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EnCana Prepares to Divide, Then Conquer

EnCana Corp.'s strategy to divide and conquer drew an enthusiastic cheer from investors and energy analysts last week, sending the company's share price to new highs and setting off rumors that one or both of the new entities could be attractive takeover targets.

The Calgary-based producer plans to split its vast enterprise into two separate companies -- one a pure play in unconventional natural gas and the other an integrated oil company with some existing southern Alberta shallow gas. Given all the regulatory approvals, EnCana expects the new companies to be formed by early next year at a collective after-tax cost of "less than $300 million." Concurrent with the announcement, EnCana's senior executives updated the company pre-transaction 2008 cash flow to a range of $9.6-10 billion, reflecting higher forecasted commodity prices.

The change is expected to have a "minimal impact" on its employees, operations, suppliers, business partners and stakeholders, CEO Randy Eresman said. "During the transition, EnCana will conduct its business as usual, honoring all business relationships."

Eresman, who has guided the company since 2006 (see NGI, Oct. 31, 2005), expects the split to take around eight months. Separate administrative structures, with separate boards, would be created for each new company, and more people would be hired. EnCana now has 6,500 employees, 500 of which are at its Calgary headquarters. An estimated 500 additional jobs would be created collectively for the two new companies' head offices, both of which would remain in Calgary.

Under Canada's Business Corporations Act, the proposed reorganization would be achieved through a court-approved Plan of Arrangement, subject to approvals from both Canadian and U.S. tax authorities. EnCana shareholders would receive one share in each new company for their existing shares.

Both of the new companies is expected to be larger than when EnCana was formed in 2002 by Alberta Energy Co. Ltd. (AEC) and PanCanadian Energy Corp. (see NGI, Feb. 4, 2002). Six years ago EnCana had an enterprise value of more than C$27 billion, with a resource base of 7.8 Tcf and 1.3 billion bbl. Today the enterprise value is around US$81.46 billion. EnCana's estimated net proved reserves at year-end 2007 were 13.3 Tcf and 0.9 billion bbl.

The separate entities are more likely to attain the market value they deserve, Eresman said. EnCana expects "good growth all around," with "slightly higher growth potential" from its U.S. portfolio, which comprises 55% of its assets.

The "new" EnCana would have an estimated 11,880 Bcfe and 1,980 million boe, and about 3,500 employees. Predicted to see annual production growth increases of 7-9%, the proposed stand-alone gas company would receive 95% of its gas production from eight different resources plays spread across North America -- coalbed methane (CBM), Bighorn, Greater Sierra, Cutbank Ridge, Jonah, Piceance, East Texas and the Barnett Shale. In addition to those established plays, EnCana has several emerging assets, which include the Horn River in British Columbia (see related story), the Haynesville Shale in Louisiana and the Mannville CBM play in central Alberta.

The integrated oil company would have an estimated 6,980 Bcfe and 1,165 million boe, with about 2,000 employees. IOCo would offer 4-6% annual production growth rates from six resources basins (Foster Creek, Christina Lake, Borealis, Shallow Gas, Weyburn and Pelican Lake) and two refineries (Wood River and Borger).

Eresman is designated to be the CEO of the new gas company, which would retain the EnCana Corp. brand. Current EnCana CFO Brian Ferguson is slated to be the CEO of the yet-unnamed integrated oil company, which is now referred to as IntegratedOilCo. (IOCo). Current management for EnCana's wide ranging operations would remain intact, Eresman said.

Some of Calgary-based FirstEnergy Capital's clients had long suggested that EnCana would be an attractive takeover target if it was split into two companies, said analyst Martin Molyneaux. However, FirstEnergy had not anticipated such a solid reaction by the market. "We never thought the market would elevate this over 8%," Molyneaux wrote . "I'm kind of surprised the market has read so much into it." EnCana, he noted, still has "a long way to go" to obtain the required regulatory approvals.

"The outlook for each of the proposed new companies is better than EnCana as it is currently configured," wrote Raymond James & Associates Inc. analysts Stephen Calderwood and Jia Liu. The new EnCana would benefit "from the improvement in the production growth rate resulting from the fact that it would be smaller and contain the highest-growth natural gas assets of the company and none of the 'no-growth' areas such as Canadian shallow gas and Weyburn oil."

Other integrated Canadian producers may contemplate similar breakups if EnCana's strategy succeeds. Calgary's Nexen Inc., which has oil and natural gas assets spread across Canada, the North Sea, the Gulf of Mexico and the Middle East, and a joint oilsands project coming onstream later this year, likely will be watching EnCana, said analysts. Other potential "break-up targets" cited include Talisman Energy Inc., Canadian Natural Resources Ltd. and Husky Energy Inc.

"If investors do buy into this, then there will be tremendous pressure on others to do it too," wrote Union Securities Ltd.'s David Doig.

Sanford Bernstein analyst Ben Dell said the "real upside to shareholders appears to be the fact that this is a tax-effective path to putting the integrated oil company up for sale." The likeliest suitor, he said, would be ConocoPhillips, which is partnering with EnCana on Canadian oilsands projects.

EnCana created its oilsands business in 2006 after allying with ConocoPhillips refineries in the Midwest. However, the oily side of its business is dwarfed by EnCana's burgeoning unconventional gas strategy, wrote Canaccord Adams' Richard Wyman and Arthur Grayfer. "The competition for capital in EnCana...might have left the oilsands business hungry for money as the growing list of new natural resource plays would likely have taken precedence," the Canaccord analysts wrote in a note to clients.

The Motley Fool's Toby Shute noted that the spinoff is not scheduled until early 2009, and investors would have almost a year to decide whether the split would be a good thing.

"EnCana is breaking the mold by breaking itself up, and I couldn't be happier," Shute wrote. "Though admittedly late to the EnCana story, I've been marveling at the merits of this profit factory for months now. The integrated oil joint venture with Conoco is a major success, and as with Suncor, EnCana's oilsands resources will lead to many years of double-digit production growth. Meanwhile, the natural gas side of the business has no shortage of emerging resource plays worth getting excited about."

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