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Analysts: Devon's Restructuring Tied to Belief in Natural Gas

Devon Energy Corp.'s decision to sell all of its Gulf of Mexico (GOM) and overseas assets may have come as a surprise to many, but most energy analysts appeared in favor of the plan, calling it a "bold move" that proves the company's belief in the future of natural gas.

The Oklahoma City-based producer last week announced that it was selling its substantial GOM and international assets by the end of next year to reposition itself as a North American onshore company (see related story).

"Capital constraints had slowed down the company growth rate, and the funding gap had become an ever so visible overhang on the story," said FBR Capital analyst Rehan Rashid. "This in turn, in our opinion, made investors lose sight of the value of Devon's core franchise and the significant acreage position in all of the big North American Shale plays.

"The bold move to sell everything else and focus on North America alleviates the funding overhang and allows for focus on the unlocking of intrinsic value via the acceleration of growth." Devon is "a strong franchise at its core," said Rashid. "We have always been of the opinion that Devon's asset base at its core remains extremely valuable. This strength is underpinned by the depth of inventory at its core Barnett [shale] asset and augmented by its Cana, Haynesville, Horn River Basin and Canadian oil projects. The availability of capital has been the missing ingredient."

Wells Fargo's energy team said Devon's 6% production growth target "looks very achievable...Given recent strategic repositioning, we like the production visibility now inherent in the company's North American asset base as the company targets a 10% CAGR [compound annual growth rate] within cash flow over the next five years. Longer term, we believe a focus on fewer assets will improve the company's operating and financial metrics."

The decision to shrink the company is proof of Devon's faith in natural gas as the energy of the future, said Longbow Asset Management's Jake Dollarhide. "Devon is putting it all in, putting all its chips on domestic natural gas," he said. The company will lose some high-risk, high-rewards assets as it repositions, but the move ultimately will pay off, he added.

Analyst David Heikkinen of Tudor, Pickering, Holt & Co. Securities Inc. said the decision to restructure was a "simple choice in the end," which will allow Devon to "regain control of its destiny."

Total company production was declining, Heikkinen noted, "and to stem declines the onshore business needed additional capital." The "conundrum" was the Lower Tertiary assets in the deepwater GOM, which "could require $6 billion in future capital, limiting Devon's flexibility in other areas. Layer in the assets now up for sale having higher operating and F&D [finding and development] costs, and the decision to hold on to North American onshore makes sense...All that's left now is execution, execution, execution (selling the assets, investing the capital, becoming a U.S. growth company)."

As it slims down, some energy analysts pondered whether Devon might become an attractive takeover candidate. During the conference call with analysts Monday to discuss the restructuring, CEO J. Larry Nichols was asked whether the move would make the company an acquisition target. However, Nichols thought he was asked if Devon would be looking for acquisitions onshore once the sales were completed.

"I see little reason for Devon to buy anybody else because we don't want to take any cash away from opportunities," he said. Then realizing he was instead asked about becoming an acquisition target, Nichols said, "I guess I was like Pavlov's dog," referring to behavioral scientist Ivan Pavlov's experiments with the famous dog that was trained to answer whenever a bell rang. Devon up to now has mostly been an acquirer.

ConocoPhillips, itself a notorious acquirer in the past few years, also has announced plans to slim down, with plans to shed $10 billion of assets, including 10% of its North American portfolio, over the next two years (see related story).

Rodman Energy Group's Cameron Smith noted last week that "there aren't that many assets out there. This could be an indication that the flood of assets that the buy side has been looking for may be beginning." Devon's assets won't depress prices for properties, he said. Instead, the sales could establish values in a market with few recent transactions.

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