While analysts consider Devon Energy Corp.’s planned acquisition of PennzEnergy Co. a smart move, PennzEnergy investors are smarting over what they consider too low a price.

Houston-based PennzEnergy and Devon of Oklahoma City, OK, announced the transaction last week. The deal would form a new Devon Energy Corp. PennzEnergy shareholders would receive 0.4475 shares of common stock of the new company for each PennzEnergy common share. Each share of Devon would be converted to one share of new Devon. PennzEnergy shareholders would own about 31% of the combined company, and Devon shareholders would own about 69%.

PennzEnergy, the exploration and production arm of Pennzoil, was spun off in December when Pennzoil Products Group merged with Quaker State. Previously (in 1997) Pennzoil was sought by Union Pacific Resources (UPR), which offered $84 a share for the company. Management rejected the offer and investors saw Pennzoil’s share price drop about 60%. “I think some of those shareholders still remember the UPR offer, and that was a missed opportunity,” said Sanders Morris Mundy analyst Irene Haas. “However, just to put things into perspective, oil prices have gone through a long period of contraction through ’98. This is definitely a buyer’s market.”

In January J.P. Morgan analyst Jay Wilson called PennzEnergy an attractive takeover target for a large independent producer or integrated energy company because the company’s stock was significantly undervalued. But at the time PennzEnergy’s management said the company was not for sale (see NGI Jan. 11, 1999).

Analysts participating in a Thursday conference call with managements of both companies had enthusiastic cheers for Devon, but a couple had sharp words for the deal and PennzEnergy Chairman James L. Pate. “You made it clear that you not only were not willing to shop the company but that you did everything to avoid doing that,” one analyst told Pate during the call. “And other than your [continued] current employment, I don’t feel we gain as PennzEnergy shareholders. I will tell you that we definitely will be voting against the deal.

“What Mr. Pate has done here has been a pattern for a couple of years. abrogating his obligations to shareholders here is clear. And we will be voting against this transaction. I think that everyone looking at this should not be assuming this combination is going to go through because what was done here is wrong, and I’d ask Mr. Pate why you would have so clearly avoided the potential to explore what alternatives would be available in a sale before making this decision.”

Pate countered that alternatives were explored, “but our alternatives were not to sell the company. We looked at a number of merger opportunities, strategic mergers, acquisitions and other opportunities to grow the company. The company is not for sale, and this appeared to us to be a very, very attractive opportunity to get a very solid asset base in North America, to be a major player in the North American gas market, to de-leverage the company and gain financial flexibility and to get a management with a demonstrated track record of delivering shareholder value. [Devon’s] valuation, of course, is much higher than ours. Their cash flow multiple is much higher, and part of this transaction anticipates that PennzEnergy is going to get an uplift in its valuation as a result of all the things that I mentioned.”

The analyst was not placated. “The rights of shareholders and shareholder value has never been something that’s important to you, and I don’t say that lightly.”

Similar displeasure could be found on an Internet message board devoted to PennzEnergy. “Pate is not to be trusted, but he sure is smart enough to take care of himself. Chairman of the board of the combined company is bound to make him a few bucks,” wrote one poster. Another fretted that the deal links the price of PennzEnergy shares to that of Devon shares. “If [Devon’s] stock drops back to its normal valuation, do not underestimate the potential financial fiasco to [PennzEnergy] shareholders.”

The deal would create an international oil and gas company with an equity market capitalization of about $2.6 billion. Total enterprise value would be about $4.7 billion. The company would rank in the top 10 of all U.S.-based independent oil and gas producers in terms of market capitalization, total proved reserves and annual production. The combined company would have proved reserves of about 2.1 Tcf of gas and 318.5 million barrels of oil, or 660 million Boe, and would have core operations onshore U.S., in the Gulf of Mexico and in Canada and substantial international assets, highlighted by interests in Azerbaijan. The merger is expected to be non-taxable to shareholders. Boards of each company approved the merger, which is subject to shareholder and Federal Trade Commission approval. The combined company would be headquartered in Oklahoma City, with operating offices in Oklahoma City, Houston, Denver and Calgary.

The deal’s critics found suspicious the timing of a Kerr-McGee announcement that it is reviewing its investment in Devon Energy. Kerr-McGee holds 9,954,000 shares, about 20%, of Devon common stock. Kerr-McGee executives Luke R. Corbett, Tom J. McDaniel, and Lawrence H. Towell last week resigned from the Devon board of directors. Kerr-McGee’s shares in Devon are subject to transfer limitations set forth in Devon’s December 1996 standstill agreement with Kerr-McGee, Devon said. In 1996, Kerr-McGee’s North American onshore assets were merged into Devon.

Devon and PennzEnergy executives said the Kerr-McGee executives were excluded from merger negotiations and were finding out about the deal concurrent with the investment community. A Kerr-McGee spokeswoman would not comment.

Combined, Devon and PennzEnergy expect to realize cost savings of $50-$60 million annually. Reductions are expected in operating, general and administrative, interest and exploration expenses. J. Larry Nichols, Devon president and CEO, will be president, CEO and a director of the combined company. Pate will serve as chairman of the board. Devon’s executive staff will remain. PennzEnergy will contribute selected executive staff. Devon and PennzEnergy will each appoint seven members to the combined board of directors. John W. Nichols, Devon’s current chairman and Larry Nichols’ father, will serve as chairman emeritus.

Although he participated in the conference call, no mention was made during the call or in the press release of PennzEnergy CEO Stephen D. Chesebro’ and his future with the company. “I get the feeling that Cheesebro (sic) is dead set against this merger,” posited one investor posting on the Internet. “I think Pate is the only one who thinks this is such a great idea.” A PennzEnergy spokeswoman reluctantly told NGI that Chesebro’ – who previously was CEO of Tenneco Energy before it was spun off from Tenneco Inc. and bought by El Paso-will be leaving the company to pursue other interests.

The combined Devon and PennzEnergy will benefit from Devon’s strong balance sheet, finding and development expertise and PennzEnergy’s inventory of development opportunities, analysts and company executives said. Highlights of the combined company include a proved reserve base of about 660 MMBoe (52% gas); U.S. proved reserves of 423 MMBoe; Canadian proved reserves of 144 MMBoe; net daily production of 230,000 Boe (60% gas); and a large inventory of exploration opportunities with an aggregate 15 million net undeveloped acres of leasehold. Devon is a top coal-bed methane producer with a strong presence in the Powder River Basin. PennzEnergy has large coal-bed holdings in the Raton Basin.

“For [PennzEnergy, Devon] will bring a sound balance sheet, great management and the much-needed capital to accelerate production growth. [PennzEnergy] does not have the balance sheet to fund the drilling without the merger,” Sanders Morris Mundy’s Haas said in a research note.

The merger is expected to be accounted for as a purchase, and the combined company expects to take a charge to earnings of between $350 and $500 million for accounting adjustments. Completion of the merger is expected in the third quarter of 1999.

PennzEnergy shares closed down 12.5 cents Thursday following the announcement at $14.50 in trading that was nearly nine times normal volume. Devon shares closed up $2.25 at $33.75 in trading that was nearly five and a half times normal volume.

Joe Fisher, Houston

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