Following a review of financial forecasts, the boards of directors of Oklahoma City, OK-based Quest Resources Corp. and Pinnacle Gas Resources Inc. have unanimously approved an amendment to their previously announced stock-for-stock merger agreement.

Under the terms of the amended and restated agreement, Pinnacle stockholders would receive 0.5278 shares of Quest common stock for each share of Pinnacle common stock they own, down from the 0.6584 shares specified in the initial agreement. Pinnacle stockholders would own 39.5% of Quest, down from 45% under the initial agreement. Quest’s current stockholders would own approximately 60.5% of Quest following the merger, up from 55% under the initial agreement.

When the merger was first approved last year, the combined company’s equity market capitalization was expected to be approximately $450 million and Pinnacle stockholders looked forward to receiving Quest common stock worth approximately $207 million (see Daily GPI, Oct. 17, 2007). Since then share prices, particularly of Pinnacle, have slid, leaving the estimated equity market capitalization of the combined company at approximately $277 million. Pinnacle shares have tumbled 59% from a high of $8.75 in May 2007 and approximately 35% since mid-October.

Quest said it initiated discussions on reducing the previously agreed upon exchange ratio after reviewing updated Pinnacle financial forecasts, including sensitivity analyses. The Pinnacle board agreed to the reduction based on its view that an adjustment would enhance Quest shareholder support for the merger while remaining attractive and in the best interest of Pinnacle’s stockholders. With the downward revision, Quest agreed to other changes in the merger agreement that enhance Pinnacle’s deal protections.

“All of the reasons that originally caused us to enter into the merger agreement with Pinnacle remain in place,” said Quest CEO Jerry D. Cash. “The combination will create a geographically diversified, CBM [coalbed methane]-focused company with significant reserve potential. In addition, Pinnacle will provide the combined company with significant unconventional resource opportunities that can be developed to support the growth of Quest Energy Partners LP.”

The agreement also reduced the size of the board of directors of the combined company from seven to six, with four designated by Quest and two designated by Pinnacle. Under the initial agreement Pinnacle was to have designated three members of a seven-member board.

It is anticipated that the closing of the merger will occur by midyear.

The merger is opposed by the money management firm Advisory Research Inc., which claims to hold approximately 8.2% of Quest’s outstanding shares. In a recent letter to the Quest board, Advisory Research officials said they “cannot understand why the board would pursue this course of action in the face of such tangible evidence of stockholder harm.” If the merger is completed, Advisory Research said it will seek to purchase a total of 10% or more of Quest shares, enough to be deemed an “interested stockholder,” and then possibly force the sale of the company to a third party.

Under terms of the deal Sheridan, WY-based Pinnacle, a developer of CBM, would survive as a wholly owned subsidiary of Quest. Pinnacle focuses on the development of CBM properties in the Rocky Mountain region. It holds CBM acreage in the Powder River Basin in northeastern Wyoming and southern Montana, as well as in the Green River Basin in southern Wyoming. Pinnacle owned natural gas and oil leasehold interests in approximately 478,000 gross (332,000 net) acres, 94% of which were undeveloped, as of mid-year 2007.

Quest Resources said it is the largest producer of natural gas in the Cherokee Basin, which is located in southeast Kansas and northeast Oklahoma. The company operates more than 1,800 producing wells, with production flowing into its 1,800-plus mile gathering pipeline system. Quest said it currently has more than 1,700 locations in its drilling inventory.

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