Houston-based Plains Exploration & Production Co. (PXP) built its emerging domestic natural gas position and nearly doubled its production with an agreement to buy cross-town independent Pogo Producing Co. in a stock and cash transaction valued at $3.6 billion.

Once the acquisition is completed, PXP would have an estimated proved reserve base of 635 million boe and a total estimated reserve potential of 1.4 billion boe of proved, probable and possible reserves. At year-end 2006 pro forma for asset sales, Pogo reported 219 million boe of proven reserves.

Wall Street enthusiastically responded when the announcement was made Tuesday, pushing up Pogo’s share price in heavy trading by $7.02/share, or 13.91%, to close at $57.50. Average trading volume for Pogo is 735,000 shares, but on Tuesday volume jumped to more than 11.4 million. Trading in PXP shares was less enthusiastic, deflating the stock price by $3.35/share (6.54%) to close at $47.88. Average trading volume for PXP is 1.126 million shares; on Tuesday, 6.34 million shares were traded. By Friday, Pogo’s price had risen to around $57.67; PXP’s price had risen to around $48.38.

In a conference call last week, PXP CEO James Flores said the Pogo transaction was “really a meat and potatoes development asset,” which offered a “significant opportunity” for both companies. “With this announcement, we realign ourselves with gas reserves and are now prepared for a gas rebound in the future.” The transaction offers “substantial producing properties and significant growth potential in Texas, primarily the Panhandle, Permian and Gulf Coast, plus the prolific Madden Field in Wyoming and the San Juan Basin in New Mexico.”

Until this year, PXP had concentrated its exploration efforts in California and along the Gulf Coast. However, PXP in April began building its gas reserves, gaining entry into the Piceance Basin with the $946 million purchase of Laramie Energy LLC (see NGI, April 23). PXP said at the time that it would pursue a master limited partnership (MLP) to drop down some of its mature exploration and production (E&P) assets.

The Pogo transaction, said Flores, now positions PXP to create one of the “best in class” MLPs in the E&P sector. PXP has retained Lehman Brothers as financial adviser to formalize PXP’s evaluation of a potential MLP filing, which is expected later this year.

Pogo management has been under increasing pressure to build value in the company after activist hedge fund Third Point LLC purchased a 7.2% stake in the independent last year, which made it the largest shareholder (see NGI, Dec. 4, 2006). Third Point over the course of several months demanded Pogo refocus its operations, and it called on CEO Paul G. Van Wagenen to resign. Pogo early this year said it would try to sell the company outright or find a merger partner.

In 1Q2007 Pogo reported a net loss of $21.195 million (minus 37 cents/share) on revenues of $351.4 million, compared with 1Q2006 net income of $67.47 million ($1.18/share) on revenues of $373.5 million. Net cash provided by operating activities in the first three months of 2007 was $247.9 million, up 3% from $240.4 million a year earlier. Pogo sold some noncore assets last year, and in May it sold Canadian subsidiary Northrock Resources Ltd. for $2 billion in cash (see NGI, June 4).

Despite some operational issues, Pogo’s first quarter gas production was 286 MMcf/d, up from 282.2 MMcf/d a year earlier. Pogo is 65% weighted to natural gas, with proven reserves of about 1.3 Tcfe. About 81% of Pogo’s assets are in its Western Division, including 720 Bcfe in the Permian Basin and Texas Panhandle, 244 Bcfe in the Rocky Mountains and 101 Bcfe in the San Juan Basin. Another 19% of Pogo’s reserves are located onshore in its Gulf Coast Division, including 180 Bcfe in South Texas. In addition, Pogo owns 6.354 million acres in New Zealand and 1.48 million acres in Vietnam.

“Today’s announcement represents a significant milestone in the proud and productive 38-year history of Pogo Producing Co.,” said Van Wagenen. He said the combined company would be able to “successfully capture the best of opportunities in our industry. We look forward to a prosperous future of great accomplishments benefiting our shareholders.”

“Paul [Van Wagenen] and his team have had a tremendous run, and…now we look forward to carrying the flag forward,” Flores said. “Pogo’s done a good job of cleaning up their assets, but there will always be some trimming of the trees, cleaning out the closets on both sides. We’ll clean some things up, and maybe sell $1 billion of assets from the combined company by the end of 2008.”

Combining the companies’ assets is expected to save about $50 million a year, Flores estimated. He said PXP needed some of Pogo’s technical and scientific expertise, and with the MLP, it also will need some of Pogo’s financial expertise. He did not disclose whether there will be workforce reductions, but he did note that PXP does not operate internationally, and the overseas assets likely will be sold. Pogo’s talent, however, will find a place at PXP, he said.

“Pogo is long technically, geologically, engineering-wise. They are a disciplined group,” he said. “We plan on embracing that and finding more barrels for PXP shareholders.”

Under the terms of the agreement, Pogo stockholders will receive 0.68201 shares of PXP common stock and $24.88 of cash for each share of Pogo common stock, which represents a total consideration of $60/share of Pogo. Total consideration for outstanding Pogo shares is 40 million PXP shares and $1.5 billion in cash. The transaction is expected to qualify as a tax-free reorganization and is expected to be tax-free to Pogo stockholders.

The boards of both companies have unanimously approved the merger agreement and will recommend the transaction to their respective stockholders for approval. In addition, Van Wagenen and Pogo’s other major shareholder Third Point LLC have agreed to vote their shares in favor of the proposed transaction, which still remains subject to stockholder approval from both companies and other customary conditions.

After closing, PXP stockholders will own about 66% of the combined company and Pogo stockholders will own the remaining 34%.

Flores will remain chairman, president and CEO. PXP CFO Winston M. Talbert, General Counsel John F. Wombwell and E&P Executive Vice President Doss R. Bourgeois also will continue in their current capacities. Two members of the Pogo board will join the PXP board at closing.

Lehman Brothers Inc. acted as financial adviser to PXP. Goldman, Sachs & Co. and TD Securities Inc. acted as financial adviser to Pogo.

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