In a deal that combines two very different exploration and production companies, both of which have faced operational challenges recently, Houston-based Plains Exploration & Production Co. (PXP) announced last Monday that it plans to buy Lafayette, LA-based Stone Energy Corp. in a stock-for-stock transaction valued at $1.46 billion plus the assumption of $483 million of debt.
Stone stockholders will receive 1.25 shares of PXP common stock for each share of Stone common stock, which represents an 11.4% premium to where Stone shares closed on April 21 prior to the announcement ($47.10). Stone shares posted gains initially on the news last Monday, rising to a high of $51.50, but then they backtracked to end on Thursday at $47.25. PXP shares lost about 12% of their value from Friday, April 21 to the end of trading on Thursday, falling from $41.97 to $36.82.
Plains is buying an operation that underwent significant downward reserves and financial revisions last fall (see NGI, Dec. 12). Stone revised its oil and natural gas reserves downward by 171 Bcfe last October, triggering an informal investigation by the Securities and Exchange Commission and a class action lawsuit by shareholders. The company also restated its financial statements from 2001 to 2004 and for the first six months of 2005. Plains CEO James C. Flores told analysts last Monday that his company has carefully weighed the risks and sees significant benefits to the deal.
Plains also made some significant changes Monday to increase its exposure to higher commodity prices. PXP said it will pay $600 million to eliminate all of its 2007 and 2008 crude oil price collars, which set a floor price of $25/bbl and an average ceiling price of only $34.76/bbl on about 42% (22,000 bbl/d) of its daily oil production. Near-month crude oil futures reached a record high of $75.17 on Friday. PXP maintains downside commodity price protection on 50,000 boe/d of production in 2006 and 2007 with a strike price of $55/bbl. It also has purchased $55/bbl puts for 2008 for 32,000 bbl/d at a price of $3.79/bbl on a deferred premium basis.
"These accretive transactions represent an opportunity for the stockholders of both companies to benefit from combining the strengths of PXP and Stone," said Flores. "Upon completion of the acquisition, PXP will be in an enviable position to accelerate its cash flow per share and strong reserve growth through the Rocky Mountain business, highlighted by the Pinedale/Jonah/Eagle projects in the Green River Basin and the large Middle Bakken position in the Williston Basin, and the Gulf of Mexico, primarily in the Deep Water with our Big Foot discovery, and continued development of its large long-lived California oil resource base.
"PXP should have a stronger balance sheet and full commodity price exposure with downside commodity price risk protection at $55 [West Texas Intermediate] 2006, 2007 and 2008. We look forward to the opportunity to carefully invest the excess cash flow in debt reduction, share repurchase or other sound investments that benefit our stockholders," he added.
Following the acquisition, PXP will have a proved reserve base of 500 million boe. Stone's proved reserves at the end of 2005 totaled 593 Bcfe (99 million boe) compared to 670 Bcfe in 2004. Its reserves are located primarily in the Gulf Coast and Gulf of Mexico (76%) with the remaining 24% in the Rockies. Stone's production at the end of last year totaled about 200 MMcfe/d (58% gas) compared to 241 MMcfe/d in 2004. The decrease was attributed primarily to the impact of the hurricanes on Stone's Gulf of Mexico production.
In comparison, PXP had about 268 Bcf of gas reserves and 356 MMboe of oil reserves (401 MMboe total) at the end of 2005 and 62,900 boe/d of production from onshore and offshore California, West Texas and the Gulf Coast region.
The deal gives PXP a new core area of operations in the rapidly expanding Green River Basin and the Williston Basin of the northern Rockies, as well as a more significant presence offshore in the Gulf of Mexico.
"The board of directors and I are enthusiastic about combining our high cash flow assets and attractive Rockies development opportunities with PXP's long life assets," said Stone CEO Dave Welch. "The combined company will have strong leverage to oil prices and the ability to grow production profitably. Stockholders of both companies will benefit from the robust portfolio of near term and long term growth opportunities."
Moody's Investors Service was somewhat less enthusiastic about the deal, but still placed Stone's credit ratings on review for upgrade. "While the PXP and SGY merger affords considerably more reinvestment flexibility and potential within the merged property base, the merged business must first reverse the under performing momentum of both property bases before mounting positive momentum," Moody's said. "SGY has been especially challenged over the last few years, a situation that was exacerbated by a still shut-in major proportion of its production due to hurricane damage."
The agency noted that Stone has faced very weak capital reinvestment productivity, the debooking of 20% of its proven reserves, and is undergoing an SEC review of prior reserve booking practices. Moody's said the review for upgrade on Stone's ratings (B2) reflects its current low rating relative to the stronger profile of the merged business, the "seasoned management and operational teams" of the combined company and a "very strong oil and gas price environment" that will boost cash flow to help "tackle the combined operating challenges, mount a larger more diversified reinvestment program, and service debt."
Moody's said the expected operating, leverage, and financial strategy of the merged companies, however, warranted a review for a downgrade of PXP's ratings (Ba2). "While the SGY acquisition adds proportionally significant new prospect opportunities, including two nascent potentially key Rocky Mountain plays, Moody's believes PXP has also adopted a strategy of sustained higher leverage (measured on reserves) into its equity strategy and we believe opportunistic share buybacks will continue to be a basic tool in PXP's equity strategy and tactics.
Moody's also noted PXP's "disappointing production response to substantial capital reinvestment in its California plays, driving all unit costs higher. The added leverage will almost double interest expense," the agency said.
If the acquisition is approved, PXP will issue 34.5 million shares to Stone stockholders and assume $483 million of debt. The companies anticipate completing the transaction in the third quarter of 2006 after shareholder approvals. PXP stockholders will own 70% of the combined company, and Stone stockholders will own 30%. The PXP board of directors will remain the same with no additions from Stone's board. Flores will remain the chairman, president and CEO and PXP's current executive staff will remain in place. Stone Energy CFO Kenneth H. Beer will join the company as executive vice president and CFO.
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