Decades ago, upstream mergers and acquisitions were made fairly swiftly. Today, they are sophisticated transactions that take on personalities of their own. By 1981, a century of building and selling U.S. oil and gas E&P companies had already past, and the energy-sector M&A space had been mostly limited to isolated cases of intrigue, many of them from the days when Standard Oil encouraged small producers to quit. That spring, however, then-Oklahoma-based Conoco Inc. received a series of friendly and unfriendly take-over bids, some of them nibbles and some hard bites, that resulted in the eventual acquisition of the integrated oil company by the DuPont conglomerate. It began with an unfriendly bid from Canada-based Dome Petroleum Ltd. and led to offers by Mobil (unfriendly), Texaco (friendly) and even Canadian liquor company Seagram (unfriendly), as well as interest from Marathon Oil and Unocal. While the contest was fascinating within the energy sector, it was important outside it too, as it was "the very first of the many mega-mergers that captivated the business world in the 1980s," Russ Banham writes in Conoco: The First 125 Years. Archie Dunham, who eventually became chairman of Conoco and recently retired, tells Banham, "...We were looking for any strategy that would keep us independent." The law at the time was that a liquor manufacturer could not own a liquor retailer. "I remember calling our regional marketing reps and saying, 'You don't know me, but we're working on a strategy to save our company, and I need you to go to Jake's liquor store on the corner of Main Street and 8th and prepare an estimate of what you think that store is worth.' Of course, we had no experience in this regard, but we were frantic." When Conoco went to DuPont for $7.4 billion, the merger was the largest yet in U.S. history. But in showing how the company has grown since, this spring ConocoPhillips paid nearly five times that much in cash and stock for Houston-based independent Burlington Resources. Its market cap at press time was more than $100 billion. Of course, the industry was no stranger to mergers at that time. In 1980, there were 31 major oil companies remaining out of 43 in 1950, according to Connecticut-based energy-research firm John S. Herold Inc. In the early 1980s alone, there were 10 combinations among these 31 companies. By early 1999, there were 15 companies remaining. Among those, in May 2006, 11 remain. "The early 1980s saw 10 major acquisitions by integrated oils that resulted in the extinction of such once-famous names as Gulf Oil, Standard Oil of Ohio (Sohio), Getty Oil and Cities Service as well as some large producers, including Superior Oil, Aminoil and General American Oil," Herold analysts report. Changing motivation "In those long-ago times, the major oils were flush with cash in a high-oil-price environment, while equity prices were languishing at the tail end of a 10-year bear market. Many companies saw their share prices trading at below replacement cost of the assets, allowing well-heeled buyers an opportunity to make cost-effective, cash acquisitions." The late-1990s consolidation wave among the major oils was done for improved economies of scale and negotiating clout: while BP could get an appointment with the head of OPEC in 1998, the combination of BP-Amoco-Arco could get an appointment with the king of Saudi Arabia. Thus, this made Exxon seem small, but its combination with Mobil put it back on top of important energy decision-makers' Rolodexes. Then, clamoring to still be heard around the world, Chevron needed to combine with Texaco and then Unocal, and Conoco needed to combine with Phillips, and Total SA needed to combine with Petrofina and Elf Aquitaine. Putting further pressure on the publicly held oils to grow exponentially and fast, was the departure of many national oil companies from within their native boundaries. For example, the huge Brazilian oil company Petrobras went public in 2000 and has been drilling across the globe. Chinese oil companies PetroChina Ltd. (2000) and CNOOC (2001) each went public, and are showing up at M&A tables and exploration-license rounds worldwide. Tom Petrie, chairman, president and chief executive officer of Petrie Parkman & Co., says the first hints of modern upstream M&A activity really appeared in the late 1970s. "The value disparity became so big in 1981, 1982 and 1983, it became very attractive for capital players to assemble positions," he says. Petrie joined First Boston Corp. in 1977 and was involved in more than $70 billion of energy M&A transactions with the firm, including the Marathon Oil/U.S. Steel combination, DuPont/Conoco, Occidental/Cities Service, Texaco/Getty Oil and BP/Sohio. In the 1980s, there were few poison-pill and other protections against unfriendly takeover bids and managements were not as adroit at countering offers, so mergers could be achieved fairly quickly. "Today, a hostile takeover is hard to do," he says of the maturation of the upstream energy M&A space. Through the bust of the 1980s, merger activity settled down, and asset-oriented transactions swelled through the 1990s. Many assets were handed down by the major oils to independents, many of them newly started. While the majors were posturing for seats at international tables, U.S. independents were posturing for invitations to majors' divestment data rooms. Independents saw their relationship to the U.S. major oils change dramatically as the last quarter-century unfolded. At the dawn of the 20th century, the integrated oil (Standard Oil) was rapidly buying up independents; approaching the 21st century, the majors (including the daughters of Standard Oil) were rapidly selling their upstream assets to U.S. independents. With this sea change, hundreds of new independents were born, M&A advisory firms were formed, public-equity markets were tapped, and private-equity providers were launched. Ken Dewey, a founder of Houston-based asset-transaction advisory firm Randall & Dewey, now part of investment-banking firm Jefferies & Co., was among those who took knowledge from a major oil and transferred it into entrepreneurial business. He and partner Jack Randall were both with Amoco prior to forming Randall & Dewey in 1989. The firm they founded was a play on the majors' coming asset-rationalization programs at that time. Dewey says, "The majors' decisions to trim their own portfolios was a key to the growth of many independents. What has emerged is a new set of very aggressive independents that have been able to grow at a rate no one would have been able to foresee, due to acquisitions." High-risk wildcatting is pretty much all that would have been left for independents after the 1980s, and most of the capital providers weren't financing exploration. The assets the majors put on the market varied in quality. "If you talk to the majors about what they did in the late 1980s and early 1990s, they will say they cleaned up the lower end of their portfolios. "They did end up later in the 1990s selling some really high-quality assets too, as they focused on trying to improve their return-on-capital measures. That forced them to sell some properties they had invested a lot in but weren't generating the book returns they needed." Some of the assets that came onto the market had huge potential. "The majors acknowledged they had some properties they hadn't looked at. With staffing constraints, they had chosen to neglect certain assets." Another phenomenon occurred in the 1990s, Dewey notes. "This was the realization by the independents that their assets were a means to trade in oil and gas. They could resell those assets or the company after a few years at a huge profit. "There was a trader mentality at work in the private sector. And then there were some very good public companies that were born that demonstrated that even in a public environment, with buying the right long-lived properties, there was potential." PrivatE Fuel Tulsa independent Randy Foutch did this with private companies. He founded Midcontinent-based Colt Resources in the early 1990s, sold it, founded Lariat Petroleum, sold it for $330 million, and this spring sold his third company, Latigo Petroleum Inc., to Pogo Producing Co. for $750 million or $2.73 per thousand cubic feet equivalent of proved reserves in the Permian Basin and Texas Panhandle. "Working for us in the 1990s was the attractiveness of this industry to the private-equity markets," Foutch says. With Lariat in particular, he used some divestments by major oil companies in Oklahoma to add to his exploration plans. "Lariat was principally a 3-D exploration company, but we saw acquisitions we could make where we could add significant upside through the drillbit. Latigo was more balanced between drilling and acquisition." Glynn Roberts, president of Houston-based Northstar Interests Inc., started his independent foray in the Gulf of Mexico in the 1990s, starting with producing-property purchases, mostly financed with bank debt. In fewer than 12 years, Northstar has grown into approximately $250 million of assets, and now draws upon private-equity capital from Natural Gas Partners as well as commercial bank capital. "3-D seismic put a lot of pressure on companies to find reserves where they didn't find them before," Roberts says. "This meant not as many properties became available to acquisition-minded companies-owners were holding onto their properties, whereas they had been dumping reserves they didn't know they had. "The liquidity of the reserves market allowed many companies to grow. Without it, the bigger companies would have been restricted to looking for international assets and holding onto their U.S. assets. Because they were willing to sell while they looked overseas and in deep water, it spawned a whole group of growth-minded independents." An increasing use of price-risk management tools smoothed commodity-price ups and downs, helping to avert 1980s-style disaster when prices collapsed in 1998-99. But these didn't always work out as well as hoped. "There were several time periods when prices fell when we didn't think they really could, and we didn't understand hedging products," Roberts says. "Some of us got into situations where we lost some money because we didn't understand them as well as we should have. "One of the things we didn't understand very well was hedging and how swap agreements or other products come into play when there are deliverability issues, such as when there is damage to onshore processing facilities and pipelines." Bob Israel, a partner with New York-based M&A and investment advisory firm Compass Advisers LLP, entered the upstream energy finance space in the late 1970s in Chase Manhattan Bank's petroleum division-and then worked at Lehman Brothers, Dillon, Read & Co. and Schroder & Co. Inc. He has viewed M&A trends in the sector across a multitude of cycles. "It's different and it's the same," he says of activity now. "There has been so much consolidation in the industry, the players have changed, but the business is the same." Commodity prices climb, prospective buyers have more cash flow and credit capacity to deploy, they pay higher prices for assets, eventually commodity prices soften, and some producers are exposed in a downward spiral of balance-sheet contraction. Just in May, there was a sudden and sharp market correction of the price of upstream stocks, rattling some executive suites. For example, Plains Exploration & Production offered $1.94 billion in April for Stone Energy Corp. A month later, the all-stock deal value was worth $1.68 billion, according to A&D Watch newsletter. The correction in turn has prompted an unsolicited cash-and-stock offer for Stone from Energy Partners Ltd. Israel says, "If demand softens and the political environment moderates, we could see a significant correction in commodity prices, and in stock prices, and this will make new opportunities for M&A." And, prices will soften, he adds. "I'd be surprised if it doesn't happen in the next two years." Of course, his favorite deals over the years have been his own, he quips. A recent high-profile assignment was advising Lukoil on a major strategic partnership with ConocoPhillips that included an initial $2.5-billion equity investment by Conoco in Lukoil, and a joint venture in Timan Pechora, Russia. Another noteworthy task was advising Conoco Inc. in its spin-out from DuPont, which was the largest IPO in U.S. history. A notable deal in which he was not involved was ConocoPhillips' recent purchase of Burlington Resources. "That may be a good deal, but it really depends on long-term natural gas prices. The deal was struck when gas was about $15 per thousand cubic feet. Natural gas is now closer to $6." One in the late 1990s that comes to mind that didn't work out was Arco's purchase of Union Texas Petroleum. "It was a top-of-market acquisition and a key element in driving Arco into the hands of BP. There have been a lot of deals over the years that haven't worked out for the buyers. At the same time, there have been many more that have, when well-capitalized buyers stepped in at low points in the cycle." Petrie says the M&A cycle is finding its roots. "Most recently, we're starting to see the focus reverse back up the food chain." While transactions had mostly been among major oils, and some of their assets were offered to independent oils, recently a couple of majors have taken in some large independents. For example, in the past year, Chevron Corp. bought Unocal and ConocoPhillips bought Burlington Resources. Another recent spike in the U.S. upstream M&A temperature is the Energy Partners Ltd. counter-offer for Stone Energy Corp., raising the stakes against Plains Exploration & Production's initial ante. In this case, two independents are publicly vying for another. "We're now in territory in which each transaction takes on its own personality," Petrie says of M&A transactions today versus those of decades ago. "In the past, deals followed a fairly predictable pattern." Today, each is specially structured for shareholders' goals and how the assets fit the buyers' profile. As for bad deals over the years, he has seen some, but "even bad deals to some degree are mitigated by commodity prices. Some deals don't measure up organizationally, but I look back now and there aren't a lot of deals I would consider really poor fits." The biggest challenge in successful M&A today is in retaining talent. "The ability to keep the strategic management of the acquired companies is very difficult. Acquiring parties have to recognize that, if a goal is to keep senior management, that's maybe not a realistic goal and can lead to disappointment." Foutch says there is still tremendous potential remaining in U.S. basins for independents. For example, in the Anadarko and other basins of the Midcontinent "we haven't penetrated half the depths in any meaningful way. Costs are an issue but we are a long ways, in my opinion, from having drilled-out the U.S. gas basins." Dewey says the generous amount of private money in the business today is driving the creation of a large number of new private companies that will be buyers. "With the rising price environment of the past few years, we see new players entering the field and creative instruments being introduced. All this is contributing to a high level of activity and transactions: large hedge funds are allocating 5% to 10% of their portfolio to energy, there is a growing number of volumetric-production-payment buyers, venture capital firms are raising record amounts, and the AIM market in London creates new opportunities for companies venturing into new regions." Israel expects commodity prices will be pushed down by the eventual realization that China will not be as rapacious a player in the global energy picture as it is projected to be, high prices globally impact demand, and new sources of energy-liquefied natural gas and heavy oil-hit the market. "The Chinese economy will not grow at a vertical pace forever. Trees do not grow to the sky," he concludes. Petrie expects, for the next five years, more asset transactions than corporate deals. "On the merger side, we've seen an exhaustion of logical combinations." And, he expects many of these upcoming asset transactions will involve resource plays, such as the Devon Energy Corp. capture of Chief Oil & Gas and its Barnett Shale position, and the past few transactions involving Bakken Shale assets.

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