After years of struggling in recent years to make ends meet in the exploration and production business and indications last December that it was examining alternatives, Enron finally decided to call it quits last week and cut its ties to its production subsidiary, Enron Oil & Gas (EOG). The announced plan would establish EOG as a widely held public company that will be independent of Enron. Analysts and industry personnel applauded the deal, pointing to divergent corporate strategies.

Under the all-stock agreement, Enron will exchange 62.27 million of its 82.27 million shares of EOG common stock for EOG’s China and India operations. In connection with the exchange, EOG will contribute $600 million in cash to one of EOG’s India subsidiaries that will be transferred to Enron.

The net effect of the share settlement agreement will reduce Enron’s ownership of EOG from approximately 82.27 million shares or 53.5%, to 20 million shares, or between 16-17%. Once the deal is closed, the EOG board of directors will be reconstituted, with all Enron officers and directors currently serving as EOG directors, resigning their positions on the EOG board.

“While EOG’s North American operations are among the best in the industry, they are no longer strategic to Enron’s North American energy businesses, as we have ready access to gas supplies in this well-developed market,” said Enron CEO Kenneth L. Lay. “The China and India operations provide valuable supplies to meet growing energy demand in these regions and are very strategic to our international activities,” he added.

EOG will issue additional equity to fund the $600 million part of the transaction. The Bank of America committed to give EOG a senior credit facility of up to $1.3 billion, which could also be used to fund the transaction.

“We expect the transaction to be immediately accretive to cash flow per share,” said EOG Chairman Forrest E. Hoglund. “The transaction also will remove the uncertainty of our ownership status and will provide EOG with greater access to both debt and equity capital with which to grow its businesses. We are extremely excited about our platform for growth in North America and Trinidad and will continue to seek new international concessions.”

Solving the uncertain ownership issue is a coup for EOG, said Steve Smith, an analyst with Dain Rauscher Wessels. “The overhang of this [ownership] issue had been a depressant on the company management, employees and shareholders. I mean, here’s a company that went up for sale, but nobody came to the party. The resolution is a positive development.” Smith estimated the deal will cause a 16% improvement in cash flow for EOG in 2000.

Enron notified the Securities and Exchange Commission in December it was considering an unsolicited offer from an unidentified company for its 53.5% share of EOG (see NGI Dec. 21). The third party was said to be interested in buying Enron’s shares and making an offer for all the remaining outstanding shares in the company. The deal was expected to also include divestiture of other Enron assets, but it never was completed.

“[Enron] is moving away from being an asset-based company and moving toward being a service-based company,” said Donato Eassey, an analyst with Merrill Lynch. “They took a look at their portfolio and decided that services, such as their energy management businesses, have a higher growth potential than production, and this deal with EOG signals a move in that direction.”

Zach Wagner, an analyst with Edward Jones, emphasized the importance of the overseas assets in the deal. “India has a growing energy market, and Enron has been trying to establish a firm foothold in India for quite some time. These assets add major long-term potential to Enron’s international portfolio.” The foreign properties include 30% interest in three Indian energy fields (one gas field, one oil field, and one oil and gas field), as well as a production sharing agreement with the Chinese government for the Sichuan field in China.

The price was also right, according to Wagner. “Enron did not overpay at all. Judging by EOG’s current stock price, Enron is giving up around $1.2 billion, but getting back $600 million and valuable assets as well.”

Both Wagner and PaineWebber analyst Ron Barone said this move also makes sense for Enron because it reduces its exposure to the mature North American energy market. “For all intents and purposes, Enron will effectively be out of the domestic exploration and production (E&P) business by year-end,” Barone said, “ultimately having greatly reduced long-term commodity price risk.”

The divestiture also will lead to a more active EOG, Smith said. “When another company has 53% of your stock, maneuverability in terms of deal-making becomes difficult. Now that it has more freedom, I look for it to enter into an ‘explore and exploit’ deal in the Gulf of Mexico, similar to the deal Apache made with Shell some months ago (See NGI, May 3).”

The transaction has been approved by the boards of both companies and has been recommended by a special committee of independent directors of the EOG board. Expected to be completed by Aug. 31, the deal does not require any governmental approval.

The deal contained a lock-up period where Enron cannot sell its remaining 20 million shares of EOG for six months. Enron does, however, have the right to sell 10 million in convertible securities, which will be automatically exchangeable into EOG shares. Barone said Enron will have all 20 million shares sold shortly after the lock-up period ends.

John Norris

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