Houston Exploration Co. (THX) shares spiked more than $5 Tuesday morning to a new 52-week high and ended the day up 9% at $49.70 after KeySpan Corp. announced plans to transfer 10.8 million THX shares back to the exploration and production (E&P) affiliate in exchange for 100% of a wholly owned THX subsidiary, Seneca-Upshur Petroleum Inc.

In exchange for the shares, THX will give KeySpan about 50.5 Bcfe of proved gas reserves in the Appalachian Basin as well as a cash contribution from a share offering, for a total value expected to be about $433 million including debt.

“We welcome Seneca-Upshur into the KeySpan family and intend to grow this business through additional investments in energy-related assets that support our core businesses,” said KeySpan CEO Robert Catell. “This transaction allows the company to further concentrate on executing its strategy of growing its core energy businesses.”

KeySpan previously announced plans to sell or reduce its stake in THX, which it does not consider a strategic asset. It apparently has found a way to restructure its share of the company in a manner that is beneficial to both companies.

As part of the deal, 6.2 million of the THX shares KeySpan is transferring will be sold in a public offering and THX will retire the remaining shares it receives, reducing the number of THX outstanding shares from 31.9 million to 27.3 million. The transaction will cut KeySpan’s ownership in THX to 24% from the current 55% level.

Assuming an initial public offering price of $45.01 (Friday’s closing price for THX), KeySpan would receive a discounted per share value equal to $40.09, before expenses.

THX will contribute its Appalachian Basin assets, including the West Virginia proved reserves valued at $60 million, and an amount of cash to Seneca-Upshur Petroleum. At the time of the transaction, it is expected that Seneca-Upshur will have cash in excess of $350 million based on the initial offering price assumptions. The new KeySpan subsidiary plans to use the cash to make additional investments in energy-related assets.

In addition, three of KeySpan’s five designated directors on the THX board will resign at the closing of the transaction, and KeySpan will retain the right to nominate two of the remaining seven directors on the THX board.

Other impacts of the transaction include the following:

Moody’s Investors Service affirmed the Ba3 senior implied rating and B2 note ratings for THX and left its outlook on the company stable, calling the deal “essentially a share buyback from KeySpan, funded with new equity, bank debt and the contribution of reserves.” While Standard & Poor’s (S&P) also affirmed its BB corporate credit rating on THX, it revised its outlook on the company to negative from stable, citing an increase in debt.

“The company’s proposed funding of the exchange transaction with KeySpan will increase Houston Exploration’s debt levels by about 40% and reduce its bank borrowing availability to about $165 million from $280 million as of March 31, which somewhat heightens Standard & Poor’s credit concerns for the current ratings,” S&P said.

“Furthermore, the company’s short reserve/production ratio of less than seven years makes Houston Exploration more susceptible to a rapid decline in commodity prices over the next 12 to 18 months, which would significantly affect its credit measures. A rapid commodity-price decline could also constrain the company’s liquidity, with the company’s need for additional bank borrowings to maintain current production levels in a low to mid-cycle pricing environment.”

Nonetheless, S&P said THX should continue to generate excess cash flow in the current high commodity price environment, providing the company with the ability to use excess cash flow to reduce some of its increased bank borrowings, which were used for the exchange transaction.

Consummation of the deal is subject to each party’s satisfaction with the public offering price. Accordingly, no assurance can be given that the transaction will be completed. The underwriters will be granted an option to purchase an additional 930,000 shares of common stock to cover any overallotments. If this overallotment option is exercised in full, KeySpan’s ownership interest in THX will be reduced to 22.5%.

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