SPE

SPE 14381

A Discriminant Analysis of Acquired and Acquiring Companies

in the Oil Industry
by J,E. Noble, Phillips Oil Co.
SPE Member

Copyright 1985, Sm5ety of Petroleum Engineers

This paper was prepared for presentation at the Wfh Annual Technical Conference and Exhibition of the Society of Petroleum Enginears held in Lea
Vegas, NV September 22-25, 1985.

This paper was aelecfsd for presentation by an SPE Program Committee following review of information contained in an abstract submitted by the
authola). Contents of the paper, as presented, have not been reviewed by the Society of Petroleum Engineers and are subject to correction by the
author(a). Ths material, ea presented, does not naceeearily reflect any position of the Society of Petroleum Engineers, its offbera, or members. Papers
presented at SPE meetings are subject to publication review by Edtorial Committees of the Society of Petroleum Engineers. Permission to copy ia
restricted to an abatract of not more than 300 words, Illuatrationa may not be copied. The abstract should wntain conspicuous acknowledgment of where
and by whom the paper is preeentad. Write Publications Manager, SPE, P.O. Box S23S36, Richardson, TX 75082-3S36. Telex, 730989 SPEDAL.

. . -m --- .,..-9. . -.
#3a- mcT J N I fWUUb IIU’4

The pu~pose o+ this study was to deter- Over the past few years the oi 1 indus-
mine if there were financial and industrial try has undergone substantial changes. The
characteristics o+ acquired and acquiring cumrrtulative impact on the oil industry of
oil companies that would distinguish the OPEC, economic recessions, conservation, and
companies in each group. A multivariate its own myopia is manifested in the restruc-
statistical technique, multiple discriminant turing of the industry through bankruptcies,
analysis (MOA), was used to evaluate 24 fi- I iquidations, mergers, and acquisitions.
nancial and industrial variables and to de- Most bankruptcies have been due to the
velop a discriminant model that best dis- economic consequences of the fall in world
criminated between 14 acquired and acquiring oil prices. Anticipating ever rising oil
companies. prices, some oil companies exceeded prudent
Using the MOA technique, eight vari- debt levels and were forced to liquidate
~~lQsg salQs/total .sSse ts $ earnin~s/share ~h~~ the ...4.;.-i-s**~ r.eii-- imi-ma.cac did
-,a.,~mp-.=” p, .*= 8..-. s-=== . . . r.fi+
... .
growth, finding cost/barrel, times Interest occur. This liquidation process was not re-
earned, PE ratio, the ratio of discounted stricted to just the smaller companies in
future net cash flows/share to the average the industry. Several of the major oil com-
price/share of common, the ratio of comfnofn panies, caught up in the price increase eu-
equity to total capital ization, and inven- phoria, incurred financial obl igations that
tory turnover were identified as those that later forced them to liquidate assets and
would best distinguish the two groups. 4 markedly reduce their operations and staff
discriminant function was derived usi ng levels in order to stay solvent.
these variables. A phenomenon concurrent with oil indus-
Acquiring companies were characterized try bankruptcies and liquidations has been
as having higher asset util ization, greater the reorganization and reallocation of the
earnings-per-share growth, a higher percent- industries assets through mergers and acqui-
age of commom in total capital ization, and stions, often involvi ng.unprecedented finan-
greater inventory turnover. Acquired compa- cial exchanges. In contrast to the reasons
nies were characterized as having lower per- for oil company liquidations and bankrupt-
barrel finding costs and greater +uture net cies, those for the restructuring of the oil
cash flow potential relative to their aver- industry through mergers and acquisitions are
age costf”share 0+ commom stocit. not as well understood. Many focus on a new
The study’s findings generally support exploration frontier: the stock market. Some
the opinion that the reorganization o+ the analysts argue that oil companies who are
oil industry through mergers and acquisi- dependent on Middle East oil, are attempting
tions reflects a beneficial reallocation of to increase and diversify their oil reserves
the industry’s assets to companies that by buying companies with reserves and pros-
place a higher value on their use and will, pective acreage in more politically stable
consequently, utilize those assets more areas (1). Those reserves and acreage can
●fficiently. be purchased at substantial discounts be-
cause most oil stocks ● re priced at a frac-
References and illustrations at end of paper tion of their asset value, reflecting l,ower
 A DISCRIMINANT ANALYSIS OF ACQUIRED AND ACQUIRING CONPANIES
2 IN THE OIL INDUSTRY SPE 14381

expected future earnings. Consequently, an variables that can be used to Predict the
oil company can acquire oi I reserves for appropriate group to which additional sub-
less cost in the stocl( market than through jects would be assigned. For a two-group
the more traditional methods of exploration case, MDA produces a single, unidimensional
and development. John S. Herold Inc., has discriminant function of the form:
published that the S80.00/share o++er +or *
Gulf Oil by Standard Oil of California (So- y= a1x1+a2X2+. ..+anxn . . . . . . . . . . . . . . . . (1)
cal) is 30 percent less than Herold’s
$114.00/share appraisal of Gulf’s 12/31/82 Where a1,a2,. ..,an are the discriminant co-
net assets (2). Socal’s offer is equivalent efficients, and x1,x2,...,xn are the inde-
to %4.40/equivalent barrel (gas reserves pendent variables that best describe the
were converted to oil at 6 MCF/barrel), differences between the two groups. Pi riches
substantively less than their oil discov- and Min~o note that: “the basic assumptions
ery and development costs, which averaged of MDA are: 1) the groups are discrete and
$9.61/barrel over 1978-1982 and were known, 2) each observation in each group is
%12.67/barrel in 1982 (3). Of course, such described by a set of measurements on n
savings are attractive to all companies in characteristics or variables, and 3) the n
the ai? im.-l,,e+n”
,,4””=., J , ,not cn!y these dependent variables arise from multiuariate normal .
on Middle East oil. populations’ (6). In several previous in-
T. Boone Pickens Jr., chairman of Mesa vestigations MDA has been used to study in-
Petroleum Company, has attempted to acquire dustrial and tax-exempt revenue bond ratings
total or partial control of several differ- (7,8), predict corporate bankruptcies (9),
ent oil companies. Pickens argues that many analyze the corporate debt-equity decision
oil companies are in a state of 1 iquidation (lo), and analyze the financial character-
because they have not been able to consis- istics of merged firms and conglomerate
tently replenish their reserves. He accuses targets (11,12).
them of wasting the cash flows from previous The purpose of this study is to use MDA
discoveries on high-risk, high-cost explora- to analyze acquired and acquiring oil compa-
tion for new reserves that are increasingly nies and determine if the two groups could
difficult to find (4). Pickens claims that be distinguished from one another on the ba-
in some companies, money has been wasted on sis of differences in their financial and
non-oil diversification and on maintaining industrial characteristics. In particular,
nonprofitable refining and marketing opera- I used a stepwise discriminant teeiiiiique,
tions. All of this waste, Pickens argues, with a Lachenbruch jackknife method (13), to
has resulted in a loss of shareholder’s study variables from acquiring and acquired
weal th. He has proposed, if successful in companies to determine which variables were
his acquisition attempts, to direct more discriminatory and to derive a linear func-
cash flow to shareholders as a return to tion of the variables that maximizes the
capital , and less to exploration and diver- separation between the two groups.
sification <5). Although Pickens has not The stepwise discriminant technique
succeeded in acquiring another oil company, enters each variable into the classification
L:- f~~gti~n one at a time the
,1,= attempted acquisitions h=ve forced until separation

several companies to seek protection from between the groups no longer notably im-
him by merging with other firms. proves. 6 one-way ~nai~~}= ~+ ~=~i=n~e F-
In the above discussion! I have ad- statistic (F-to-enter) i% computed for each
dressed only a few of the possible variables variable and is used to detemine the appro-
that have influenced the reorganization of priate variable to enter into the classifi-
the oil industry. As these and other vari- cation function. At each step the F-statis-
ables are considered, the relative weight tics are computed, conditional on the uari-
given the information received from each is ables already present in the function, and
a function of our subjective interpretation; the variable with the greatest F-statistic
the true significance of each variable and is entered. This is the variable that best
~h~~r interdependence are often unknown. In discriminates between the groups. After
this study, I have used multivariate analY- each new variable is entered, the classifi-
sis, which ai iows Siiiiui ~=fi@Gi% ccfi%i~:~=ti=~ --a:--
~=\lWll 1,.--+;AR
TUllk\,”,l
~= ~:~~p,~~~~a

o+ several variables, in an attempt to iden- The classification of an original sam-

tify those financial and industy variables ple by the functions produced from kbak same
that best distinguish between acquired and sample will likely underestimate the mis-
acquiring oil companies. In addition, I classification probabilities (14). In this
have attempted to describe the distinguish- study the Lachenbruch jackknife method was
ing variables and analyze their influence on used to better determine the accuracy of the
the reorganization of the oil industry. classification function derived by the step-
wise discrimination technique. In the Lach-
PI= R IMI~ WLYSI ~ enbruch method each observation is sequen-
tially omitted, the classification function
Multiple discriminant analysis (MDA) is is calculated based on the remaining vari-
a multivariable statistical analysis tech- ables, and then the omitted observation is
nique that is both descriptive and predic- reclassified. This procedure is especially
tive. It can be used to identify a set of valuable when the sample distribution is of
variables that best describe the differences questionable normality or when a large hold-
between sample groups. Subsequently, MDA out sample is not possible (15).
can produce a discriminant function of those
 c P-(7 14381 xrfin r .P 3
UT . E . ..” ----

SSITID le and Variable Sele ction crimination function by multiplying the

standard deviation of each discrimination
The year 1982 was chosen +OP this anal- variable by its corresponding function co-
ysis because it was the last year complete efficient. The function coefficients for ‘
financial and industrial data were available each discriminant variable were determined
for the selected companies. The variables to maximize the ability of the function to c
selected were twenty four financial and in- discriminate between the analysis groups,
dustrial characteristics that are conven- they do not indicate the relative importance
tionally used in the analysis of oil compa- of each variable. The discriminant function
nies. These include size; the growth rates coefficients for each variable and their
o+ sales and earnings-per-share; the finan- relative contributions are indicated .in Ta-
cial ratios from four categories (16): 1 i- ble 4. Table 5 lists the means of the dis-
quidity, leverage, profitability (or effi- criminant variables for the two sample
ciency), and market value’; and the following groups.
industry ratios: reserves/production , oil
production cash flow returned to exploration J)isc riminat ion Variables
and development (plowback), the discounted
future cash flow per share of stock (annu- SALETA (Sales/Total Assets) is the cap-.
ity), and the discovery and production cost ital turnover ratio and illustrates the
per barrel of oil. These variables are sales generating abil ity of the company. It
identified in Table 1. indicates how well the firm is utilizing its
Fourteen oil companies were seIected assets. The results of this study indicate
from Moody’s 1983 Investors Fact Sheets - that acquiring firms have about a 64 percent
Industry Review (17). The companies were higher SALETA ratio than do acquired firms.
selected by the following criteria: 1) they This could mean that acquiring firms are
were 1 isted by Moody’s as a major or a large working close to their asset capacity and
oil producer, 2) they were a Canadian or ● n need an increase in capital to generate fur-
American company, 3) they were engaged sole- ther business. The general undervaluing of
ly in the oil business, 4) their financial oil industry stocks would make the acquisi-
data were available on Compustat (18), and tion of another oil company an attractive
!3) their industrial data were available in investment option. The lower SALETA ratio
the Arthur Anderson & Company report: u for acquired firms could also mean that
?~Q d rve Di (Survey of 30 those companies are under utilizing their
Pi
~~ ) 1980-19 (19). Although assets and in a competitive capital market
it did not meet all of the above criteria, their assets are bid away by acquiring firms
the Marathon Oil Company was added to the who can put those asset to greater use.
sample. Subsequent to its acquisition by EPSGR (Earnings/Share growth) is the
U.S. Steel, Marathon acquired the Husky Oil average yearly growth in earnings/share from
Company. Consequently, it was considered an 1980 to 1982. It is apparent from the data
acqu!r’!ng c_ompanY in this study. The compa- in Table S that companies in the acquiring
nies selected for this study are 1 isted in sample group have had a 60 pGI=cent higher
Table z and are identified as being either auera~e EPS qr~th rate than those companies
acquired or acquiring companies. ARCO and in the acquired group. Using the Gordon
Pennzoil were added to the list since at the Model we can illustrate how the higher
time of the study they were considered to be growth rate gives the acquiring companies an
probable acquiring companies. Dome was se- advantage in attracting investment capital .
lected because of the divestiture of its If we assume that the computed EPSGR values
U.S. properties and its general financial are relatively constant and that they ap-
condition at the time of the study. proximate dividend grwth, the stock price
of a company is given as:
R~ s
Po=Do(l+g)/(ks-g) .................. <2)
The results of this analysis indicate
that eight of the twenty four variables pro- where Do is the current dividend, g is the
vide the best discrimination between the two dividend growth represented by EPS(3R, and ks
groups. The analysis was stopped after the is the required rate of return on the stock.
eighth step because there was no apparent We can rearrange this equation and solve for
improvement in the discrimination function kss ,the expected rate of return, to show
with the addition of subsequent variables. that the acquired companies provided a lower
The eight discriminant variables are listed rate o+ return to iiivestcrs than de the ac-
in Tabie 3 aian~ with the step at which each quiring companies:
variable entered the function. Also listed
k5* ~
for each step are the F-statistic for test- [Do(l+g)/(Po)l+g . . ...*....*.*.. (3)
ing the group difference, the degrees of
freedom, and the appropriate F distribution where [Do(l+g)/(Po)l is the expected
value at the 0.01 significance ievei. It is dig!d~nd yield and g is as previously noted.
apparent from the data in Table 3 that on The dividend yields (DO/Po) calculated in
the basis of the eight selected variables, this study were 7.5 percent and 4.83 percent
we can re.iect the hypothesis that no differ- for acquiring and acquired companies respec-
ence exists between the two groups. tively. The calculated EPSGR were 9.6 per-
It is possible to determine the rela- cent and 6.0 percent for acquiring and ac-
tive i mpo, -~=~ce @ each garible in the dis- quired companies respectively. The expected
 A DISCRIMINANT ANALYSIS OF ACQUIRED AND ACQUIRING co~ANIEs
4 m I’m OIL
TxlllTTCWDV
Alwuu- . .. . SPE 14381

rate O+ return subsequently calculated ~or” #lt4JITY is the ratio of the present
acquiring companies was [7.SA(l.096)1+9.6A = value of future net cash flows, discounted
17.82 percent and [4.83’.’.06 )1+6IWX.WX = 11.12 at 10 percent, to the average market value
percent for acquired companies. It is evi- of company stock. The net flows were esti-
dent that the ●cquired companies were infer- mated by applying year-end oil and gas
ior investments. prices to the estimated future production *
The variable COSTBLL is the ratio of from proved reserves, less projected future
exploration and development costs to the ad- production and development costs. The esti-
ditions of oil and gas equivalent barrels to mated average production 1 ife for a reserve
reserves. It includes the costs incurred in was 30 years. The results, presented in Ta-
acquiring unproved properties. The variable ble 5, indicate that the acquired firms have
is commonly referred to as the “finding a higher average ANNUITY value than do the
Costm experience of an oil and gas comPanY acquiring firms. This difference reflects
and is used as a measure of the efficiency the fact that the acquired companies typi-
o+ the company in replacing reserves pro- cally have lower average production and
duced. The figures used in this study are development costs per equivalent barrel of
yearly auerages for 1980-1982. All costs oi 1 and gas production. Whether an acquir-
incurred in any one year were related to ing company can capture the higher AI’UWJITY ,
reserve additions for that year and no costs value o+ an acquired company is subject to
or reserve additions were included for ac- debate. It may be possible if the acquired
quisition 0+ proven reserves-in-place. The company was operated autoncnnously and not
results of this study indicate that the ac- burdened with the increased costs of the ac-
. . +~~rnj Qrf
quiring companies nave 3~.24 pei=ceiit higher ~~:~!~g if the acquirinq company
finding costs than do acquired companies. adopted the production and development prac-
For several years high finding costs were tices of the acquired firm. There is a po-
more than compensated for by rapid increases tential benefit for the acquiring company
in oil and gas prices. When prices stopped from the synergism that could result from
increasing and started to decl ine, companies their efficient asset utilization and earn-
h=d to ~~? ?he!p costs in order to attain an ings/share growth and the lower costs of the
economic profit. The acquired companies acquired company.
represented an opportunity +or the acquirin9 The variable CMCAP is the ratio of com-
companies to lower their finding costs an mon stockholder’s equity to total capital i-
average of 27.7 percent. In some cases more zation. Higher CMCAP ratios generally re-
significant cost reductions were possible. flect lower financial leverage and less con-
As noted previously, Socal’s acquisition of centration of business risk on the stock-
Gulf reduced their costs for new reserves by holders of the company. The lower the CM(XP
over 54 percent. The stock market was be- ratios the higher the financial leverage and
coming a new oil and gas “exploration fron- the greater the financial risk is to the
tier”. firm. The beta of the company’s stock in-
XINT is the ratio of earning before in- creases in proportion to the financial risk
terest and taxes (EBIT), plus depreciation, of the firm. The CMCAP ratios were 65.3
to regular interest charges. It indicates percent and 56.2 percent for acquiring and
the safety margin available to creditors be- acquired companies respectively.
fore earnings are no longer able to cover The last variable selected for the dis-
the cost of debt. The results of this study criminant function was INUTO, inventory
indicate that while the acquiring companies turnover. The INUTO value is considered to
have a higher average XINT than do acquired indicate how efficiently the company is man-
companies, the difference is not great. Most aging its inventory; the higher the value
oil companies that had excessively used debt the more efficient the management. A high
were speculating on continued oil price in- IWO value though does not always mean in-
creases and were forced into bankruptcy when ventory is being managed optimally. The op-
prices fell. timal inventory level is the minimum level
PE is the ratio of the average market required to support a given sales volume and
price of company stock to the earnings should be the objective of inventory manage-
avai)able to each share. It reflects the ment . High INUTO may indicate that the
anticipation of investors about the compa- average inventory level is too lw. The av-
ny’s future earnings. Generally, a higher erage INUTO value was 11.92 and 9.39 for ac-
FE is indicative G+ expected high:~ dividsnd “,, : - i R- .-I af-mttimnrl comp~~iQs respectively.
~UI} Illw =nu -.-y-.. --
growth, lower stock risk, or higher dividend
yield. The acquiring companies in this Pi= riminatimn Function
study had a S1 ightly higher PE ratio than
the acquired companies. Considering the The discrimination function that
previous discussion on 8ALETA and EPSGR, a resulted from this study is as follows:
greater difference in PE ratios between the
two groups was expected. I believe that the Y = 25.91618(SALESTA)+24.93590(EPSGR)+
PE ratios for the acquired firms had in- 0.58947(COSTBLL)-0 .02660(XINT)-
creased because speculative investors were 0.60157(PE)-2.34853(WUITY)-
bidding up the price of acquired companY 24.74035(Ct+iCf4P)-i .32509(ih&Ti3)-
stock in anticipation of their acquisition 1!5.20381 . . . . . . . . . . . . . . . . . . . . . . . . . (4>
and the opportunity to earn abnormal re-
turns.
SPE 14381 J. E. NOBLE 5

nies. The categories from which the dis-

Using this function, a discriminant
criminant variables were drawn were lever-
score was calculated for each company in the
age, profitability, market value, industry,
two a priori sample groups. These scores
were plotted along a canonical axis to il- and growth. Only liquidity and size vari-
lustrate the distance between and the dis- able% did not factor into the resulting dis-
tribution o+ companies within the groups. criminant function. *
The group centroid discriminant score (mean A multivariate technique, multiple dis-
canenica! caorc!~nates) uas also computed. criminant analysis (MOA), was used to devel-
The discriminant score for each sample com- op a discriminant model +roiil 24 +inancia)
pany and the group mean canonical coordi- and industrial variables that best discrimi-
nates and are presented in Table 6. A plot nated between 16 acquiring and acquired com-
of the companies’ discriminant scores along panies. Using the MOA technique, ei~ht
the canonical axis is presented in Figure 1. variables: 8ALESTA, EPSGR, COST8LL, XINT,
The midpoint of -0.47 was. chosen as the PE, ANNUITY, CMCAP, and INUTO were identi-
cutoff point between the two groups. This fied that best distinguished between the
point was midway between the highest and sample companies. A discriminant function
lowest discriminant scores for acquiring and was derived using these variables and
acquired companies respectively. demonstrated a prediction accuracy O+ 92.9 .
T~~l@ 7 contains the original and the percent. A test of the proportion o+ cor-
jackknife classification matrices. The rect ciassi+ications tipheid at the 0.00S
original matrix classified 100 percent of significance level the ability of the func-
the sample companies correctly, while the tion to distinguish between the sample ac-
Jackknife matrix classified 92.9 percent of quired and acquiring firms.
the companies correctly. These results The results of this study should prove
indicate the high predictive potential of helpful in identifying some of the reasons
the discriminant function. for the reorganization of the oil industry.
4 t-test of the proportion of correct Acquiring companies have been characterized
classifications was performed on the jack- as having higher asset util ization, greater
knife classification matrix (20). The re- earnings-per-share growth, higher percent-
sults, presented in Table 8, reject the hy- ages of common in total capital ization, and
pothesis at the 0.005 significance level greater inventory turnover than acquired
that there is na sicyificant difference be- companies. Relative to acquiring companies,
tween the two groups. The ability of the acquired firms have been cnarac+e~ized as
function to correctly classify the acquiring !?avinq i-e~ per-barrel finding costs and
companies was upheld at the 0.025 signifi- greater future cash flow potential per-
cance level and at the 0.10 level for the dollar in stock value due to their lower
acquired firms. It should be remembered, cost structures.
however, that the classification ability of The oil industry has typically been
the discriminant function may be significant capital intensive. The majority of its prof-
only with respect to the oil companies in- its have derived from the sale of large vol-
cluded in the analyzed sample and not to the umes of refined products with relatively low
entire industry. The ability of the func- profit margins. Proportionally, the acquir-
tion to correctly classify beyond the sample ing companies have made a larger percentage
companies is dependent on the degree to of their investments in “downstream” assets,
which the sample represents the entire e.~. refining and marketing, while acquired
population of oil firms. companies have made a larger percentage of
It would be desirable to have a holdout their investments in ‘upstreama assets, e.g.
sample against which the classification oil and gas reserves. Historically, as
ability of the discriminant function could ener~y consumption increased concurrent with
be tested. t+ t-test o+ the proportion of the growth in 8NP, those companies with
correct classification performed on the re- large investments in marketing and refining
sulting classification matrix would either enjoyed greater profits and larger EPS
corroborate the previous conclusions about growth than those companies invested pri-
the predictive ability of the discriminant marily in oil and gas reserves. This is
function or create doubt about the repre- reflected in the results of this study.
sentativeness of the sample used to derive The business environment changed for
the function. Unfortunately, the population the oil industry after the 1979 oil crisis
of acquired and acquiring companies was too and subsequent recession. Some of these
smal) to permit the selection of a holdout changes werei 1) energy consumers became
sample. price conscience and competition dramati-
cally cut the profit mar~ins on most petro-
leum products, 2) energy consumption per
unit of GNP declined for the first time, and
The purpose of this study was to deter- 3) the oil industry was faced with increas-
mine if there were financial and industrial ingly insecure oil suppl ies. It became
characteristics of acquired and acquiring paramount that those companies with large
oil companies that would characterize the “downstream” investments make their refining
companies in each group. This study’s find- and marketing operations more economically
ings indicate that financial and industrial efficient and attempt to secure their re-
variables provide the means to distinguish serve bases by increasing their investments
between acquired and acquiring oil compa- in “upstream” assets.
 A DISCRI~W ANALYSIS OF ACQUIRED AND ACQUIRING
—.- ~,..- COMPANIES
IN Lliu OIL IN~USTRY SPE 14381

As oil company stock prices dropped, 9) Alman, E., “Financial Ratios, Dis-
due to the anticipated decline in companY criminant Analysis and The prediction of
earnings, acquiring companies were motivated Corporate Bankruptcies”, Journal of Fi-
to bid for the relatively scarce, underuti- nance , September 1968, pp. 589-609.
lized assets o+ target firms by offering
premiums for their stock. Even while paying 10) Martin, J. and D. Scott, Jr., “A *
a stock premium, the acquiring company could Discriminant f+nalysis of The Corporate
often buy oil and gas reserves at signifi- Debt-Equity Decision”> Financial Man-
cantly less cost than the finding costs of agement, Winter 1974, pp. 71-79.
either the acquiring or acquired company.
The Socal-Gulf transaction is an excellent 11) Stevens, D., “Financial Characteristics
example of such savings. of Merged Firms: A Mul tivariate Analysis”,
I believe that the results of this Journal of Financial and Quantitative
study support the conclusion that the re- Analysis, March 1973, pp. 149-158.
organization of the oil industry, through
acquisitions and mergers, reflects a bene- 12) Simkowitz, M. and R. Monroe, “A
ficial reallocation of the industry’s assets Discriminant Analysis Function for
to companies that place a higher value on Conglomerate Targets”, Southern Journal of”
their use and will, consequently, utilize Business, November 1971, PP. 1-16-
those assets more efficiently. The reorga-
nization should increase the oil industry’s 13) ~DP7M - Stepwise Discriminant Analy-
economic efficiency by removing less effi- sis, Biomedica 1 Statistical so f twar e. 1982
cient companies and should attract addition- Edition, W. J. Dixon, Ed., University 0+
al capital investments to the industry. California Press.
A subsequent study should attempt to
verify the val idity of the discriminant 14) Pinches, G., “Factors Influencing
function derived in this study. As noted Classification Results from Multiple
earl ier, the function may be appl icable to Discriminant Analysis”, Jou rnal of Business
only the study’s two sample groups. Further Research, &ugust 1980, PP. 429-4S6.
study seems Justified considering the appar-
ent discrimination accuracy of the derived 15) Ibid.
function.
~6) Brealey, R. and S. Myers, Principles of
ACKNtMdLEDGFIIM~ ~
Cor r t 2nd Edition, 1984,
McGraw-Hill, pp. 569-587.
This study was conducted at The University
of Tulsa to partiaiiy satis+Y the ,r:q’u:Pe- ~7> IIM=odY’~ Investor Fact Sheetr& , Indus-
ments for the M.B.~. degree. I would like trial Review, 1983, Moody’s Investors Ser-
to thank Dr. Alan Frankle for his direction vice.
during the course of this study and Phillips
Oil Company for permission to publish this 18) Conmustat, 1984, McGraw-Hill.
paper.
19) Oil and Gas Industries Service Program,
ER~CES Oil and as s 0s Clo u s (1980-
=9 l~83sR=~; ~“i~nd=n and cmpany-
!> -.-
=+ilapfj A,: “Are the Oil Stocks
Oversold?”, Fortune, August 24, 1981, pp. 20) Dixon, id. and F. HasseYj ~
50-s6. to Statistic Analys is, 1969, McGraw-Hill, P.
101.
2) ~, April 1984, John S.
Herold, Inc., pp. 1-3.

3) Ib d. correct ●nd N=number of sample f rms.

4) Nu ty, P., “Boone Pickens, Company

Hunter’ Fortun5, December 26, : 983, pp.
54-60.

5) Ib d.

6) Pinches, G. and K. Mingo, “A

Multivari.ate Analysis of Industrial Bond
Ratings”, Journal of Finan ce, March
1973, pp. 1-18.

7) Ibid.

8) Forbes, R. and A. Frankle, “Tax-Exempt

Revenue Bonds: fire Ratings A Proxy +or Cred-
!t-QUai ikY?” ~ R~d n ECO-
nomic Research, pp. 68-77.
 T6SLE 2

OIL ~lES SELSCTSO #640 THEIR RESPEHIVE GROUPING

TABLE 1 1) Atlantic -Richfield Acquirin9

2) o*ttY Acquir*d
S~ OF FItW4C1AL WV INDUSTRY CIWWXERISTICS 3) ml+ Acquir?d *
4) Mobi 1 Acquiring
$!sri~bl= S) Occidental Acquirin9
6) Shcl 1 Acquired
Liquidity Not WorKing Cap i tal~ 7) Standard (Cal i forni ●) Acquiring
Total Assets (M6CTA) 8) Texaco Acquiring
Current Ratio (CR) 9) Pennzoi 1 ficquiring
Quick Ratio (QK) 10) Suprr ior hcquimd
N@t Working Capital/ 11) Husky Acquired
Sal ● S (twcsA) 12) Marathon Acquirin9
13) Phillips hcquiring
Leverage D-bt Rat i o ( OEBTRT) 14) Oome acquired
Times Inter*st Earned (XI NT)
Cmmrmm StocK Ratio ( cnc%P )

Pro+ itabi 1 i ty Sales to Total Asset% ( SALST6 )

Invrntory Turnover ( Iwo}
Net Profi t t’hrgin (NFtl)
Return on Total Assets (R1-rm)
R?turn on Equi tY (RTNEQ)
Return on Capi tal ( RTNCAP )

Market Value Pi-ice/Earnings (PE)

Dividend Yield (O IVYLO)
Mark ● t/SooK (MKBK)
Dividend PaYout ( DVPYOT )
WRIASLE SELECTI CN SEQU94CE - GROUP F-TESTS
Industry Cest/Sarr@l of Oi 1 Equ. ( COSTBLL)
Reserve Aticii ti=ris,f
Product ion ( RESPROO ) aLEQ
New Ressrve Costs/
Net Production Revenue ( PLOWBK ) 1 SALSTA 6.590 1,12 9.33
Di scountcd Cash FIOUJ/ 2 XINT 5.091 2,11 7,21
#J~ . Stock vatu~ (WUITY) 3 WUITY 4.564 3,10 6.5S
4 C?ICAP 4.210 4,9 6,42
Growth EPS (3 Year Avcra9e) (EPSSR) s EPSGR 6.395 5,s 6.63
Sales (3 Year Iweragr) ( SALESGR) 6 lWTO S. 270 6,7 7,19
7 PE 10.120 7,6 S.26
Size Nat . Log of Total Assets ( LNTA) s COSTBLL 26.220 8,5 10.29

TASLE 4

FU4CTION COEFFICIENTS #@ RELATIVE cCUTRISUTILV4 OF WRIASLES

SALSTA 25.916 0.377 9.770

2 EPSi3R 24.9S6 0.134 3.341
3 COSTBLL 0.589 5.004 2.947
4 XINT -0.027 7.296 -0.197
5 PE -0.602 6. SS7 -3.947
6 #UuITY -2.349 2.445 -5. ?43
7 cnCAP -24.740 0.240 -5.938
s IWO -1.325 5.011 -6.640

TASLE 5

WI#3LE UEMS FOR StWPLE GROWS

SALETA i .345 0.022

EPS13R e .0?4 0.060
COSTSLL 15.914 11. s12
xlNT 9. 73s 9.447
PE s. 8s6 S.612
NuITY 5.s0s 6.160
ctlPAP 0.653 0.562
Iwo 11.916 9. 3s7
 7ASE 6

S#lPLE COUPtV4Y 01 SCRIPW4T SCORES UITH Mm WLI.IES

I nan t

Acquiring 1) Atlantic-Richfield 5.33

4) Mobi 1 4.83
;; Occidental 5.90
Standard (Cal iforn i a) 7.30
8) Texaco 5.1s
9) Pennzoi 1 3.59
12) Marathon 5.49
13) Phillips 3.93

A-n,tipi~*
-- y----- c~~aflies Mean canonical Wal U@: 5.19

Acquirrd 2) Q*ttY -8.23

3) Gulf -6.62
6) Shel 1 -6.41
10) Superior -6.32
ii) HUS!(Y -7.31
14) Dane (U. S.) -6.46

+Cqu i red C~pW its Mean Canonical Val u*: -6.92

T6iSLE 7

CtiSSIFIWTIU4 I’W+TRICES

Original Classification Matrix

Group P*rcOnt Number of CaScS classified inta Gf’otip

correct Acquiring Acqu i r*d
Acquiring 100.0 s o
Acquir@d 100.0 0 6

Total 100.0 8 6
Jackknifed Classification Matrix

et-alp P* Pc*nt Number of CaS@S Class if lad into Group

Corr@ct Acquiring Acqu i r-d

Acquiring 100.0 e Q
Acqu i red S3.3 1 5

Total 92.9 9 5

TASLS 8

TEST OF PROPORTIUd OF ~ECT JACNI041FE0 CIASSIF1CATIC44

P* Pc9nt
~“~ ~

Acquiring s 100.0 2.S3

Acqu i red 6 83.3 1.63

Total 14 92.9 3.21

ts(O.025) = 2.31 t~(o.lo) = 1.44 ti4(o .605) = 2.96

10) s)
6) 1)
3) 9) 12)
2) 11)14) 13) 4) s) 7)

+..+..+..+..+.. +. .+..+.. +. .+. .+..+..+..+ . .+..+..+..+..+.. +

-8 ‘6 ‘4 ‘2 o 2 4 6 s 10
● I ●

● = than Canon ical Values [ = Midpoint