The future of The Houston Exploration Co. (Houston Ex) had been uncertain for much of last year. But late Sunday the outlook for the domestic onshore independent came into sharper focus when Denver-based Forest Oil Corp. agreed to acquire the company for $1.5 billion in stock and cash and assumption of $100 million in debt.
The price equates to roughly $2.40/Mcfe of proved reserves, wrote Bank of America equity analyst Michael Schmitz. Forest is paying about 80% of Bank of America's estimated liquidation value for Houston Ex based on year-end 2005 proved reserves and long-term commodity prices of $45/bbl and $6.75/MMBtu. Merrill Lynch said the deal valued Houston Ex at about $2.44 Mcfe, slightly less than the $2.60-3.00+/Mcfe at which other onshore asset deals had recently been struck.
The deal follows a tumultuous year for Houston Ex in which the company sparred quite publicly with its largest shareholder over strategic direction and allocation of capital. That shareholder, JANA Partners LLC, bid for control, offering $62/share, but was rebuffed. Analysts at the time saw the move as an attempt to put the company into play. Houston Ex then put itself up for sale but there were no takers (see Daily GPI, June 27, 2006; June 23, 2006).
Forest said Monday it did not participate in the auction, choosing to wait for a better, negotiated deal. Forest's share price then slid with the fall in natural gas prices.
Houston Ex shares (THX) Monday closed up 4.11% to $50.69, while shares of Forest (FST) slipped 3.49% to close at $30.13.
Acquiring Houston Ex positions Forest as one of the top independent onshore North American exploration and production companies and will create a highly concentrated and complementary set of oil and natural gas assets focused in all regions of Texas. Indeed, both companies have recently jettisoned their Gulf of Mexico offshore operations to focus on onshore plays.
On a pro forma basis the merged company would have estimated proved reserves of approximately 2.0 Tcfe, of which about 69% would be classified as proved developed and approximately 70% would be natural gas. Forest management and its board of directors will continue in their current positions with Forest, and it is anticipated that Forest will create a new business unit to be located in Houston.
"We are undertaking this significant acquisition to further strengthen our onshore North American asset base and to add drilling inventory for our proven acquire and exploit strategy," said Forest CEO H. Craig Clark. "This strategy has provided us with superior risk-weighted returns over the last several years. This acquisition will add in excess of 3,200 drill sites to our existing inventory. Furthermore, these assets are located in tight gas sand basins in which we have extensive experience and have recently benefited from new technological applications like horizontal drilling and fracture stimulation. We believe that our stated organic growth goals can be achieved in the foreseeable future within our existing free-cash flow model. In order to reduce our leverage and to further narrow our geographic focus, we will seek to sell our Alaskan entity in 2007."
Houston Ex CEO William G. Hargett said the deal is the successful conclusion to a strategic review the company began last year, as well as a refocusing of its asset portfolio to onshore natural gas (see Daily GPI, April 10, 2006; March 2, 2006; Nov. 9, 2005). "The transaction with Forest not only provides immediate value to Houston Exploration's shareholders, but also affords them the opportunity to participate in the upside potential created by our combination."
JANA holds 14.7% of the outstanding shares of Houston Ex and has agreed to vote in favor of the Forest Oil transaction. JANA has also agreed not to propose any extraordinary transactions with Forest or to seek to influence the management or control of the company for a year following the close of the sale to Forest.
In an open letter sent in June last year, JANA Managing Partner Barry Rosenstein charged Houston Ex with corporate waste and breach of its fiduciary duty to shareholders. He said the board had overseen a "massive transfer of shareholder value to company executives," particularly Hargett, over the last several years. He cited "massive compensation increases" for Hargett -- more than 500% between 2003 and 2005 -- and other executives "in exchange for the paltry returns they have generated during a time of massive growth in the oil and gas exploration industry" (see Daily GPI, June 23, 2006).
JANA, a $5.5 billion "activist" hedge fund, also sharply criticized Houston Ex management for not locking in last year's high natural gas prices with futures contracts. Houston Ex production still is not hedged and Forest management said Monday they are comfortable with the unhedged position at least until the transaction closes.
"We're happy not to be hedged at this point," said Forest CFO David H. Keyte. "Now if prices dive another dollar on the nearby strip, it will start to temporarily break through our assumed economics. But I think that we do have a view that gas over the next three years is going to improve from here and you have to have that view or you wouldn't be buying a 100% gas asset. At this point it's working well within the plan and we're comfortable not being hedged on it until close."
Forest said it intends to decrease overall capital expenditures in the combined company and to reallocate capital being spent on the Houston Ex assets. Under Forest's pro forma business plan, 2007 capital expenditures for the combined company would be approximately $900 million and 2007 estimated production would be 540 MMcfe/d. However, as the acquisition is not anticipated to occur until the second quarter of 2007, Forest is unable to issue formal guidance for the combined company at this time. Forest said it would issue guidance after closing.
Rosenstein and JANA would appear to be satisfied now that Forest will be taking over. "Forest Oil has a strong track record of keeping F&D [finding and development] costs and operating expenses low, and its disciplined management team has maintained some of the most favorable cost controls in the industry during the inflationary period of the last several years," Rosenstein said in Forest's press release announcing the deal. "In addition, we believe there are significant synergies, particularly given Forest Oil's demonstrated expertise in analogous acquisitions and the direct overlapping acreage positions in the combined portfolio."
Upon completion of the transaction, it is anticipated that Forest shareholders would own about 73% of the combined company, and Houston Ex shareholders would own approximately 27%.
Currently, Forest's principal reserves and producing properties are in Alaska, Louisiana, New Mexico, Oklahoma, Texas, Utah, Wyoming and Canada. Forest said Monday it would divest the Alaskan assets to help pay for the Houston Ex deal. The combined company will have a strong position in South Texas and the Greater Carthage areas of East Texas -- two core tight gas assets with horizontal drilling opportunities. The greater presence in the major Texas basins "should result in additional opportunities in the acquisition market," Forest said. The combined company also will have a strong production base and acreage position in the Arkoma Basin, near the emerging Fayetteville Shale play. The deal increases Forest's exposure to the Rockies with a significant acreage position and about 1,900 drilling locations in the Denver-Julesburg Niobrara.
"FST and THX have reasonable overlap onshore with the exception of the Rockies, which will be a reentry for FST," wrote Merrill Lynch analyst John P. Herrlin Jr.
Clark enumerated the activity areas for the combined company, placing them into four categories:
Houston Ex is just the latest deal in Forest's ongoing plan to expand onshore exploration and production. Last summer Forest assumed operatorship of the Katy Field, located in Waller, Fort Bend and Harris Counties, TX, from ExxonMobil and, separately, executed an exploration joint venture agreement with a third party increasing its gross acreage to 20,000 in the Barnett Shale primarily in Hill and Erath Counties, TX (see Daily GPI, Aug. 3, 2006). In 2005 Forest spun off its extensive Gulf of Mexico offshore holdings and merged them with a subsidiary of Mariner Energy Inc. in stock-for-stock deal, making Forest a pure onshore play (see Daily GPI, Sept. 13, 2005).
"Since 2003, this is our fifth corporate acquisition and the largest to date," Keyte told analysts during a call Monday. "We expect to employ the same tactics we have in the past to transform a good trade into good business. This means shifting the capital emphasis to more low-risk drilling programs, reducing both cash costs and drilling costs; transform the business to a free cash flow generator; and weed out underperforming properties. With this transaction, since Craig [Clark] became CEO in late 2003 we have spent nearly $3 billion to purchase oil and gas assets in our key areas."
During the same call, Clark touted his company's prowess at the acquire and exploit game. "We always have a plan in place for acquired assets and companies when we buy them...We are at our best when the acquire and exploit methods need to be employed," he said.
The Houston Ex deal is quite similar to Forest's 2004 acquisition of The Wiser Oil Co., a Dallas-based independent, for $330 million (see Daily GPI, May 25, 2004), Clark said.
The latest acquisition is said to be immediately accretive to Forest shareholders on a cash flow, production and reserves-per-share basis. Rationalization and prioritization of project inventory and capital of combined entity is anticipated to result in estimated organic production growth of 7-8% within Forest's free cash flow model. Operational and corporate synergies including the utilization of Forest's Lantern drilling rigs are anticipated to result in an estimated decrease of 10-15% in cash costs per unit, and improved finding and development costs.
Under terms of the agreement, Houston Ex shareholders will receive total consideration equal to 0.84 shares of Forest common stock and $26.25 in cash for each share of Houston Ex common stock outstanding, or an estimated 23.6 million shares of Forest common stock and cash of $740 million. This represents $52.47 per share of consideration to be received by the Houston Ex shareholders based on the closing price of Forest shares on Jan. 5. The exact amount will be determined by elections and an equalization formula. It is anticipated that the transaction will be tax-free to Houston Ex and the stock portion of consideration will be received tax-free by its shareholders. The cash component of the acquisition is expected to be financed with a new $1.4 billion revolving credit facility, which has been underwritten by JP Morgan Chase Bank NA.
The boards of directors of Forest and Houston Ex have each unanimously approved the deal, which is subject to regulatory approvals and other customary conditions, as well as both Forest and Houston Ex shareholder approval. Credit Suisse Securities (USA) LLC acted as the financial advisor and Vinson & Elkins LLP acted as the legal advisor to Forest for this transaction.
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