Exxon has suffered too much for flawed XTO deal

July 29, 2010

Disgruntled investors have wiped more than $40 billion off the value of Exxon Mobil since its splurge on U.S. gas giant XTO Energy — almost exactly the firm’s price tag. With Congress ditching carbon emissions rules, clean-burning gas looks like a bad bet. Yet to assume that XTO has zero value seems wrongheaded.

Even before lawmakers went cold on limiting greenhouse gases, investors were skeptical of the purchase. Between the announcement of the deal on December 14 and Thursday’s bumper second-quarter results, Exxon stock had slid 16 percent. Adjusting for an average 4 percent fall of peers Chevron and Royal Dutch Shell, investors have lopped slightly more than XTO’s entire $41 billion enterprise value off Exxon’s market capitalization.

True, Exxon’s huge outlay on XTO is starting to look questionable. With the benefit of hindsight about what the Democrats would and wouldn’t push through Congress, it may not have been the time for Exxon to nearly treble its U.S. natural gas production.

That said, anemic gas prices in 2009 didn’t stop XTO from eking out $6 billion or so of operating cash flow during the year. In addition, while the gas market looks grim it’s probably not getting any worse. Though demand may not spike, conventional natural gas production in the United States is set to halve by 2030, providing some support for prices. Meanwhile, Exxon’s traditional discipline and gold-plated AAA credit rating will surely lower costs at XTO.

Exxon’s better-than-expected $7.6 billion profit in the second quarter is a reminder that there is more to the company than XTO. Unlike ConocoPhillips, Exxon is continuing to lift output. With a well-stocked pipeline, annual production growth of between 2 and 3 percent looks within reach over coming years. Nor is Exxon as exposed to the troubled Gulf of Mexico as Chevron. And a top-notch reputation for safety should become even more valuable to Exxon as risk aversion increases in the wake of BP’s spill.

XTO may not deliver the plump returns on capital Exxon shareholders have grown accustomed too. But the deal isn’t the total wipeout the loss of market value would suggest. The company’s stock has suffered too much.

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