The combination of Conoco Inc. and Phillips Petroleum Co., announced a week ago in an enterprise deal valued at $53.5 billion, will create the third largest integrated U.S. energy company, and also reduce the number of majors overall. ConocoPhillips, as it is set to be called when the merger closes, would be the third largest U.S. company based on market capitalization and oil and gas reserves and production. Worldwide, it would be the sixth largest.

Under the terms of the agreement, Bartlesville, OK-based Phillips shareholders will receive one share of new ConocoPhillips common stock for each share of Phillips they own. Houston-based Conoco shareholders will receive 0.4677 shares of new ConocoPhillips common stock for each share of Conoco they own. Based on the closing market prices for the shares of both companies on Friday, Nov. 16, and their debt levels as of Sept. 30, 2001, the new company would have an enterprise value of $53.5 billion ($34.9 billion of equity; $18.6 billion of debt and preferred securities).

The transaction would give the edge to Phillips shareholders, who would control about 56.6% of the company while Conoco shareholders would own about 43.4%. The transaction is structured to be tax-free to the shareholders of each company, and transaction is expected to be accretive to earnings and cash flow per share of each company after achieving anticipated annual cost savings of approximately $750 million. The companies expect to achieve the annual rate of synergies within the first year after closing.

Energy analysts with Deutsche Banc Alex. Brown said the merger was “born of both companies somewhat disadvantaged position versus the super majors in terms of financial strength, geographic diversity and long-term production growth.” They noted that in upstream delivery, Phillips “lacks diversity and is dependent on relatively few projects to drive growth. Technology issues and political factors could adversely affect the timing of developmental operation and could undermine delivery of forecast volume growth.”

On the other hand, Conoco, said Deutsche Banc analysts, has a portfolio in both upstream and downstream that is “focused and generally of high quality. Organic volume growth over the next five years is expected to be 3%, about average for the group.” Analysts noted that Conoco has less exposure than most of its mid-cap U.S. peers to “mature basin production declines in its portfolio.”

Upon completion of the merger, Archie W. Dunham, Conoco chairman and CEO, will serve as chairman of ConocoPhillips and will delay his scheduled retirement to 2004. James J. Mulva, Phillips chairman and CEO, will be president and CEO of the combined company, and also become chairman when Dunham retires. The ConocoPhillips board of directors will consist of 16 directors, eight designated by each of the two companies, including Dunham and Mulva. ConocoPhillips will be headquartered in Houston, with a “significant and continuing presence” in Bartlesville..

“This merger of equals represents an excellent strategic fit for both Conoco and Phillips,” said Dunham. “It will position ConocoPhillips as a stronger U.S.-based, global energy producer by significantly enhancing its capability and growth prospects on five continents in both current and prospective ventures, while generating major synergies. It will create significant long-term value for the shareholders of both companies, partly through cost savings, but also because of a significantly larger portfolio of global assets, skills and opportunities. With a very strong balance sheet, more capital for upstream investment, and greater operational efficiency downstream, ConocoPhillips will be a tough new competitor to the larger global majors.”

Mulva said the merger would ensure that the United States would be “home to a third major international petroleum company,” adding that with “deep roots in Oklahoma, ConocoPhillips will continue to have a significant operational presence here. ConocoPhillips intends to continue the philanthropic and community commitments of Conoco and Phillips. In addition, ConocoPhillips will initiate technology or other partnership commitments with the University of Oklahoma and Oklahoma State University.”

In the upstream segment, ConocoPhillips will have pro forma year 2000 hydrocarbon reserves of 8.7 billion boe and daily production of 1.7 MM boe, based on the companies’ estimates for 2001 year-end production. ConocoPhillips will have numerous legacy asset positions, including those in Alaska, Canada, the Lower 48, the North Sea, Venezuela, China, the Timor Sea, Indonesia, Vietnam, the Middle East, Russia and the Caspian area.

In the refining and marketing segment, ConocoPhillips will operate or have equity interests in 19 refineries in the United States, the UK., Ireland, Germany, the Czech Republic and Malaysia, with a refining capacity of 2.6 million bbl/d. It will also have a strong marketing presence in the United States. In addition, ConocoPhillips will continue Phillips’ equity participation in the natural gas gathering and processing joint venture, Duke Energy Field Service, and in the chemicals and plastics joint venture, Chevron Phillips Chemicals.

The companies expect the combined enterprise to achieve annual cost savings of at least $750 million within the first full year after closing. These savings will result from more efficient exploration, production and downstream activities, and the elimination of duplicate corporate and administrative positions, programs and operating offices. A transition team will begin work “immediately to ensure integration occurs quickly and smoothly,” the companies said in a statement.

Upon closing the transaction, the ConocoPhillips board of directors will adopt a competitive dividend policy. Currently, Conoco pays an annual dividend of $0.76 per share and Phillips pays an annual dividend of $1.44 per share. The merger is conditioned upon, among other things, the approvals of the shareholders of each company and customary regulatory approvals. The transaction is expected to be completed in the second half of 2002.

Morgan Stanley, Credit Suisse First Boston and Salomon Smith Barney acted as financial advisers and Cravath, Swaine & Moore acted as legal counsel to Conoco. Goldman, Sachs & Co., J.P. Morgan Securities Inc. and Merrill Lynch & Co. acted as financial advisers and Wachtell, Lipton, Rosen & Katz acted as legal counsel to Phillips.

Conoco had 20,000 employees and $27.7 billion in assets at Sept. 30, 2001. Phillips had 38,500 employees and $35.4 billion of assets at Sept. 30, 2001.

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