Are you a disciple of the value-investing gurus Benjamin Graham and Warren Buffett? Have you observed that investors often become infatuated with a successful company and bid its shares well above intrinsic value? Valuation extremes are the result of investor manic-depressive behavior. Remember the recent fads for Beanie Baby and Pokemon paraphernalia? Or, more apropos for investors, do you recall Wall Street's history of the various sizzling sectors that subsequently fizzled with obsolescence, loss of novelty or industry consolidation or integration-for example, the telegram, automobile, canal construction, railroad, tulip bulb? A great pestilence of "investor lack of intelligence" was manifest in 1999 when so called old-economy stocks like the oils were beaten down as investors demonstrated a seemingly insatiable demand for Internet and other new-economy plays. But back to basics: Do you believe that, in time, comparable assets will be accorded comparable values? If you've answered yes, we have a proposition for you! Sell ExxonMobil (XOM, $36.86/share) and buy John S. Herold's Synthetic ExxonMobil (SXOM, $27.15). The Norwalk, Connecticut, research firm has created "Synthetic ExxonMobil" from a group of nine energy stocks that, on balance, provide a competitive portfolio of energy assets and financial performance. Synthetic XOM comprises the following publicly traded global energy companies: TotalFinaElf, Conoco/Gulf Canada, Phillips, Occidental, Suncor, Enterprise, Penn Virginia and Hawaiian Electric. (Editor's note: Although this concept was prepared prior to the merger announcement of Conoco and Phillips, the news does not alter our conclusions.) These energy issues were selected by Herold's equity research team to provide similar worldwide energy-asset exposure while, on an individual and collective basis, they are valued at significant discounts to the Irving, Texas-based energy behemoth. You can liken Synthetic XOM to a generic brand of XOM: it looks similar as far as assets and should perform competitively, but at a meaningfully lower capital cost. We maintain that if comparable petroleum assets have comparable intrinsic value and earning power (a thesis we find quite compelling), we reckon that Synthetic XOM will narrow the valuation disparity with highly regarded XOM. We stress that our position does not state that ExxonMobil is overvalued in an absolute sense in the stock market today. In fact, XOM trades at a price-to-earnings ratio (12.0 times 2000 earnings per share) discount to the average industrial. XOM provided a commendable total return to investors of 10.1% in 2000, and was roughly unchanged through mid-August 2001. Meanwhile, the Dow Industrials produced a negative 4.6% total return in 2000 and fell another 2.6% through mid-August. Our position is that XOM-a great company that has delivered outstanding shareholder returns through bear and bull markets alike-currently commands a market valuation that makes it unattractive relative to other energy-share alternatives. Fundamental valuation dynamics, a very powerful market force, will eventually drive asset valuations toward equilibrium. Hence, if XOM shares gain in value, then Synthetic XOM should appreciate further. Or, if XOM declines in value, Synthetic XOM should experience less erosion in value. The "value differential" we have identified is not razor thin. We're talking about an apparent relative undervaluation which implies appreciation potential of 50% were Synthetic XOM to reach a valuation equilibrium with XOM. (Of course our case for selling the shares of XOM was more convincing earlier in 2001 when the stock stood at $47.72. It split in July.) Admittedly, our thesis is not bulletproof. XOM has a slate of outstanding tangible and intangible assets that are impossible to replicate exactly and we concede that XOM's "trophy assets" do justify some valuation premium. The giant oil also has a high degree of integration among its vast asset and employee base. XOM regularly "high grades" its assets (selling noncore assets and focusing on core assets), and its streamlined corporate structure focuses on performance-based compensation-all of which have translated into operating efficiencies and, consequently, higher returns. Another key benefit offered to XOM shareholders is the exceptional liquidity in the stock market that allows institutional investors to purchase and sell immense blocks of shares with relative ease. XOM is, if anything, overcapitalized. We note that XOM's balance sheet is rock solid-nearly $11 billion in cash against only $23 billion in long-term liabilities-and this affords great financial flexibility and one of the few AAA credit ratings in corporate America. It is understandable that investors accord some premium valuation to these attributes of XOM. As such, a 50% appreciation potential for Synthetic XOM is certainly optimistic. However, consider the fact that a tightening of only 25% in the relative valuation of XOM and Synthetic XOM results in a very respectable gain in a relatively "riskless" (arbitrage) position. XOM appears expensive not only to other energy alternatives, but also relative to its historical valuation range. In time, investors may have bid up XOM's shares partly because of the benefits of a large, diversified asset base, which shielded owners from much of the volatility (energy prices) of the oil and gas industry. However, investors don't have to pay someone else, or energy executives, to manage the cyclicality of the oil and gas business. Rather, they can manage risk through their own investment portfolios of a diversified group of oil and gas equities. What the "new" XOM looks like The challenge in constructing a Synthetic XOM was in replicating the breadth and depth of the "original" XOM's global operations. The company conducts business in more than 200 countries. ExxonMobil's depth among various business lines is attributable to its involvement in almost every aspect of the petroleum and petrochemicals business, from exploration and production, the midstream, downstream, power, minerals and coal. At year-end 2000, it employed 119,000 people, the highest number of workers among all oil companies. We constructed Synthetic ExxonMobil with the folowing components. • TotalFinaElf is an international integrated oil and gas and specialty chemical company with operations in 100 countries. We included TOT in our basket of stocks for its expansive exploration and production, refining and marketing, and chemical operations around the world. TOT has a particularly strong presence in Africa, Europe and the Middle East. The group is also a major supplier of liquefied natural gas (LNG) with interests in six liquefaction plants. This fits nicely with XOM's LNG business, which includes RasGas in Qatar and Arun in Indonesia. • Occidental Petroleum Co.'s principal businesses are oil and gas exploration, production and marketing, and chemicals production and marketing. Oxy provides Synthetic XOM with a substantial position in the U.S. upstream, notably in long-lived, mature fields. Occidental has a 78% interest in the Elk Hills oil field, located in the San Joaquin Valley, California. Through its acquisition of Altura Energy last year, Oxy also has a commanding presence in the Permian Basin. Oxy's U.S. production base is somewhat comparable to XOM's Aera joint venture with Shell in California. • Phillips Petroleum is an integrated oil company which has equity interests in Duke Energy Field Services (natural gas processing and marketing) and Chevron Phillips Chemical Co. Phillips and Tosco merged in the third quarter of 2001. TOS is a refiner and marketer of petroleum products, primarily on the East and West Coasts of the U.S. Phillips provides Synthetic XOM exposure in exploration and production, especially in Alaska (Prudhoe Bay, Kuparuk and Alpine fields), the U.S. midstream and downstream. Philipps also operates the Kenai LNG plant in Alaska. Phillips's assets give the basket of stocks exposure in the Norwegian upstream, notably from the Ekofisk complex. Norway accounts for about 20% of XOM's European oil and gas production, primarily from the Statfjord Field. Tosco provides Synthetic XOM with a strong presence in the U.S. downstream. Also, Tosco's retail division sells annually more than 6 billion gallons of transportation fuels, including the Exxon and Mobil brands in the Northeast. In an ironic twist, it is noteworthy that a significant component of Tosco's existing U.S. refining assets were actually purchased from Exxon and Mobil in the early 1990s. • Suncor Energy is an integrated oil and gas company in Calgary, whose three operating segments are oil sands, E&P and Sunoco, which refines and markets crude. Suncor's oilsands project in northern Alberta is comparable to Imperial Oil's syncrude joint venture (25% working interest) and the Cold Lake oilsands project. Suncor also provides Synthetic XOM exposure to the Canadian downstream. Most of ExxonMobil's Canadian assets are held through its 69.6% interest in Imperial Oil. • Conoco operates in more than 40 countries and is active in both the upstream and downstream segments of the global petroleum industry, including E&P, transportation, marketing and refining. In addition to significant production in the U.S. and the U.K. and Norwegian North Sea, Conoco provides significant southeast Asian assets to Synthetic XOM. Through the acquisition of Gulf Indonesia, COC established a commanding presence in Indonesia primarily in Sumatra, Java and the West Natuna Sea. Also, Conoco and its joint venture partners, Petronas and Statoil, own a 100,000-barrel-per-day refinery in Melaka, Malaysia (Conoco 40%). ExxonMobil's Asian-Pacific assets are dominated by Australia, Malaysia, and to a lesser extent, Thailand. Its major producing fields in Malaysia include the Jerneh gas field, and a number of oil fields such as Guntong, Tapis, Bekok and Palas. Through the Mobil merger, XOM has a 100% working interest in the Arun gas field in Indonesia. • Enterprise Oil is a London-based independent with assets in the U.K. Continental Shelf, the Norwegian sector of the North Sea and the Norwegian Sea, Italy and the Gulf of Mexico. It also has exploration interests in the Republic of Ireland, Brazil, Cambodia, Greece and Kazakhstan. Enterprise gives our basket a strong presence in the European E&P business, especially in the North Sea, as well as exploration potential in other European countries, the U.S. Gulf of Mexico, Brazil and Cambodia. As an overseas E&P company, it, like its peers, generally trades at a discount to domestic producers. We also included Enterprise for its role as a possible consolidation candidate. • Penn Virginia is engaged in leasing mineral rights and collection of royalties, E&P, and coal and timber. We included PVA primarily for its coal business-it owns mineral rights to 480 million tons of coal reserves in central Appalachia, including reserves found in both surface and underground mineable seams. • Hawaiian Electric Industries is a holding company with subsidiaries engaged in the electric utility, savings bank and other businesses, operating primarily in Hawaii. HE provides Synthetic XOM exposure to unique power assets that are similar to XOM's power plants in Hong Kong. HEI Power Corp., a subsidiary of Hawaiian Electric, was established in 1995 to develop, build, own and operate electric power-generation facilities in the Asia Pacific region. It is irrefutable that ExxonMobil has done an outstanding job of building value for shareholders over time. The graph depicts the consistent year-to-year increases in appraised net worth (ANW) (notwithstanding a handful of years) since 1984. We don't dispute that there are great investment and operational merits to a top-notch company such as XOM. Rather, we are providing investors with a competitive energy alternative, Synthetic XOM, that appears to be a significant bargain relative to the real thing. M Aliza Fan is a Houston-based senior analyst with John S. Herold Inc., the energy and consulting research firm in Norwalk, Connecticut.