality of their loan portfolios following losses on some highly levered transactions of the 1980s. Highly levered transactions were clearly out of favor, and some institutions were out of the market altogether, after the posting of reserves against bad loans had reduced their lending capacity. Consequently, there was a limited number of institutions among which to syndicate a large loan. There were several possible ways to make an MW acquisition more attractive to lenders. One was to reduce its size, though both Amoco and Apache would oppose reducing it beyond a certain point. Another was to have Apache or MW issue equity either to Amoco, to the public, or to some other private investor. Both Amoco’s and Apache’s shares were traded on the New York Stock Exchange; historical stock price data for both companies is presented in Exhibit 9. Yet another possibility was for Amoco itself to lend to Apache, or to guarantee some part of Apache’s external acquisition debt. Finally, Apache could expect to borrow more, the more it could reduce the banks' exposure to a worst-case scenario. Experienced lenders' prime concern was an unexpected drop in oil prices like the one that had occurred in 1986. In early 1991, with a war underway in the Persian Gulf, most experts foresaw higher rather than lower energy prices, though they varied a great deal in their prediction of the near-term path of prices. Not surprisingly though, banks were among the most conservative forecasters. Some had lent too aggressively following the oil price shocks of the 1970s, only to lose badly when oil prices fell. Despite the problems Apache had to overcome, in at least one respect the lending environment was favorable. Inflation in the United States had been low for nearly a decade and interest rates had been generally falling. Long-term treasury bonds offered yields of 8% to 8.25%, and yields on B-rated debt had dropped more than 150 basis points in two months, despite the turmoil in the Middle East. Lower rates made whatever financing was available less expensive, and a lower opportunity cost of capital made long-term investments like MW more attractive. Contemporary financial market data are presented in Exhibit 10