While Hurricane Ernesto's strong winds don't appear headed to the Gulf of Mexico, another sort of wind blew into the exploration business Monday, a strong merger wind. In a move that surprised just about everyone, Woodside Petroleum, an Australian-based firm with interests in the Gulf, offered $23 to $24 per share for control of Energy Partners ( EPL), a New Orleans exploration and production business with strong ties to the Gulf of Mexico. The offer is certainly intriguing to Energy Partner shareholders, who would realize a 33%-plus premium based on Friday's close. And the deal should be intriguing to the company's directors, sans one minor detail: The company is in the final stages of completing its own merger, purchasing Stone Energy ( SGY), another exploration company with a focus on the Gulf of Mexico. Therein lies the rub. Woodside consummating a marriage with Energy Partners would require EPL to leave Stone at the altar, literally. Woodside has conditioned its offer on Energy Partners' rejection of the Stone merger.
Stone-Cold ShoulderEnergy Partners' decision to bid for Stone did not come lightly. In fact, Stone was in the process of working through a merger with Plains Exploration ( PXP) when Energy Partners came a-calling. Stone considered both deals carefully, and only after EPL agreed to front the $43 million-plus breakup fee due Plains did Stone agree to walk down the aisle with Energy Partners.
If the date wasn't expensive enough after the $43 million fee paid to Plains for the breakup, consider this: Should EPL walk away from the Stone transaction, Stone is due more than $26 million in breakup fees from Energy Partners. That's one expensive fling! That said, Woodside's offer has to be considered by EPL's board. The proposal comes from a reputable company with plenty of financial firepower and provides EPL shareholders with a guaranteed premium that otherwise wouldn't be certain anytime soon, given the uncertainties of the pending Stone merger and a company that hasn't experienced robust exploration success in recent quarters. Moreover, it creates more bulk for EPL in the Gulf of Mexico to help it compete with bigger players such as W&T Offshore ( WTI) that have captured major mergers over the past year, some would argue at the expense of EPL. Still, Energy Partners is likely to make the argument that its franchise is worth more than the current Woodside offer and that the Stone merger would create a larger company with good, competitive bloodlines. In addition, Energy Partners and its adviers know that the first unsolicited offer typically isn't either the best or final offer. As a result, I'd look for EPL to kindly reject the current Woodside offer and ask for more. While it's hard to imagine a deal in which EPL buys Stone and the combined entity is then purchased by Woodside, it's not impossible. More likely, however, is a sweetened Woodside bid for EPL, probably in the mid-to-high $20s per share, that would cause EPL to turn its back on Stone.
A word of caution: Playing equities on the potential of a deal can be risky. Remember, there is no deal between Woodside and Energy Partners, and there is a realistic possibility that one won't get done. Even once deals are announced, conditions can be dangerous for investors. Just ask the arbitrage players who were short Energy Partners and long Stone Energy on Monday before the Woodside deal was announced. Let that be a lesson to those who believe they can simply follow the "smart" money to make money. Longtime readers of this column know I have always espoused taking profits on deal moves rather than hanging around in a position for the morsels. That strategy would have saved plenty of headache in this case.
A Sea of OpportunitiesIn addition to the intrigue the Woodside bid provides for EPL investors, it also signals the continued interest in the Gulf of Mexico from seasoned energy explorers. That is especially true when one considers that the bid comes at the apex of hurricane season, when the risks to energy production are greatest. That leads to the question: What other Gulf of Mexico-focused companies might benefit from the newfound interest in Gulf assets? While exploration and production mergers rarely establish trends, it is smart to think about who else has assets that might be attractive to others.
Companies like Bois d' Arc Energy ( BDE), Callon Petroleum ( CPE), Petroquest Energy ( PQUE) and McMoRan Exploration ( MMR) all have good Gulf assets. And all are of a size that makes them possible targets for combinations, if they're willing. That said, all have other assets that might keep a pure Gulf of Mexico player from shopping. Larger companies such as W&T Offshore, ATP Oil & Gas ( ATPG) and Mariner Energy ( ME) could play either side. W&T, for example, recently completed the acquisition of most of Kerr-McGee's ( KMG) Gulf assets and says it wants to get even larger. While the proposed Woodside/EPL deal may not immediately lead to additional combinations, it certainly shows the continued interest in Gulf of Mexico assets. Oh, one more for the list: Stone Energy may soon be available. If this deal doesn't work out, Stone should think about a different dating service.