The Diversification Discount in the Oil and Gas Industry: Marathon Corporation Downstream Demerger Case Study

Abstract: This paper examines the success and implications of a decision by Marathon Corporation to spin-off its downstream assets from the upstream counterpart in early 2011. It is found that due to recent developments in the oil and gas industry and risk profile differences in the upstream and downstream firm, the demerger has led each firm to unlock hidden shareholder value and specialize to mitigate the effect of a diversification discount. Marathon Oil achieved this through strategic disposal of base assets in favor of increased investments in unconventional US shale plays, mainly Eagle Ford and Bakken, which contain highly lucrative production opportunities as a result of cheap extraction costs and plentiful reserves. Marathon Petroleum on the other hand conducted a share repurchase, dividend increase and plans to IPO a MLP in mid 2012, which has resulted in the combined market cap of the two firms to be USD20 higher during first trading day than the previous Marathon entity. Comparing pre-demerger performance to post-demerger performance, Marathon Oil and Marathon Petroleum perform better relative to index than as an independent company.