Financial, legal and other advisory experts who facilitate energy deal-making eventually conclude, "After making sure deals close for others and watching E&P clients reap the benefit, I should give this a try myself." But if that idea gains much traction, then they realize it is time to bring in more operational fire power.

In particular, the light goes on when completion of a successful merger or acquisition transforms their fledging E&P company into so much more.

Such is the case now with Houston-based Dune Energy Inc., which started in 2003 from scratch.

In a negotiated transaction this past spring, followed by an oversubscribed capital-raise, small-cap Dune acquired Goldking Energy Corp., a private E&P company backed by Natural Gas Partners, for $302.5 million in cash and approximately 10 million Dune shares valued at $18 million.







At the beginning of this year, the combined entity's pro forma production was about 29 million cubic feet a day, but that should reach nearly 60 million a day by year-end. Pro forma reserves are 142 billion cubic feet equivalent.

The deal brought a number of good things to Dune, which had proved reserves of about 30 billion cubic feet equivalent (Bcfe). For starters, it added another 112 Bcfe of proved legacy gas reserves in Louisiana and on the Texas Gulf Coast in 23 fields with 136 producing wells, 100% operated, 55% gas. In addition to the proved reserves, of which 36% are proved undeveloped (PUD), management has identified an unrisked net 35.5 Bcfe of probables on 14 locations.

Second, the deal brought a new chief operating officer, Hal Bettis, who had been with Goldking. Third, at about the same time, Dune hired a new chief executive officer and president: James A. Watt, an informal advisor to the Goldking deal who joined the company as soon as the purchase-and-sale agreement was signed. He went immediately on the road, joining chairman and founder Alan Gaines to raise money for the transaction.

Watt jokes, "We're like the dog that caught the bus-now what do we do with it?"

He knows. The geophysicist and ex-Amoco employee turned troubled family firm Box Energy in Dallas into Remington Oil and Gas Corp., which was sold last year for nearly $1.4 billion. His assignment at Dune? Execute the program well, post-merger, and add an exploration component in 2008. "The market knows my track record. I've probably drilled a dry hole in every basin in North America," Watt says, laughing. "But I have drilled a few good ones too."

Gaines' role is to keep looking for the next acquisition. "It takes a long time to find a deal, but Alan has a nose for it. He pursued Goldking for eight months, and it wasn't really for sale. Right now, we need to show the market we know what we are doing."

Gaines says of the new team, "We needed a CEO and a COO who had experience with South Louisiana's challenging geophysics and are young enough that they would want to stay here at least five years. Jim was that guy. Hal was that guy."

An investment banker who formed Gaines, Berland Inc. in 1983 in New York, Gaines also advised financier Carl Icahn on energy deals in the 1980s and 1990s. After selling his interest in his namesake firm in 1998, he formed Dune in late 2002, believing commodity prices would trend higher.

Dune was growing slowly but surely, adding acreage and production in the Barnett shale fairway in Denton and Wise counties where it has two rigs drilling, and at Welder Ranch in South Texas and the Bayou Couba salt dome field in St. Charles Parish in South Louisiana. It had made several small acquisitions to get started, including for $30 million in the Barnett.

It also has a development agreement with American Natural Energy Corp. and ExxonMobil at Bayou Couba where the partners completed a 3-D seismic shoot in the first quarter. "Depth migration is now under way. We could be looking at Ts (trillions of cubic feet) of gas, some of which are subsalt, so we have high hopes," Gaines says.

Gaines had known Goldking CEO Leonard Tallerine for about 15 years. About midway through a friendly dinner, it occurred to Gaines, "Why don't we buy this company?"

One problem, which did not daunt him, was the outsized nature of his idea. At year-end 2006, Dune's size was about $35 million on a PV-10 basis, whereas Goldking's was about $570 million (based on the 12-month strip this past spring). But Gaines knew the folks at Jefferies Randall & Dewey in Houston and approached them specifically to help accomplish this merger.

"We bought a company almost 15 times our size if you look at the PV-10 at the time of the deal. Or another way of looking at it, our public market cap was about $110 million at the time we announced the deal, but we bought a private company for $320.5 million," Gaines says.



The deal

The transaction had many moving parts. "It could have died, and almost did, about 10 times," he says. He credits the investment bankers at Jefferies, including Rich Goldenberg, and at its Houston unit, Jefferies Randall & Dewey, including George Hutchinson and co-presidents Ralph Eads and Claire Farley, for managing the process.

"We raised $216 million of convertible preferred stock and $300 million of senior notes-but we started out with $145 million and $285 million, so we were nicely oversubscribed." Jefferies was the sole underwriter. Gaines and Jefferies agreed to stop the road show ahead of schedule, since it was oversubscribed and had already been upsized.

"What many people may have glanced over was the fact that we made a $15-million good-faith deposit on the offer and we had to take out a senior lender. Who would do that? The solution was, for the second time in their corporate history, Jefferies took the money out of its own capital to the tune of $65 million-which was about a quarter of its 2006 net income. So they really stepped up to the plate for us," Gaines says.

Petrobridge Investment Management had been the original senior lender to Dune before this transaction, stepping outside the box a few times, in Gaines' words, to assist in its growth. At closing, Natural Gas Partners took $18 million in Dune common stock, "kind of unusual for them. This was their incremental return, if you will, and it validated the transaction," Gaines says.

Overall, there were no material restrictive covenants and no amortization such as a bank would have required, so Dune could deploy its cash from the offering 100% on the Goldking purchase and subsequent drilling. "That was very attractive to us. This was a middle-market, high-yield deal, which is Jefferies' forte."

Gaines remains chairman of Dune, but he has a new trio around him-Watt, Bettis and chief financial officer Frank Smith, formerly with Remington. Former Dune COO and president Amiel David remains on the team as a senior advisor to the board and works closely with Gaines on M&A ideas. Two former Remington board members also joined Dune's board.

"I am not an operator. I'm a financial person," Gaines says. With the company leapfrogging in size with the Goldking deal, he knew it was time to bring in someone with strong operating experience.

Enter Watt, who had grown Remington to 278 Bcfe of proved reserves in the Gulf of Mexico. Remington was acquired last year by Helix Energy Solutions Group Inc. for $1.24 billion.

After that, Watt, a New Hampshire native, had joined Florida-based micro-cap Maverick Oil and Gas Inc. to do a turnaround there. He restructured and paid down the debt. During that time, he met with the Jefferies team, and through them, met Gaines. They began to discuss a plan to do a three-way merger of Dune, Goldking and Maverick, but the conversation soon evolved to just Dune and Goldking. He left shortly after that to join Dune.

Dune's situation is not that of a turnaround, but one of a fledgling E&P company buying one much larger. "Dune is not a distress situation; it's a buy-and-build," says Watt. "The Dune opportunity has a lot of similarities to the Box-Remington thing. It's a larger entity, but this group of properties is capital- and technology-starved. In the near term, it's mostly PUD drilling, then we'll expand to deeper drilling.

"Alan is a fascinating guy. He started this company with a few million dollars of his own money and no assets. He really bootstrapped this to where it is now. When he came across the Goldking assets, he recognized the opportunity."

Gaines also recognized it was time to bring strong operational management onboard.

"I had known of Jim, but I did not know him personally. I was putting out feelers for a new CEO and Claire Farley suggested Jim. They brought us together." Jefferies had represented Remington in its sale to Helix, and introduced Gaines to Watt. "We had a similar world view. He's an operator and I am the financial guy, so our skillsets are complementary."

The complexities of operating in South Louisiana had not escaped Gaines. In addition, he knew that Gulf Coast properties were still out of favor with The Street-so were a buying opportunity. Watt, meanwhile, was good at integrating aspects of mergers since he had done several at Remington, and most of his 35 years of experience have involved South Louisiana and offshore operations.

Today, post-merger, the company has about 65 employees, and most of Goldking's competent technical staff was part of the allure for Dune.

"This company is not just about drilling the Barnett shale; South Louisiana is complicated," Gaines says. In the Barnett, Dune now has about 8,000 acres, most of which are in the fairway, with at least 115 locations left to drill, more with down-spacing to 20s. The Barnett offsets the more challenging environment of South Louisiana, in Gaines' view, and ameliorates some of the risk.

The company will spend about $60 million in the Barnett and has about $100 million in cash. "We want to show The Street we can intelligently deploy that cash and successfully drill and operate wells," Gaines says.



Going forward

In September, Dune assumed full operatorship of Bayou Couba Field and purchased an additional 12.5% working interest in its approximately 11,500-acre area of mutual interest, for $3.5 million. That brings the company's working interest to 37.5%. At press time, Dune was expecting to soon spud Fee #5, a 12,000-foot well aiming for Middle Miocene sands. Based upon the company's 2006 year-end reserve report, gross reserves associated with this proved undeveloped (PUD) location total 4.6 Bcfe.

Dune will retain a 100% working interest in this well, based on prior agreements with the former operator as well as the fee owner. With its supermajor partner, Dune is participating in depth migration of the 3-D data set recently shot over the field, to better image deeper anomalies. Management expects to begin drilling these deeper projects in 2008.

At Garden Island Bay at the southern end of Plaquemines Parish, on an old salt dome, Dune has drilled six wells so far this year, has two presently drilling, and plans an additional two prior to year-end. Production is approximately 8 million cubic feet per day, with two wells awaiting production hookup. "We hope it will be similar to Swift Energy's nearby Lake Washington Field development, which has really vaulted them as one of the largest oil producers in the state," Gaines says.

At Chocolate Bayou in Brazoria County, Texas, Dune was expecting to spud Weitting 30 #1 at press time. Its 2006 year-end reserve report attributes 9.0 Bcfe of gross PUD reserves for Frio-age sands at this location. The well will be deepened to 14,200 feet to test the IP Farms sand interval, for which no reserves are presently booked.

Garden Island Bay intrigues Watt because it represents the kind of asset he wants to tackle for Dune. "Some 900 wells have been drilled in there, but none was below 15,000 feet. All these financial people [Goldking and the owners before that] focused on not taking any risks, just drilling the PUDs. It's what I call financial drilling," he says. "But I am an explorationist. We can drill deeper and test the whole geologic structure.

"The reserve report said there were $55 million of PUDs but we are going to spend an added $32 million on drilling what I would call deeper-pool tests or probables."

Because these deeper wells will go to about 13,000 to 14,000 feet, they are a calculated risk, he says, but not as much as the major deep drilling to 18,000 feet that is often associated with high-risk South Louisiana exploration. "We assume our drilling will come out of cash flow. We've increased our drilling program for this year, but we have not really changed the risk profile."

He says Dune will not necessarily limit itself to the Barnett shale and Gulf Coast region, but it needs to buy properties with a lot of upside.

"I still think the idea of drilling and finding new reserves is the way you build a long-term company," says Watt. "I like trying to build a company. I like the technical challenges. I learned some things at Remington that I hope to apply here."

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