LEGAL EDGE. Anadarko Petroleum Corp. (APC): Preview of April 4 Tronox Hearing March 28, 2014 CFRA LEGAL EDGE

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1 LEGAL EDGE Anadarko Petroleum Corp. (APC): Preview of April 4 Tronox Hearing THE BRIEF We maintain Anadarko at Actionable Positive into Friday April 4 hearing in the Tronox fraudulent transfer case KEY TAKEAWAYS Key hearing April 4 on subject of final damages figure in Tronox fraudulent transfer case Wide range of outcomes on final damages figure ($850 or $1.66/share to $20.3 bln or $39.60/share) We believe $5.15 bln is the most likely gross damages award (subject to various puts/takes) Judge may provide important clues at April 4 hearing to help guide the parties towards settlement Based on current information we view $5 bln to $7 bln as a reasonable settlement range, pre-tax/insurance Maintain Anadarko at Actionable Positive SUMMARY We maintain Anadarko at Actionable Positive (new rating initiated pre-market 12/13/13) ahead of key April 4 supplemental post-trial hearing on the subject of damages in the Tronox fraudulent transfer case, before Judge Gropper of the Southern District of New York. We will attend the hearing. Background Familiarity with the multi-billion dollar Tronox fraudulent transfer case is assumed; for further reference please see our December 13, 2013 Report Positioning Post-Tronox (link) and March 4, 2013 Report Positioning Into (& After) Tronox Ruling (link). Recall that on December 12, 2013, Judge Gropper issued his post-trial opinion, finding for plaintiff Tronox environmental and tort creditors and against Anadarko/Kerr-McGee on liability (both actual and constructive fraudulent transfer) and providing provisional guidance on damages (range of $5.15 bln to $14.17 bln). The parties have filed an additional series of briefs, covering both the specific issue on which Judge Gropper requested briefing (whether Anadarko s 502(h) offset should be subject to an 89% multiplier, which translates to gross damages of $5.15 bln, or diluted to 2.8%, which translates to gross damages of $14.17 bln) and related damages issues, including whether the gross damages figure should be subject to appreciation and pre-judgment interest. Both sides also raised arguments which amount to requests for reconsideration (without formally saying so); we chalk this up to certain ambiguity in Judge Gropper s December ruling as to what constitutes a provisional ruling (which lawyers, being lawyers, tend to interpret as still up for grabs, so we might as well take a shot ) and what is not. Our expectation is that Judge Gropper will brush most of these ancillary arguments aside and focus primarily on the 89% versus 2.8% multiplier. We are also hopeful that the judge will provide some guidance on plaintiffs request for 30.4% appreciation (tacks on an additional $1.56 bln in the $5.15 bln gross damages scenario) and bonding. While a formal ruling could come any time on or after April 4 (Judge Gropper could rule orally from the bench on April 4, or issue a ruling any time before his October 3, 2014 retirement) consistent with prior SELECT COMPANIES MENTIONED Anadarko Petroleum Corp. (APC) Sector: Energy Market Cap: $42.7 bln EV: $54.4 bln Shares Out: Tronox Rsrv. $850 1-yr CDS: 23 bps 5-yr CDS: bps LEGAL ISSUE Tronox fraudulent transfer case UPCOMING EVENTS Any time US Supreme Court ruling in Executive Benefits case involving bankruptcy court authority 4/4/14 Supplemental hearing re damages before Judge Gropper in Tronox fraudulent transfer case (we will attend) 5/2014 8/2014 Expected timing of final judgment in Tronox fraudulent transfer case 10/3/14 Judge Gropper s official retirement date RELATED REPORTS 1/31/14 Special Interest List 12/13/13 APC Report 3/4/2013 APC Report CONTACTS Nick Rodelli, JD Phone: nick.rodelli@cfraresearch.com Michael Gordon, JD Phone: michael.gordon@cfraresearch.com 1

2 practice we believe Judge Gropper will likely provide significant clues about his thinking at the April 4 hearing. This is consistent with our view that Judge Gropper appears to be architecting an environment to encourage settlement. This effort encompasses the following: (1) clear signals from Judge Gropper at trial that he simply wasn t persuaded by Anadarko s liability contentions (see March 4, 2013 Report for examples); (2) Judge Gropper s detailed, meticulous December 2013 written opinion on liability (fact findings get deference on appeal we note Judge Gropper is very rarely overturned on appeal); (3) acknowledgement by Judge Gropper that many damages-related issues, and several other questions, are novel and/or difficult (many of which won t get as much deference as the judge s fact findings on appeal), thus creating appeal optionality for the losing side, and a reason for the winning side to risk-adjust the final damages figure for settlement purposes; and (4) presenting the parties with provisional guidance of a wide damages range ($5.15 bln to $14.16 bln), some hints to where he s going (we think, $5.15 bln) while leaving enough unresolved to make both sides anxious. Assuming no settlement before the April 4 hearing (a possibility we would not rule out) we conclude that the parties may need more guidance from Judge Gropper, to help inform the parameters of a reasonable bid/ask range for settlement. And we expect Judge Gropper to give it next Friday, albeit perhaps subtly. Reasonable Settlement: $5 to $7 bln Range The range of potential damages outcomes in this case is exceptionally wide, with too many permutations to list. Details for certain of these alternative scenarios (inclusive of low/mid/high cases specifically, along with our probability-adjusted net damages assumptions) are set forth in Table 1 at right. Table 1: Low/Mid/High Damages Scenarios With Probability and Risk-weighted Damages Low Mid High Damages (Less) Legacy Liabilities/Creditor Shortfall KMG Allowable 502(h) offset claim Offset Recovery Percentage $14.46 bln $14.46 bln $14.46 bln $850 $4 bln $4 bln $13.61 bln $10.46 bln $10.46 bln 100% 89% 2.8% Offset amount $13.61 bln $9.31 bln $293 Sub-total damages (exappreciation/ interest) Appreciation Pre-judgment interest Net damages $850 $5.15 bln $14.17 bln $0 to $258 $0 to $105 $850 to $1.2 bln $0 to $1.56 bln $0 to 683 $5.15 bln to $7.4 bln Probability Assumption 10% 75% 15% Risk-weighted Net Damages $103.2 $0 to $4.3 bln $0 to $1.87 bln $14.17 bln to $20.3 bln $4.70 bln $2.59 bln A word on the different scenarios. The low scenario of $850 to $1.2 bln corresponds to the $850 charge taken by Anadarko, as of December 31, 2013, reflecting both a 100% multiplier to Anadarko s 502(h) offset and using an $850 net creditor 2

3 shortfall (rather than the $4 bln figure from Judge Gropper s opinion, keyed to the estimated amount of legacy environmental and tort liabilities as of 2010). While we don t specifically question Anadarko s position that the $850 figure is the most appropriate reserve for the Tronox liability for accounting purposes (Anadarko says it used the low end of the $850 to $5.1 bln reasonably possible range, since no other figure in the range was more probable) we believe Judge Gropper is very unlikely to come in at $850 (we model 10% probability, charitably). Slightly more likely (we model 15% probability) is the prospect that Judge Gropper awards the high end of the damages range ($14.17 bln, potentially subject to up to an additional ~$6 bln for appreciation and pre-judgment interest, netting to $20.3 bln in a worst-case outcome), a scenario that would require the judge to adopt plaintiffs theory of a 2.8% multiplier, which in effect would so massively dilute Anadarko s 502(h) offset as to render the offset de minimis. Much more likely in our opinion (we model 75% probability) is the $5.15 bln figure, for the reasons we outline below. Note further that risk-weighted (probability adjusted) low/mid/high damages scenarios sum to $7.39 bln, a figure that in the settlement context could, and probably should, be downward-adjusted for delay, risks of appeal reversal, etc. (though risks on appeal could go both ways; i.e., there is some risk that a lower damages figure could be adjusted higher on appeal). Thus one way of looking at the case as it stands (based on current information, and subject to adjustment based on our observations next Friday) is that a reasonable settlement could fall somewhere in the $5 to $7 bln range ($11/share at midpoint) before taking into consideration potential tax deductibility (rough-cut of up to $1.6 bln at the $6 bln midpoint, netting to ~$4.4 bln out-of-pocket, based on Anadarko s deferred tax benefit of $274 taken on the $850 Tronox charge). It is also possible that insurance coverage would further reduce Anadarko s net out-of-pocket. Opinions differ about what s in the stock for Anadarko with respect to the Tronox issue. In the end, our judgment is that a settlement along the lines outlined above, which provides finality on the Tronox liability and its attendant overhang/uncertainty across operations, capital allocation, etc., would be well-received, supporting our Actionable Positive rating. Ironically, such a settlement probably was not practicable until after Judge Gropper s December 2013 opinion, when Anadarko management (and shareholders) saw just how ugly the downside Tronox liability scenario could be. Now, informed by more realistic expectations, the groundwork has been set to potentially lay the Tronox liability to rest. Why We Believe 89% ($5.15 bln damages) is the Right Recovery Percentage As demonstrated above, the crucial variable in the Tronox damages model is the multiplier, which is the percentage recovery applied to Anadarko s 502(h) offset. Plaintiffs say it should be 2.8%, after diluting the recovery percentage by adding back the allowable 502(h) offset claims into the unsecured claim pool. Plaintiffs say only this interpretation compensates plaintiffs for the risks associated with their environmental/tort claims, and that future claimants in similar circumstances may well decline to accept a contingent legal claim if the upside is capped in the manner Anadarko seeks here. Anadarko, for its part, argues that the plain language of the bankruptcy plan controls, that 100% recovery (or at minimum 89% recovery), is in accord with the bankruptcy plan, with 89% representing the midpoint of estimated creditor recovery. Anadarko argues that the 89% multiplier is also consistent with fraudulent transfer law policy of placing parties back to status quo positions held before the outbound transfer. 3

4 As was the case in our March 2013 report, where we forecasted a loss by Anadarko on liability, and a damages figure that would likely surprise consensus to the upside (and possibly include a damages range, subject to further briefing, which turned out to be the case), we focus primarily on available inputs into Judge Gropper s thinking (most notably the December 2013 ruling, to be supplemented by next Friday s hearing). While Judge Gropper clearly contemplated both the 89% and 2.8% scenarios, we interpret the balance of his analysis, including his case law citations and the framework and flow of his ruling, as supporting the 89% figure. As one specific example, we cite footnote 130 of Judge Gropper s opinion, which we interpret to support Anadarko s position that adding back the 502(h) offset into the unsecured claim pool, thereby diluting the recovery multiplier to 2.8%, would be inconsistent with the bankruptcy plan, and would be tantamount to improper hindsight analysis. Conclusion We continue to rate Anadarko Actionable Positive, subject to developments, including next Friday s Tronox hearing. 4

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