Houston-based independent Pogo Producing Co. took a huge strategic leap last week with its purchase of Unocal Corp.'s Canadian subsidiary Northrock Resources Ltd. for $1.8 billion in cash. The transaction will boost Pogo's proven reserves by an estimated 45%.
However, following the announcement, Standard & Poor's (S&P) placed Pogo on Credit Watch with negative implications. Analyst Brian Janiak noted that 90% of Northrock's volumes are hedged through 2007, "which will bring cash flow certainty. Still, some level of incremental debt leverage is likely, which may precipitate lower ratings..."
Moody's Investors Service also weighed in on the deal, placing Pogo's ratings under review for downgrade. "Though a major element in its strategic plan to transform its property base, Pogo is paying a high $16.82/boe for proven reserves and a bit over $60,000/boe of current daily production for a strategic package that has underperformed in recent years," Moody's analysts said. "Some of the hoped for drilling upside is in geologically complex and/or deep geologic horizons. The fully loaded acquisition cost approximates $17.70/boe of total proven reserves."
Pogo, which has been the subject of takeover rumors in the past, will acquire Unocal's 644 Bcfe of estimated proven reserves on about 300,000 acres in west central Alberta, northwest Alberta, southeastern Saskatchewan and southwestern Manitoba, plus an additional 1.1 million undeveloped acres. Pogo estimates that the Northrock properties contain more than 200 Bcfe of probable reserves and another 500 Bcfe of possible reserves. The assets are 55% oil and 45% natural gas.
CEO Paul G. Van Wagenen said it was "hard to know exactly" what sort of growth Pogo can expect from the acquisition, but estimated the company "will be able to meet 10% growth next year on these properties...This in one fell swoop is a keeper. We intend to attack this with a lot of vigor and capital dollars."
At Dec. 31, 2004, Pogo had estimated proved net reserves of 1,778 Bcfe, consisting of approximately 116.4 million bbl of oil and 1,080 Bcf of natural gas. With the sale of its interests in Thailand and Hungary, Pogo currently has operations in the Gulf of Mexico, the Permian Basin and the Rockies, as well as in New Zealand. Its market capitalization was approximately $3.1 billion at the end of last year.
The Unocal acquisition, which is expected to close in the third quarter, will be accretive to Pogo's earnings, cash flow, production and reserves per share starting in 2006, the company said.
"Northrock represents an outstanding accumulation of assets," Van Wagenen said. "Under Pogo ownership, we foresee a new and vigorous chapter in Northrock's history." He said Pogo intends to spend about $50 million on the assets in the fourth quarter after the deal is closed, and another $200 million in 2006 to drill 150-175 wells.
Unocal, which is undergoing merger talks with both Chevron Corp. and the China National Offshore Oil Corp., announced in May that it would sell off the Canadian properties, and it expects to realize after-tax proceeds of $1.5 billion. To prepare for the acquisition, Pogo is selling underperforming assets in Hungary and Thailand for a total of about $829 million, which partially financed the Northrock purchase.
"We had our eye on these properties a long time, and we just weren't sure they'd come to market," Van Wagenen said during a conference call. "This type of quality rarely is available." He estimated that the transaction will help the 35-year-old producer to extend its reserves by just over nine years.
Northrock's oil and gas fields in Alberta will become an extension of Pogo's existing properties in the Rocky Mountains, Van Wagenen said. The characteristics of the acreage is similar, he said, which will pose no operational challenges. The full potential of Northrock will be realized once the required pipeline infrastructure is finally in place, he said.
To ensure higher prices for the purchase, Pogo has hedged about 90% of Northrock's production for 2006 and 2007 with oil costless collars that guarantee a minimal price of $50/bbl and a maximum price of $78-82 in 2006 and $75-77 in 2007. The hedges also ensure a minimum price for natural gas of $6/Mcfe.
Pogo's debt-to-capital ratio with the acquisition will rise to 45%, from 32% as of March 31. However, the CEO said Pogo is targeting a debt ratio of 30-40% over the next few years as a result of being able to pay down debt with the free cash flow generated by the new assets. Pogo also increased its capital budget through the rest of 2005 to $500 million from $340 million.
Northrock, which Unocal purchased in 2000, represents essentially all of Unocal's Canadian oil and gas reserves and production. Based on recent financial reports, Canada accounted for less than 7% of Unocal's worldwide hydrocarbon reserves (year-end 2004) and production (1Q2005).
In a note to clients, Lehman Brothers analyst Thomas Driscoll wrote that the Pogo stock may "come under pressure as a result of the premium price paid for the assets...We do not believe that these assets have the demonstrated reinvestment opportunities to justify the premium paid. The plus for PPP [Pogo] is that the acquisition provides some clarity related to PPP strategic direction." Driscoll estimated that Pogo is paying $16.77/boe for the assets, a 20-25% premium to where it trades.
However, Driscoll added, "attractive hedges could mitigate the disappointment that investors are likely to feel about the price paid for the acquisition."
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