Marathon Oil's Epic Mismanagement of Its Share Count

WTI Crude Oil Spot Price Chart
WTI Crude Oil Spot Price Chart

WTI Crude Oil Spot Price data by YCharts

As those prices, oil producers generate a lot of cash flow. Marathon Oil Corporation was no exception. Cash flow from operations for Marathon for those three years came in as follows:

  • 2012: $4.0 billion
  • 2013: $5.3 billion
  • 2014: $5.5 billion

With all of that cash flow coming in, Marathon needed to decide how to use it. One decision the company made was to repurchase shares.

In 2013, Marathon spent $513 million repurchasing 14 million shares at an average price of $36.64 per share. In 2014 the company spent even more, deploying $1.015 billion repurchasing 29 million shares at an average price of $35 per share.

Now, I'm sure the company was trying to reward shareholders by repurchasing shares. The problem is that I'm not sure what the logic behind the share repurchase decision itself was.

A side effect for oil producers of high oil prices and the resulting strong cash flows is a high share price. By using that $1.5 billion of cash to repurchase shares when oil prices were high, Marathon's board of directors and management were effectively buying at the worst possible time.

That isn't good, but the story gets even worse.

A share issuance plan -- selling low

Buying back shares when the price is high and then stopping the repurchasing when cash flows and the share price tumbles is less than ideal. For Marathon shareholders, there's an even more bitter pill to swallow.

After spending $1.5 billion of shareholder cash to repurchase 43 million shares at an average price of more than $35 per share in 2013 and 2014, Marathon announced on Feb. 29 that it will issue 145 million shares at $7.65 per share.

MRO data by YCharts

Drink those numbers in for a moment. Marathon just told its shareholders that it will issue more than 3 times as many shares as it had repurchased and that it would be doing it at one-fifth the price it had paid. All of this within two years.

Under pressure

Whenever I've made a mistake, my father has always been there to tell me that "hindsight is 20-20" to try to make me feel better. Yes, that is certainly a valid point when it comes to Marathon's share count horror story. Not many people saw this oil crash coming.

However, there are a couple of things that I would point out.

One is that this is a very cyclical business. We only need to go back to 2008 for the last oil crash, and the one before that was only 10 years prior. My second point is that the people at the top of a company such as Marathon make huge amounts of money because they're supposed to have the experience and ability to do better than this.

The question I would like answered is, why don't more of these companies let cash build on their balance sheets during the good times, so that it's there when the next crash inevitably comes around? I suspect the answer would be that the analysts that cover these companies and the funds that own the majority of the shares wouldn't allow it.

If a management team chose to let cash build up in the bank they would be called on to do something with it almost immediately. Heck, a management team that tried to use this kind of long term strategy would likely be at risk of losing their jobs. The investors in these companies are likely just as much to blame for the short term thinking that pushes these companies to the brink during oil crashes as management is.

Tough to swallow, but probably the right decision

You might be surprised that I don't think the equity issuance at these depressed prices is a mistake. This is the corner the company has backed itself into.

This issue came up in the Q4 earnings conference call , with one analyst asking how Marathon expected to cover a nearly $600 million spending shortfall (using current strip pricing).

Marathon's plan for that is a non-core asset sale target of $750 million to $1 billion and the fact that it has $4.2 billion of liquidity in the form of $1.2 billion in cash and an undrawn $3 billion revolving credit facility.

Selling assets at this point in time is a tough endeavor if you're looking for a decent price, and tapping into the revolving credit facility isn't a great option, either, with a $750 million debt maturity in 2017.

In the end, the equity issuance is probably the best option, although one that only the investment bankers who are getting the fees will love. For investors looking at Marathon, I'd suggest taking a pass and looking elsewhere. Your money probably deserves better than what this team has shown it can do.

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