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Bear of the Day: Occidental Petroleum (OXY)

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Warren Buffet and Carl Icahn are two of the most prolific investors of our time and they both figure into the story of today’s Bear of the Day – Occidental Petroleum (OXY - Free Report) .

Icahn is one of Occidental’s largest single shareholders, and he has been locked in a battle with the company’s board after their approval of a $55B takeover of Anadarko Petroleum earlier in 2019 which included the assumption of $40B in debt. Engaged in a bidding war for Anadarko with Chevron (CVX), Occidental sold off $9B worth of global assets and secured $10B in financing from Warren Buffet’s Berkshire Hathaway.

Icahn has described the current OXY board as “willing to take inordinate risks and gamble stockholders’ money to further their agendas.” He claims that they “grossly overpaid for Anadarko” in a deal that – because of the Berkshire funding deal – did not require a shareholder vote.

Occidental sold Berkshire 100,000 shares of preferred stock which pay an 8% annual dividend and granted warrants to purchase up to 80 million shares of common stock.

The acquisition of Anadarko’s assets gives Occidental immediate exposure to the shale-oil boom in the Permian Basin in West Texas, but also leaves the company scrambling to continue shedding assets and cut operational costs to shore up their debt-laden balance sheet.

Occidental’s level of debt combined with guaranteed preferred dividends is approximately 4.2X projected annual earnings – more than 4 times the industry average.

Occidental CEO Vicki Hollub defended the acquisition, arguing that the assets that have been acquired will seem cheap in the long run if oil prices rise. That’s a big “if” however - with US producers now pumping out more than 12 million barrels of oil each day, OPECs apparently limited ability to prop up global prices and a seismic shift in public sentiment about the future of fossil fuels.

Where oil is going to be trading in the future is anybody’s guess, which is why Occidental’s bet is so risky for shareholders like Icahn. He has recently sold approximately 1/3 of his original stake in OXY, but still owns about 22 million shares.

It hasn’t been a great year in the Oil and Gas industry which has seen share prices basically flat even as the S&P 500 has gained 23%, but it’s been much worse for Occidental which is down more than 35% since making the winning bid for Anadarko. The Icahn sales aren’t the only factor – plenty of analysts have made similar observations about the debt load – but the fact that Icahn still owns $850 million worth of OXY shares could put additional pressure on the price if he continues to sell.

What about Buffett?

It might seem ill-advised to bet against a company that has the apparent support of the Oracle of Omaha, and Buffett has profited handily in the past by providing huge-money financing to companies with limited options. His $5B backstop of Goldman Sachs (GS) during the financial crisis was legendary and also earned Berkshire a tidy  $3.7B profit – thanks largely to the exercise of warrants as GS shares recovered.

Buffet’s participation suggests he believes in Occidental’s prospects, but unlike institutional equity investors like Icahn, T Rowe Price and BlackRock (BLK), the stock doesn’t have to appreciate for Berkshire to make money. The 8% yield on his preferred shares is more than double the industry average and the warrants – which will only pay off if the shares rally considerably – could also cause significant dilution to owners of common shares.

The Oil and Gas industry can be a dicey place to invest, with the potential for windfall profits offset by a host of risks that are completely out of control of industry participants. Investors in the industry would be wise to consider Antero Midstream (AM) or Tidewater Inc (TDW), both Zacks Rank #2 (Buy).

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