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is looking for a Rocky Mountain high.
The recent announcement by the Oklahoma City exploration-and-production company that it will acquire fellow explorer
may be a precursor of more consolidation, especially in the natural gas-rich Rocky Mountains.
Kerr-McGee agreed to buy Westport Resources for a total of $3.375 billion, including $2.475 billion in equity and $900 million in net assumed debt. Under the merger agreement, Westport shareholders will receive 0.71 Kerr-McGee share for each Westport share, an implied price of $36.57 per share, or an 11% premium based on Tuesday's close.
To complete the transaction, Kerr-McGee will have to issue more than 48 million shares. If completed, the combination would increase Kerr-McGee's total reserves by about 30%. In addition, the combined companies suggest they can achieve roughly $40 million in cost-saving synergies.
Although Kerr-McGee says the acquisition will be accretive, it'll come at a price. According to information from both companies, Kerr-McGee appears to be paying around $1.90 per thousand cubic feet equivalent for Westport's year-end 2003 total proved reserves of 1.781 billion cubic feet equivalent, of which 65% are proved, developed reserves. That price is generally in line with other acquisitions recently announced by companies such as
Investors aren't overly impressed, as Kerr-McGee shares are down nearly $3 in midmorning trading. The credit rating agencies were unimpressed as well: S&P downgraded Kerr-McGee's short-term debt and is reviewing its long-term debt rating.
To Buy or to Drill
Kerr-McGee's decision to buy Westport shows the dilemma that many exploration-and-production companies face today. With commodity prices near recent highs and finding costs (the amount paid to find new oil through drilling) rising rapidly, many companies are looking to buy reserves and production to replace declining performance, often at a lower price than it would cost to drill new wells. That's especially true for companies that can sell future production at or near current prices. Kerr-McGee seems to be taking that approach.
"We believe there will not be any regulatory issues regarding the merger, and the companies expect a third-quarter close," said Merrill Lynch energy analyst John Herrlin. "Kerr-McGee is locking in the economics by hedging Westport's production out to the tune of 90% through 2006, and Kerr-McGee stated they expect bottom-line accretion in 2005 and $40 million in merger cost savings."
Now, Kerr-McGee's challenge is to maximize the value of Westport's properties, and that will involve new drilling, especially in Westport's Rocky Mountain fairway. With only 65% of Westport's reserves classified as proved, Kerr-McGee has plenty of drilling opportunities.
"Westport's extensive inventory of low-risk U.S. exploitation opportunities complements Kerr-McGee's high-impact deepwater exploration program, providing us a more predictable performance profile," said Luke R. Corbett, Kerr-McGee chairman and CEO, in the release announcing the transaction.
Many pundits think -- or hope -- that the Kerr-McGee/Westport deal could be the start of more consolidation among E&P companies, especially those focused on the Rocky Mountains. The Rockies provide one of the few exploration basins left in the continental U.S. that boasts meaningful growth in natural gas reserves and production. Yet little consolidation activity has taken place in the region, and that has confounded analysts.
Environmental and permitting regulations are likely responsible. However, many of those roadblocks have been removed. Federal programs are encouraging a more rapid permitting process at federal and state levels, and Interior Secretary Gale Norton seems to support more drilling opportunities in the Rockies. In fact, E&P companies will apparently be allowed to bid in May for drilling rights in five proposed wilderness areas in western Colorado that are currently controlled by the Bureau of Land Management. In the past year, the Interior Department lifted "wilderness protection" on about 600,000 acres in Colorado.
So, who's next? Speculation of additional M&A activity in the region could give a boost to some share prices, including those of
Western Gas Resources
Patina Oil & Gas
Although several data points hint at additional consolidation -- the need to grow reserves and production among them -- the M&A game is speculative and uncertain. Regulation, valuation and corporate structure are all meaningful issues that require resolution before any transaction can be closed.
Yet investors will likely begin to factor in the possibility of additional E&P consolidation as a result of the Kerr-McGee/Westport news. If nothing else, this transaction strongly suggests that a component of reserve and production growth for many E&P companies will continue to come from acquisitions.
Christopher S. Edmonds is vice president and director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to