Talks Signal Attractive Arco Is in Play

Bidders covet its production stronghold in Alaska and its West Coast refining and marketing units.
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BP Amoco

(BPA)

should expect to sweeten any offer it makes to buy

Atlantic Richfield

(ARC) - Get Report

, several oil-market observers say. Arco's production stronghold in Alaska and its West Coast refining-and-marketing operations make a bidding war likely, they say.

"The fact of the matter is, Arco is in play," says Fadel Gheit, senior energy analyst at

Fahnestock

in New York. "If BP plays the scrooge here, they will lose the whole deal." Fahnestock hasn't done any underwriting for Arco or BP Amoco.

Arco rose 8 11/16, or 13%, Monday to close at 74 1/16 after BP Amoco confirmed its merger talks with Arco. BP closed up 4 9/16, or 4.5%, at 105. The news drove other oil stocks higher:

Chevron

(CHV)

added 3 1/8, or 3.6%, to close at 89 15/16 and

Texaco

(TX) - Get Report

rose 2 3/16, or 4%, to end at 57 3/4.

The news added emphasis to the group's newfound resurgence, which dates back to early March, shortly before

OPEC

agreed to cut production in an effort to boost prices. So far OPEC's efforts have worked: Crude oil is now trading near $16 per barrel, more than 30% up from its recent lows.

The low oil prices have spurred a wave of consolidation as companies figure size combined with cost-cutting can help them survive and possibly even flourish. Huge oil firms have been formed in BP's $54 billion purchase of

Amoco

and in

Exxon's

(XON) - Get Report

pending $73 billion acquisition of

Mobil

(MOB)

, while smaller companies focusing on exploration, such as

Ocean Energy

(OEI)

and

Seagull Energy

(SGO)

, are also joining forces. Pressure is expected to increase on domestic integrated oils such as

Phillips

(P)

, Texaco, Chevron and even newly public

Conoco

(COC)

if Arco sells.

Other potential bidders for Arco, long considered a target, include

Royal Dutch/Shell

(RD)

, Exxon and Texaco, observers say. Representatives at each company declined to comment on market rumors.

"The fact of the matter is Arco is in play," says Fadel Gheit, senior energy analyst at

Fahnestock

in New York. "If BP plays the scrooge here, they will lose the whole deal."

Gheit at Fahnestock says the most logical buyers of Arco include BP Amoco and Exxon, even though Exxon is in the middle of closing the Mobil deal. Exxon has a large amount of production in Alaska, Gheit says, and absolutely no overlap in its marketing operations with Arco. The two companies already jointly operate Alaskan wells. But Exxon's agreement with Mobil, currently undergoing regulatory scrutiny, could throw "a monkey wrench" in any plans Exxon may have for Arco, Gheit says, since it may only be able to swallow one acquisition at a time.

By purchasing Arco, BP could re-enter the important West Coast marketing arena with a hefty 22% share. In the early 1990s BP Amoco's predecessors sold their West Coast service stations and a refinery that amounted to just a toehold in the market. BP and Arco also are the No. 1 and No. 2 players in the oil-rich Prudhoe Bay region in Alaska, making it easy for the two companies to combine operations and cut costs, Gheit says. BP also may have been making a preemptive gesture to try and close the deal before Exxon had a chance to bid, Gheit says.

But it may have to pay more than the reported price -- $25 billion, or 77 per share, a 20% premium to Arco's Friday close of 63 3/8. Recent deals have offered closer to a 30% premium. Arco is currently trading about 11% below its 52-week high of 82 1/2, a price Gheit says Arco will undoubtedly will seek.

Any company other than BP stepping in as an Arco bidder would have to prove that it could add more value than BP, says Sam Albright, who follows major oil firms at

Jefferies

in Los Angeles. Jefferies has not performed underwriting for BP Amoco or Arco. BP and Arco are a perfect fit in Alaska, and BP certainly covets Arco's marketing operations, he says. "What you've got to wonder is if BP will pay more" if another bidder steps in, he says.

In addition, BP's shareholder base is much more growth-oriented than Arco's, says an industry consultant in New York who declined to be named. As such, current BP shareholders may be opposed to BP seeking to merge with a firm better known as a value play.

The consultant says Royal Dutch may also be interested in Arco. "Is Royal Dutch going to sit by and let BP Amoco bypass them?" he asks. If BP is successful in a bid for Arco, the new company would have crude oil reserves of over 11 billion barrels, leapfrogging Royal Dutch. Shell has the resources to make a bid, as well the motive, from a market-share perspective, he says.

Texaco would have a difficult time upping the ante if it becomes involved in a bidding war, observers say. In addition, it would have to sell its interest in its refining and marketing joint venture with Royal Dutch, a possibility it would be "more than willing" to consider given the chance to buy Arco, Gheit at Fahnestock says.