A Week on the Wild Side

By Charles Alexander

The failure of the Gulf-Cities Service merger sends Wall Street into a spin

Aftershocks from a collapsed merger. Surprise bankruptcies. Gyrating stock prices. A startling new takeover bid late on Friday. Even to the most seasoned Wall Street veterans, last week was wild.

At the close of business on the previous Friday, Aug. 6, Gulf Oil Corp. had dropped a short-fused bomb on the stock market. Citing antitrust objections by the Federal Trade Commission, Gulf abruptly pulled out of an agreement to acquire Tulsa-based Cities Service Co., the 19th largest U.S. oil firm, for $5 billion, or $63 per share. When trading opened last week, the price of Cities Service shares had dropped to $30. Scores of brokerage firms and speculators who had bought huge chunks of the stock for prices as high as $56 were staring at the possibility of losing perhaps $700 million. Hardest hit were several smaller firms that specialize in speculating on merger deals, a daring practice known in the trade as risk arbitrage (see box).

At the end of the nerve-racking week, news flashed across Wall Street tickers that Occidental Petroleum of Los Angeles, the twelfth largest U.S. oil company, had bid to acquire Cities Service for an average price of $41.67 per share. Cities Service announced that it would consider the offer at a special meeting of its board of directors early this week but also said that it was still talking to other major companies about possible merger deals. Though far less generous than Gulfs original bid, the Occidental offer could reverse more than a third of the losses that investors have sustained on Cities Service stock. Moreover, brokers hoped that this new development would spark higher bids for Cities Service from other companies.

Occidental's action, plus a drop in the Federal Reserve's discount rate from 11% to 10.5% and the prime rate by some leading banks from 15% to 14.5%, provided an upbeat ending to a gloomy week. The financial community had earlier been rocked by the sudden bankruptcy of Lombard-Wall, Inc., a New York City firm that specialized in trading government securities. Though Lombard-Wall had only 55 employees, it had run up staggering debts, including $45 million owed to Chase Manhattan Bank. Chase was already reeling from an after-tax loss of $117 million that resulted from its dealings with another government bond dealer, Drysdale Government Securites, which went bankrupt in May. The reasons for Lombard-Wall's problems were unclear, but one possible explanation was that the firm had guessed wrong on the direction of interest-rate movements and sustained heavy trading losses.

On the same day that the news about Lombard-Wall broke, Colin, Hochstin Co., a New York City brokerage firm, announced that Justin Colin, one of its partners, had filed a personal bankruptcy petition. He had lost heavily on investments in two small West Coast airlines that went out of business last year. The troubles of Colin and Lombard were new evidence of the current fragility of financial markets.

The breakdown of the Gulf-Cities Service deal was potentially the most dangerous threat to Wall Street. After Gulf first made its acquisition bid in June, a flock of investors hoping for a quick profit bought some 27 million Cities Service shares. Two weeks ago, however, rumors began swirling that the giant oil company was having second thoughts about the acquisition. By the time Gulf renounced the deal after the market closed on Friday, Aug. 6, the price of Cities Service stock had already fallen by one-third, to 37 1/4.

After Gulfs announcement, Cities Service shareholders faced a long, agonizing weekend. Says William LeFevre, strategist for the Purcell, Graham & Co. investment firm: "People were afraid that the stock would lose a third of its value and open at $25 or lower." Cities Service Chairman Charles Waidelich fumed at Gulf: "I am outraged. This is the first time something like this has happened between two major U.S. corporations." Waidelich called a meeting of his board of directors on Sunday afternoon, Aug. 8. After 31/2 hours of discussion, the directors voted to make an all-out effort to find a new partner.

On Monday morning, Aug. 9, traders at brokerage houses were warned over office intercoms and at emergency meetings to prepare for a hectic, perhaps catastrophic week. "Everybody was scared to death," says Barton Biggs, chief market strategist at Morgan Stanley. The New York Stock Exchange prolonged the tension by postponing the start of trading in Cities Service. The scene around Post No. 4, where Cities Service shares are bought and sold, was pandemonium. Says one trader: "Every time word went out that the stock was about to open, 50 gesticulating sellers surged forward." But the stock did not open until 3:25 p.m., only 35 minutes before closing time. In a convulsive frenzy during that brief period, 2.8 million shares of Cities Service were sold. The stock finished the day at 30 3/8, down 6 7/8.

Heavy trading continued all week, but the price, after its Monday plunge, stabilized. Hopes that a new merger partner would soon appear helped hold up the value of the stock. Cities Service declared an open house at its Manhattan offices and invited potential suitors to come by to peruse confidential company data. Waidelich was actively wooing all the largest oil companies, as well as several non-oil firms. Rumors flew that Phillips Petroleum Co. and the Union Pacific Corp. were showing interest.

Starting last Thursday night at the Carlyle Hotel in New York City, Cities Service officials huddled in meetings with Occidental Chairman Armand Hammer and his top lieutenants. By just after lunch on Friday, they had reached the outline of an agreement. At 2:59 p.m., trading in Cities Service was suspended with the price at 33 1/4. Expectations of an offer helped rally the entire market. After being down all week, the Dow Jones industrial average gained 11.13 points on Friday to finish at 788.05. An hour after the market closed, Cities Service announced the Occidental bid.

The offer was a fittingly dramatic move for Hammer, still an irrepressible empire builder at age 84. With Hammer at the helm, Occidental has grown in 25 years from a small, nearly bankrupt firm to an energy colossus with annual revenues of more than $14 billion. Much of the company's oil, however, comes from such politically unstable parts of the world as North Africa and South America. The firm has been anxious to increase its domestic holdings, yet it found few opportunities for obtaining energy property in the U.S. Hammer told TIME: "If you want elephants, you go where they are. But it has been one of our goals for a long time to make Occidental more domestic oriented." Cities Service has 10.6 million acres of undeveloped U.S. land, which are believed to hold at least 300 million bbl. of oil and 3 trillion cu. ft. of natural gas.

Despite the possible resolution of the Cities Service crisis, Wall Street is still bitter toward Gulf. Grumbles one trader: "How does a company with Gulfs standing in the corporate community dare to lock itself into a $5 billion deal and then change its mind?" Ironically, Gulf was originally cast as the hero in the Cities Service drama. In June Cities Service was trying to escape an unwanted takeover bid by Mesa Petroleum, a relatively small Amarillo, Texas, oil firm. Unwilling to be controlled by a company less than one-twentieth its size, Cities welcomed Gulfs merger bid of $5 billion, which Mesa could not match.

Gulf needed Cities Service's valuable energy reserves to bolster its declining oil production. Soon after Gulf made its bid, though, several Wall Street analysts said that the company had acted hastily and paid too high a price. Then the FTC raised antitrust objections. The agency argued that if Gulf bought Cities Service, the combined company would have too large a share of the gasoline and kerosene jet fuel markets in some areas of the Southeast and would own too much (31%) of the Colonial Pipeline Co., which transports petroleum products from Texas to New Jersey.

Waidelich knew the deal was in trouble but remained optimistic that Gulf and the FTC could reach a settlement. Minutes before Gulf's stunning announcement on Aug. 6, Waidelich anxiously telephoned Gulf Chairman James Lee. "Can't you tell me what is going on?" Waidelich asked. After some hesitation, Lee admitted that Gulf was canceling the merger. "Jim, that's terrible," Waidelich gasped. "I know. I feel terrible too," replied Lee.

Cities Service felt terrible enough to file a $3 billion lawsuit charging that Gulf was guilty of "intentional and malicious breaches of contract that are of a dimension unprecedented in the annals of American business history." Waidelich contends that Gulf used its dispute with the FTC as an excuse to back out of a deal that it no longer considered financially attractive. John Carley, the FTC'S general counsel, seemed to support that charge: "We were ready, willing and able to negotiate on any aspect of the proposed merger." But Gulf obviously was not. Said Chairman Lee: "I don't have the stomach to go through any such mess." Apparently Armand Hammer, even at 84, has a stronger stomach.

--By Charles Alexander.

Reported by Frederick Ungeheuer/ New York and Benjamin W. Cate/ Los Angeles

With reporting by Frederick Ungeheuer, Benjamin W. Cate

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