Marriage of the Majors: Phillips to Buy Conoco

Although Conoco shareholders may be disappointed in the price, they probably have little choice.
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In a deal that matches the last major wallflowers at the industry's consolidation dance,

Phillips Petroleum

(P)

will acquire

Conoco

(COC)

for more than $15 billion in stock.

The combined companies, to be named

ConocoPhillips

, would create the third-largest integrated energy company in the U.S., based on both market capitalization and oil and gas reserves and production.

Phillips shareholders will receive one share of ConocoPhillips stock for each share of Phillips, while Conoco shareholders will receive 0.4677 share of the new entity for each share of Conoco. On Friday, Conoco shares closed off 10 cents at $24.30, while Phillips gained 42 cents to close at $51.82. Phillips will also assume $9 billion in Conoco debt.

Reviewing Other Options

While that might seem like a pretty big dowry, its lack of a premium could disappoint Conoco investors.

"It almost looks like a take-under," says Tyler Dann, integrated oil analyst at Banc of America Securities and a member of the

TSC

Energy Roundtable. "A lot of investors were buying Conoco with the anticipation they would get around $30 a share. Now, they get $23, $24 a share in Phillips stock. That has to be a rude awakening."

But other suitors aren't exactly filling up Conoco's dance card.

BP Amoco

(BP) - Get Report

and

ExxonMobil

(XOM) - Get Report

would face significant antitrust issues if they put in a bid. Although

ChevronTexaco

(CVX) - Get Report

might have been able to craft a deal for Conoco that could pass regulatory muster with minimal divestitures, its own recent combination makes another deal very unlikely.

Others, such as

TotalFinaElf

, may be interested, but a competing stock deal won't likely interest Conoco management. That leaves

Royal Dutch/Shell

(RD)

.

"What you need to look at now is a cash offer, and that would be difficult for anyone to make, with the possible exception of Shell, and I just don't think that is likely," Dann says.

The New Company

The new ConocoPhillips is estimated to have an enterprise value of $53.5 billion, about $35.9 billion of that in equity. Phillips shareholders will own 56.6% of the new entity.

Each company will appoint eight members to a new board of directors. Current Conoco Chairman Archie Dunham will serve as chairman until his retirement scheduled for 2004. Then, current Phillips Chairman and CEO Jim Mulva will assume the chairman's title in addition to his immediate appointment as president and CEO of ConocoPhillips.

The companies say the deal will be accretive to earnings and cash flow of each company after achieving annual cost savings of about $750 million, which they say will occur in the first full year after completing the combination. The deal is expected to close, subject to regulatory approvals, in the second quarter of 2002.

But Dann thinks those projections may be optimistic. "By our numbers, it is not quite accretive," he says.

Initially, the combined companies will have reserves equal to about 8.7 billion barrels of oil and nearly 1.7 million barrels in daily production. The assets of the combined companies will be approximately 62% oil and 38% gas. However, Dunham said in a Sunday afternoon conference call that he'd like to position the company closer to 50% gas over time, a strategy Conoco

began to articulate early this year. In an attempt to step up its gas focus, Conoco

recently acquired

Gulf Canada

.

ConocoPhillips will also have an impressive stable of exploration and production projects in Alaska, the North Sea, Venezuela, China, the Timor Sea and Indonesia, Vietnam, Russia and gas interests in Saudi Arabia.

A combination of Conoco with Phillips will create a downstream powerhouse, with a refining capacity of 2.6 million barrels of oil per day. But refining could be an issue with regulators, as Dann estimates the merged entity would have about 25% of refining capacity in the Rocky Mountain region and may have to divest assets to obtain regulatory approval.

ConocoPhillips would also operate more than 20,000 gasoline stations, although the company hasn't said which name will remain its primary retail brand.

Next in Line?

With no major integrated oil company left untouched by the recent consolidation trend, refiners may be the next target, according to Tommy Pritchard of Pritchard Capital Partners, a Covington, La., energy investment firm.

"This could be good for companies like

Marathon

(MRO) - Get Report

," says Pritchard. "They are very similar to these two companies, except they don't have the exploration assets."

Other names in that group include

Sunoco

(SUN) - Get Report

and

Valero

(VLO) - Get Report

. But additional combinations in the refining business, especially with the large, integrated oil companies, might have a tough time passing regulatory scrutiny.

One analyst also thinks that the merger may spark additional takeovers in Canada. "There may be a renewed interest in Canadian names like

Alberta Energy

(AOG)

," says Scott Walters of Toronto-based Research Capital. "A deal like this will always lead to talk of other possible deals in the sector."

Then again, if investors focus on the price, it might not be a positive for the oil patch after all.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds' firm was long Phillips, 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

Chris Edmonds.