Offshore pioneer Kerr-McGee Corp. will become the fifth largest independent producer following a $3.4 billion merger with Denver-based Westport Resources Corp., which was announced last Wednesday. The transaction substantially expands Kerr-McGee’s land-based prospects, increasing its proved reserves 30% and also boosting its total daily production more than 34%, which will be weighted 54% to natural gas.
Combined, the new Kerr-McGee, to be headquartered in Oklahoma City, will have about 1.3 billion boe of proved reserves, with 57% of the total in natural gas. Of that total, nearly 76% of the reserves would be located within the United States. The merged company also would provide more than 71 million gross acres for exploration. Last year, the two companies produced a combined total of 158,000 bbl/d and 842 MMcf/d.
“Westport’s extensive inventory of low-risk U.S. exploitation opportunities complements Kerr-McGee’s high-impact deepwater exploration program providing us a more predictable performance profile,” said Luke R. Corbett, Kerr-McGee CEO. He said Westport’s “substantial property base in the Rockies expands our platform for applying our proven tight-gas and supply-chain expertise.”
Corbett estimated that the new properties have a probable and possible resource potential of 1.8 Tcfe, and said more than 2,500 low-risk drilling locations already have been identified.
Although the merger on paper looks strong for Kerr-McGee, analysts and shareholders failed to be impressed. The shares were down $2.10 to close at $49.41 on heavy volume. Westport, meanwhile, saw its stock gain about 3.5%, or $1.15 to close at $34.20.
Following the announcement, Standard & Poor’s Ratings Services (S&P) placed Kerr-McGee’s “BBB” rating on CreditWatch with negative implications and lowered its short-term corporate credit rating to “A-3” from “A-2.”
S&P noted that the acquisition will improve the company’s debt metrics and “modestly benefit operations. However, S&P is concerned about the company’s “very high finding and development costs (a problem shared by Westport), the still high component of undeveloped reserves, the large amount of future spending associated with developing these reserves, the company’s significant debt leverage and whether it will be able to achieve debt reduction from internally generated cash — something it has not demonstrated on a consistent basis.”
Fadel Gheit of Oppenheimer & Co. said the merger will limit Kerr-McGee’s financial flexibility. Gheit reduced Kerr-McGee’s rating to “sell” from “neutral.” He wrote that “one can justify the deal strategically as it will balance Kerr-McGee between oil and gas, and offshore and onshore; however, it comes at a very hefty price.”
CreditSights analysts also were not impressed, saying, “We view the transaction as a short-term fix for KMG; while it does improve the company’s declining production profile and financial constraints over the near-term, it fails to provide a long-term platform for profitable growth and returns.”
Under terms of the agreement, which has been approved by both boards, Kerr-McGee is offering 0.71 share for each share of Westport. Based on the offer, Westport would cost $36.57 a share, or 11% above its share price of $33.05 in Tuesday trading on the New York Stock Exchange. Kerr-McGee also would assume $900 million of Westport’s debt.
Few mergers big or small have occurred within the U.S. oil and gas industry in the past year, and in fact, this transaction is the largest since another Oklahoma City-based producer, Devon Energy Corp., merged with Ocean Energy Inc. in February 2003 for $3.5 billion in stock and $1.8 billion in debt.
Westport’s strength comes from its low-risk development prospects, mostly located in the Rocky Mountains and South Texas, but it also has some offshore prospects. Its U.S. acreage is considered relatively easy to develop, however, the deal would help Kerr-McGee most by allowing it to move away from its focus on maturing offshore prospects. Currently, Kerr-McGee produces 86% of its oil and 51% of its natural gas from the Gulf of Mexico and North Sea.
And Westport has a savvy growth record. Over the past three years, Lehman Brothers estimates Westport has quadrupled its reserves at a cost of about $1.36/Mcf — compared with Kerr-McGee’s $1.52/Mcf. Lehman analyst Thomas Driscoll estimated that the Denver-based independent grew its production last year 26% over 2002 (see NGI, Jan. 26).
Westport’s growth has come from small, low-cost acquisitions and successful drilling programs. Last year it bought privately held United Resources’ South Texas assets for $350 million (see NGI, Nov. 10, 2003) and purchased a field in Greeley County, KS last year for $1.7 million.
One of Westport’s biggest assets, however, came from a deal put together in late 2002, when it purchased 600 Bcfe in the Uinta Basin and a gas gathering system from El Paso Corp. for $502 million (see NGI, March 11, 2002). Westport now has about a third of its operations in the Uinta Basin, where Kerr-McGee also operates.
Of the $3.4 billion purchase price, Kerr-McGee said approximately $2.1 billion is expected to be allocated to the 297 MMboe of proved reserves equating to approximately $7.23/boe. An additional $.9 billion is associated with 300 MMboe of probable and possible resources, or $3.10/boe. The company expects to convert these probable and possible resources into proved developed reserves at a cost of approximately $3.75/boe.
Kerr-McGee has entered into hedges, primarily in the form of costless collars, that when combined with Westport’s existing hedges, cover approximately 90% of Westport’s anticipated proved production through 2006. Details are available at www.kerr-mcgee.com under the Guidance tab within the Investor Relations section.
As a result of the transaction, Kerr-McGee’s net debt as a percent of total capitalization is expected to decrease approximately to 42% from 54% by year’s end. In addition, the companies expect to realize cost savings of approximately $40 million annually. The transaction will be accretive to both earnings and cash flow per share beginning in 2005.
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