Marathon Spends $500M to Acquire Pennaco

Fueling rumors that USX-Marathon Group may separate its steel and energy businesses and then sell a beefed up oil and gas business, Houston subsidiary Marathon Oil put together a $500 million deal to acquire two-year-old Pennaco Energy Inc., a company whose key assets are tied to coalbed methane (CBM) gas production in the Powder River Basin of northern Wyoming and southern Montana.

To make the deal, Marathon will pay about $19 a share --- $446 million in cash, including $54 million for Pennaco's debt. The deal, announced after trading ended last Friday, was agreed to by both companies' boards, and represents a 30% premium to Pennaco's price of $14.63 on Dec. 22. Marathon said it would make a cash tender offer on or about Jan. 8, 2001 for 100%, but not less than a majority, of the outstanding Pennaco shares on a fully diluted basis.

Denver-based Pennaco is one of the largest leaseholders in the Powder River play. It has more than 400,000 net acres and current net production of more than 50 MMcf/d. Net proven reserves are estimated to be 200 Bcf, with more than 800 Bcf of potential. Marathon estimates that the acquisition and development costs of Pennaco's proven plus probable reserve base will be about $4.50/boe.

"Much of the growing global demand for energy will be met by natural gas, and this is particularly the case for the United States," said Marathon president Clarence Cazalot. "The North American gas market is a core area for Marathon, and this acquisition will enhance our already strong presence. Its assets will provide a significant new reserve base that we can develop and deliver quickly to the marketplace."

Cazalot called Pennaco a "well run, highly regarded company with an entrepreneurial spirit." He said it was a "great strategic fit with our growing North American gas business. The shallow, more rapidly drilled CBM wells will complement our focus in Oklahoma on deeper, higher productivity wells and result in a more balanced portfolio of growth opportunities."

Pennaco CEO Paul M. Rady said, "Marathon's tender offer reflects the proven and potential value of Pennaco. Over the past two and one half years, Pennaco's management team and employees have made outstanding progress in building and developing our position in the Powder River Basin coalbed methane play. We are very proud of our company's accomplishments and believe that it is Pennaco's growth potential that has attracted an outstanding company like Marathon to our organization."

Although Pennaco's assets are positive, it has had disappointing production results in recent months. In October, Pennaco revised downward its estimate of natural gas production for the fourth quarter, saying it would produce between 58 MMcf/d and 63 MMcf/d of gas net, compared with a previous target of 70 MMcf/d to 75 MMcf/d (see Daily GPI, Oct. 20).

Pennaco said then that several of its competitors had installed mini-compressors at the wellhead on properties adjacent to Pennaco's producing wells, which increased production rates on the competitor wells and temporarily reduced Pennaco's production. Two months ago, Pennaco installed its own blowers to resume a higher production rate. The company also reported a slower rate of production than expected on its Felix and Fitch Ranch projects because of persistent downhole water pump problems. Those glitches also have been resolved.

Despite some recent problems, Pennaco also has had amazing successes. Earlier this month, the Wyoming Department of Environmental Quality, which has slowed the water quality permit approvals process in recent months, gave the green light for four of Pennaco's future drilling projects (see Daily GPI, Dec. 8). It has about a dozen more permits awaiting approval by the state.

Marathon has undergone a lot of changes in the past year, including a restructuring effort that is continuing. In November, USX Corp. unveiled plans to review its criticized tracking stock structure of both Marathon Oil and U.S. Steel, which included the possibility of selling one or both units. USX CEO Thomas Usher told financial analysts then that legal and financial advisers had been hired to look at alternatives to the stock structure of Marathon and U.S. Steel, a process that he said would take several months.

Analysts have criticized the tracking stock setup, which was established in the early 1990s. They said the combination leaves Marathon Oil's stock heavily undervalued, and have hinted that selling the unit makes the most sense. Through tracking stocks, USX controls both companies, but it allows investors to put funds into either business, with securities tied to the value of Marathon or U.S. Steel. However, separating the companies could add as much as 10% to both companies, say some analysts.

Marathon, the No. 5 U.S. oil company, also has had other financial problems. Earlier this year, it began to overhaul its business, restructuring its savings targets and installing a new management team. It cut its overall exploration and production workforce by 25% and began an early retirement program. Worldwide, E&P employees have fallen to below 3,000, about 24% less than at the end of 1999.

Marathon also said it would focus on three or four new E&P areas and deepwater projects. Oil and gas production in 2001 is expected to be about 3% higher, or about 430,000 bbl/d, up from 416,000 bbl/d expected this year.

While some of the cutbacks have helped the bottom line, E&P has not done as well. In November, Marathon said that poor drilling results are leading to a $200 million oil and gas write-down charge in the fourth quarter, with a downward revision of about 100 MM bbl in reserves.

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