Business Proposal: 1998, and Dupont

Pages: 8 (2416 words)  ·  Bibliography Sources: 4  ·  Level: College Senior  ·  Topic: Business  ·  Buy This Paper

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[. . .] The cash will be used to finance opportunities that are earning a higher rate of return than Conoco is currently earning for DuPont. With the price of oil falling, Conoco has seen declining returns for DuPont over the past several years, and there is no indication that the oil market is going to change any time soon. Thus, it is better for DuPont shareholders to sell the entire stake in Conoco now, and extract maximum value for the business. There is the risk that the price of oil changes, and in that scenario a two-step divestiture might be preferred, but such a change is entirely speculative at this point. We must make this decision based on the information that we have at present, and that is that Conoco's value is not going to change much over the next few years.

For DuPont shareholders, selling Conoco will generate substantial free cash flow. The amount of this cash flow will depend on two factors. The first is the value of Conoco, which will be assumed close to the $4.3 billion on the books today. The second is the value of the shares that are being sold. A share of Conoco will entitle the shareholders to a vote and a share in any dividends that are declared. However, the value of the share will be slightly lower if DuPont is maintaining controlling interest in Conoco. The value of a minority share would be sold at more or less the present value of the expected future cash flows of Conoco. Indeed, to sell such minority shares, DuPont would need to offer them at a slight discount in order to entire investors to take on the risk of holding a Conoco share. Thus, the expected payoff to DuPont is lower if DuPont maintains a majority stake in Conoco. The following chart outlines the cash flow that DuPont can expect from selling a percentage stake in Conoco vs. selling the entire company:

Stake

Value

$4.3 billion

60%

$2.5 billion

40%

$1.55 billion

The table shows that as the percentage divested declines, the amount that DuPont can expected for each share will decrease. The market for IPOs is moderate right now, and investors will be wary of buying an oil play in a struggling oil market, especially if Conoco is going to be run exactly the same as it is now, under DuPont's leadership. If there is the opportunity for the investors to affect change at Conoco to improve the oil company's performance, they will pay more for the each share.

Valuation Methodology

There are many factors that will contribute to the pricing of the issue. The underwriters will gauge the market for the issue. The strength of the market will determine in part whether DuPont ultimately does a two -- stage divestiture or a one-stage. If the market is weak, the value that DuPont extracts for Conoco will be lower, especially if it discounts in order to sell out an entire $4 billion-plus issue.

There are numerous valuation methodologies that can be used for Conoco, which has been privately-held for many years. The price/earnings ratio is one method. Conoco does not have such a ratio, but there are many similar oil companies that would. This methodology holds that Conoco is likely worth roughly the same P/E as its peers, applied to its earnings. As a distinct unit, Conoco has specific earnings that can be communicated in the pro-forma. Using industry P/Es, Conoco's value should be in the range of $18-24 per share.

Another valuation methodology is to undertake a thorough financial statement analysis of Conoco in order to determine its health and value going forward. This method would also be part of the P/E analysis to see where Conoco fits with its peers. The balance sheet and income statement would be analyzed, as would the cash flow statement, to identify the book value of the equity, the financial condition of the company, and any major issues that might be in the financial statements. The price-to-book and price-to-cash-flow ratios can be used in a manner similar to the P/E ratio, the former more if Conoco is sold for liquidation purposes (it's not) and the latter if cash flow is deemed more important than economic earnings.

Conclusion

Conoco is valued at $4.3 billion. DuPont should extract this full total, but should do it in two stages. There is risk associated with the two-stage process, in that it costs more with higher underwriting fees and there is the risk that the first issue will have a lower-than-expected valuation because it is only a minority stake. The risks are arguably larger for the one-stage divestiture, however, since the value of Conoco could increase, or the conditions for IPOs could weaken. However, the IPO market is expected to remain strong. The value of Conoco is likely to increase. This points to DuPont selling a minority stake now in order to extract some immediate cash from Conoco, and then selling the rest at a later date when oil prices begin to move upward.

Works Cited:

Chang, J. (1998). DuPont begins to sell Conoco in effort to focus on biotech. ICIS.com. Retrieved October 4, 2013 from http://www.icis.com/Articles/1998/05/18/87415/dupont-begins-to-sell-conoco-in-effort-to-focus-on-biotech.html

ConocoPhillips. (2013) Who we are. Conoco Phillips. Retrieved October 3, 2013 from http://www.conocophillips.com/EN/about/who_we_are/history/conoco/Pages/

Moore, H. (1998). Record-setting Conoco IPO raises $4.4 billion. The Street.com. Retrieved October 4, 2013 from http://www.thestreet.com/story/21347/1/record-setting-conoco-ipo-raises-44-billion.html

WTRG.org. (2013). OPEC events and oil prices (graph).… [END OF PREVIEW]

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https://www.essaytown.com/subjects/paper/1998-dupont-considering/8336811.