The combined market capitalization of Anadarko Petroleum Corp. and its latest acquisition targets -- Kerr-McGee Corp. and Western Gas Resources Inc. -- comes to nearly $41 billion, almost double that of Anadarko alone and rivaling EnCana Corp. at $42.28 billion.

Anadarko said it will pay $21.1 billion cash for Kerr-McGee and Western in two gas-heavy deals that will give it leading positions in the Gulf of Mexico and the Rocky Mountain region. It's the eighth-largest energy deal of all time, according to Thomson Financial, behind BP Amoco's 1999 acquisition of ARCO (see Daily GPI, April 5, 1999) and ahead of last year's Chevron Texaco-Unocal pairing (see Daily GPI, April 5, 2005).

"We are creating a combined company with industry-leading positions in the deepwater Gulf of Mexico (GOM) and the Rockies, two of the fastest-growing oil and natural gas producing regions in North America," Anadarko CEO Jim Hackett said. "The core assets being acquired strongly complement Anadarko's existing properties, providing the scale and focus needed to deliver more robust, predictable and efficient growth."

Speaking to energy analysts during a conference call, Hackett said Anadarko's strategy, revamped two years ago, "remains intact. It's consistent with what we said we would do and what we will continue to do." Kerr-McGee and Western give the company "lower risk" properties with more access and diversified plays in the deepwater GOM and the Rocky Mountains.

And adding assets in North America was important. "Our country is not immune" to the volatile global energy markets, said Hackett, and Anadarko wanted more predictability within both its earnings and exploration opportunities. "What we said and what we believe, is that we wanted to whittle down and concentrate more on North America. There are now a lot of high grade assets in the entire company." He said Anadarko did not like what was happening in some of the overseas exploration areas nor the fact that many "do not like North America right now. They are taking more out of our hides, and we're reacting to that."

Kerr-McGee is fetching $16.4 billion, $70.50/share, plus assumption of net debt and other liabilities estimated at $1.6 billion. Nearly the entire price will be assigned to oil and gas properties as Kerr-McGee's gathering and processing assets are part of the upstream business and separate valuations are not available. Western is going for $4.7 billion, $61/share, plus assumption of debt and other liabilities estimated at $600 million. About $1.6 billion of the total will be assigned to midstream gathering, processing and transportation assets. Nearly all of the remainder will be assigned to two Wyoming gas plays: coalbed methane (CBM) in the Powder River Basin (mainly the Big George coals), and tight gas in the Pinedale field.

"Kerr-McGee's outstanding deepwater holdings and skill sets will elevate Anadarko into the top echelon of deepwater operators," said Hackett. "Similarly, Kerr-McGee's long-lived natural gas resource plays in Colorado and Utah, along with Western Gas Resources' in Wyoming, will combine with Anadarko's assets to make us one of the largest producers in several of the most prolific basins in the Rockies. Together, these acquisitions create a more focused portfolio, which will enhance our ability to deliver very competitive growth rates and returns."

E&P mergers have been on the upswing, led by activity in the GOM (see Daily GPI, May 23). The last blockbuster deal was the recently completed acquisition of Burlington Resources by ConocoPhillips for $35.6 billion (see Daily GPI, April 3). Other recent deals are the acquisition of privately held Barnett Shale player Peak Energy Resources Inc. by Fort Worth-based XTO Energy Inc. in a stock deal worth $105 million (see Daily GPI, June 2); and Chesapeake Energy Corp.'s $932 million cash purchase of assets held by Four Sevens Oil Co. Ltd., its partner Sinclair Oil Corp., and other parties (see Daily GPI, June 6). And more consolidation of independents has been expected (see Daily GPI, March 8).

Shares of KMG rocketed up to the $68-plus range Friday on news of the deal. The previous close was $50.30. Western zoomed to nearly $60 from a previous close of $40.91. Anadarko (APC) fell to about $45.78 from a previous close of $48.39. Standard & Poor's Ratings Services saw the news as a potential negative for Anadarko's credit but a potential positive for the target companies. S&P placed all on CreditWatch: Anadarko (BBB+/A-2) negative, KMG and Western positive. Moody's Investors Service took a similar stance. S&P valued the deals at $22.4 billion, including existing debt at the targets, net of cash on hand and proceeds from pending asset divestitures.

Anadarko is paying hefty premiums based on recent share prices of KMG and Western. In a conference call Friday, Hackett explained that sector share prices have declined on softer gas prices since the time Anadarko entered negotiations with KMG and Western. He defended the deals and pointed to the Nymex strip as justification. Long-term fundamentals, as evidenced by a still-robust Nymex strip, tell a different story. Investors complaining about the deals' pricing are in it for the short-term, Hackett said.

"The fact that spot gas markets and equities got a little weaker over the last two weeks didn't really change the value of the assets," Hackett said. "In fact, if you went out and sold these assets in the open market, they'd generate a tremendous arbitrage with where the equities are. It's a dislocation in the current market versus the forward curve for commodity prices. If you overlaid the forward curve the next three years for gas one week ago versus where it is today with weaker spot prices by a good measure, they overlay each other pretty directly -- the correlation is really high. So long-term value hasn't become any different. The arbitrage has simply increased in proportion to the decline in the stock price."

Still, Anadarko's offer was likely more than welcome at KMG, said Matti Teittinen, an equity analyst with John S. Herold Inc. who follows the company. "They were probably blown away by the offer," he told NGI (see related story).

KMG had been a foundering company and only recently found its legs again. In April it became a pure-play E&P company with completion of the sale of its chemicals unit, Tronox Inc. (see Daily GPI, April 3).

KMG's year-end 2005 proved reserves (excluding pending Gulf of Mexico Shelf divestitures) totaled 898 million boe, of which approximately 62% is natural gas. Proven undeveloped reserves represented 30% of the total. Production in 2006 is expected to be about 92 million boe, with natural gas representing approximately 60%. Anadarko expects to ultimately recover more than 3.1 billion boe on the KMG properties, at a full-cycle cost of approximately $39.2 billion ($12.40/boe), including the acquisition cost.

KMG's core properties are in the deepwater Gulf of Mexico and onshore in Colorado and Utah. They include 504 deepwater Gulf of Mexico blocks, encompassing seven operated and three non operated producing fields, three operated and five non operated discoveries in varying stages of development, and four additional prospects that will be drilled this year. These assets are supported by KMG's extensive "hub-and-spoke" infrastructure, which offers highly cost-effective future development potential, Anadarko said. In Colorado, KMG holds 451,000 net acres in the Wattenberg gas play, located largely on the Land Grant, where Anadarko owns the royalty interest. In Utah, KMG holds 237,000 net acres in the Uinta basin's prolific Greater Natural Buttes gas play.

In addition to its extensive, rapidly growing U.S. portfolio, KMG produces oil and is continuing to develop and explore offshore China, has made discoveries and is pursuing the development of fields on the North Slope of Alaska and offshore Brazil, and is exploring offshore Australia, West Africa and the islands of Trinidad and Tobago.

Western Gas Resources year-end 2005 proven reserves totaled 153 million boe, with proved undeveloped reserves representing 57% of the total, while 2006 production is expected to total about 12.5 million boe. Essentially all of the reserves and production are natural gas. Anadarko expects to ultimately recover about 705 million boe on the Western Gas Resources properties, at a full-cycle E&P cost of approximately $6.7 billion, or less than $10/boe, including the acquisition cost of the oil and gas properties.

Western CBM properties within the Powder River Basin are estimated to hold about 9 Tcf of original gas in place and are adjacent to Anadarko's assets in this developing play. Western also has a 10% average working interest in its Pinedale/Jonah joint ventures, which encompass world-class fields totaling more than 40 Tcf of original estimated gas in place. Anadarko expects that combining its properties with Western's will accelerate development and produce strong volume growth through the end of the decade, and possibly longer, with more than 12,000 identified drilling locations in inventory.

"Two years ago, we unveiled a strategy that included a solid North American foundation of onshore resource plays, a growing deepwater Gulf of Mexico program and an expanding international portfolio," Hackett said. "Kerr-McGee and Western Gas Resources strengthen Anadarko's position on all three counts, with captured growth projects that are consistent with our core skill sets. The transactions enable us to create a more focused operating strategy with a larger and lower-risk asset base."

Anadarko's revised strategy was bearing fruit in 2005 when the company added $300 million to its capital budget to build up domestic operations in onshore acquisitions and drilling, Wyoming CBM, and deepwater Gulf exploration (see Daily GPI, June 23, 2005).

Industry skeptics wondered about the premium Anadarko is willing to pay for the two producers, but Hackett said the company is taking a "patient and measured approach to equity," and is "committed to returning to a debt ratio of 40% or less."

Asked why Anadarko had committed to the transactions instead of building organically, Hackett said the "bottom line was that Anadarko found a much more compelling proposition" with KMG and Western. "These acquisitions move us into the top tier of producers. We're not only much bigger, but we will be more efficient because of the synergies from combining our efforts. We'll be more focused in specific regions."

Asked if the sale of Anadarko was ever on the table, Hackett said, "we never forget we are an open equity market, but our main ambition was not to sell ourselves. We want to assure anybody that by combining these three companies, we think that with the team we've assembled, we will continue to find creative opportunities, particularly for organic growth, secondarily for other value creation opportunities in the business. We just happened to find two companies that frankly, a year ago were not as attractive to us. Kerr-McGee was not attractive to us last year. We wanted to be opportunistic, and these are two entities that will really work for us here."

Anadarko's "major growth driver is still the drill bit...not acquisitions," Hackett said.

"Neither one was for sale when we first talked to them," said Hackett. Anadarko had not settled on prices, and it conducted due diligence and went through all of the numbers. Then management made the separate offers. Both of the deals are independent of each other.

"Most of the peer group was buying back stock. We were buying back stock. But we had a framework for evaluation. We took a look at the pro forma balance sheet...looked at it hard and considered it a better transaction for the future. We laid out a lot of upside in saving money in the transactions, and we saw that as part of the answer. We saw a tremendous amount of upside in both of these companies beyond 1 T of reserves, the business, the opportunities."

The "new portfolio," said the CEO, "means we will rely less on any single project." For instance, he said Anadarko's K2 project in the deepwater GOM, "is world class, but it has contributed to volatility" within the company because of its location in the deepwater. "By adding Kerr-McGee and Western, we optimize the portfolio and have sustainable growth, and it diversifies our concentration in the deepwater...the Rockies."

With the double play, "we'll have the people, we'll have the skills, we'll have the high growth in high margin areas. We'll have an unparalleled position, and we'll be the premier independent in the Gulf of Mexico to rival the majors," the CEO said.

"From a professional standpoint, all the folks coming here believe this will be a big plus for them," said Hackett. "In this business, we have found people want professional challenges. In both of these companies there is a good deal of respect for Anadarko, and we have the same feeling for them. We will expand their professional horizons horizontally and vertically. We will make the Gulf of Mexico business bigger, we will make the Rockies bigger. This is a fairly unique company, and unless you want to work for a major or for a smaller producer, this is a pretty good place to work."

Although the workforce will evolve, Hackett confirmed that KMG CEO Luke Corbett has agreed to join the Anadarko board of directors.

The transactions are separate, and all of the regulatory issues will be handled independently, Hackett noted. Both deals are expected to close at about the same time.

Anadarko said it will optimize its portfolio through some asset sales, which will help to pare acquisition-related debt, but the company emphasized that the acquisitions are consistent with its focus on unconventional resource development and high-impact exploration. "All three companies have certain assets that we will likely deem to be non core once combined," Hackett said.

"We might consider selling anything," he said. "Clearly, the core is in the Gulf of Mexico and the Rockies, but there are no sacred cows. We want to optimize the assets, we want to come out the other side with a tighter equity story. But we want to stop the speculating. It does our employees no good. We really like what Kerr-McGee has done in the Gulf of Mexico in exploitation and on the facility side. They've got a lot of exploration talent and we like what they've accomplished there. But in both cases, we respect what they've done with their organizations."

Hackett said Anadarko was not going to talk in any detail about what might be sold off "because we're not certain which assets are going to move...which ones we will divest ourselves of. We're not sure what it will mean in terms of equity. But we will be selling assets, net $15 billion to pay down debt. How we get there, it depends a bit on what we sell. We have work we need to do to continue with our financial discipline."

Hackett said, "there's a lot of risk operationally to be talking about who will be staying, what assets we will sell. People are concerned about their jobs. And while it may satisfy a short-term need for certain people [to discuss asset sales], even if we do, we don't want to say until we've closed. We don't want to get too aggressive when we are merging three cultures. We may have some retention issues. We don't want to go out with a number that's too aggressive. We have a good track record to do what we say we will do."

Anadarko will finance the acquisitions through a $24 billion, 364-day committed acquisition facility provided by UBS, Credit Suisse and Citigroup. Anadarko plans to use proceeds from asset sales, free cash flow from operations and the issuance of equity to reduce debt over the next 18 to 24 months.

Anadarko CFO Al Walker said that until the company has "a more definitive plan" of what it would sell, "any way of answering [what we'd sell] would be somewhat shallow. We have looked at a series of different asset packages, and we've concluded we could get to the $15 billion number fairly easily." Speaking with reporters, Walker said the company hoped to wrap up its sale of acquired assets quickly. "Right now we're trying to target what we think will be the optimal grouping of assets that we would take into the market over the next several months and what we would take into market subsequent to closing."

Analyst Teittinen said the Rockies and GOM assets are "most likely safe." But he said KMG's southern assets in South Texas and along the Gulf Coast have been "less the focus" for the company. He also thought the Brazilian assets could be put on the block, even though they are in deep water. "But it's really too early to say."

Plans are for the sale of assets and equity securities to raise about $15 billion to pay down about two-thirds of the acquisition debt, he said. The company's goal is to have a debt-to-equity ratio of 40 or better, Walker said.

"Given our outlook for energy markets, these transactions make a lot of sense for Anadarko shareholders. We expect to hedge up to 75% of the acquired production through late 2008 using a series of three-way collars, with floors designed to ensure a return on our investment and ceilings that allow considerable upside," Hackett said. "We also expect cost reductions as we consolidate certain administrative functions, but the biggest synergies are expected to come from combining the complementary assets of the three companies and the skills of their employees. In today's tight labor markets, gaining qualified people is a bigger focus than achieving cost savings through consolidation.

"Anadarko is offering Kerr-McGee and Western's shareholders significant premiums over the companies' recent current stock prices, but looking backward 30 days results in premiums that are more comparable to precedent transactions. In any case, we believe we are capturing a substantial disconnect between current property valuations and equity market valuations, and gaining some exceptional properties and talent in the process," Hackett said. "The day-one metrics on proved reserves and daily production are in-line with other recent transactions. On a full-cycle basis, including the acquisition and future development costs, we expect to ultimately recover 3.8 billion boe from the acquired properties at less than $12.00/boe. Opportunities to gain access to such large, high-margin resource opportunities at such economic full-cycle costs are rare, and we are excited about the value we expect to create for Anadarko shareholders."

The Anadarko, KMG and Western boards all have approved the deals. The KMG and Western boards have recommended their shareholders approve the respective acquisitions. The KMG agreement includes a right to match competing offers and a break-up fee of $493 million to be paid under certain circumstances. The Western agreement includes a right to match competing offers and a break-up fee of $154 million to be paid under certain circumstances. Holders of 17% of Western's outstanding common shares have agreed to vote in favor of the transaction. Both deals, subject to regulatory approvals, are expected to close by the end of the third quarter. In both deals, for Anadarko Credit Suisse and UBS acted as financial advisors, Goldman Sachs provided the fairness opinion and Akin Gump Strauss Hauer & Feld LLP acted as legal counsel.

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