Oklahoma City-based Kerr-McGee Corp.'s (NYSE: KMG) purchase of Rockies gas producer HS Resources Inc. (NYSE: HSE) will boost its portfolio of low-risk U.S. natural gas reserves. In a transaction value of $1.7 billion, Kerr-McGee will pay $66 per share of HS and assume approximately $450 million of debt, gain proved reserves of 1.3 trillion cu. ft. of natural gas equivalent (Tcfe) at a cost of approximately $1.10 per thousand cu. ft. equivalent (Mcfe). In addition, Kerr-McGee picks up a gas-gathering system, undeveloped acreage and other assets valued at approximately $300 million. HS also has 800 billion cu. ft. equivalent (Bcfe) in probable and possible reserves. The acquired reserves, predominately in the Denver-Julesburg (D-J) Basin of northeastern Colorado, will increase Kerr-McGee's proved U.S. gas reserves 77% and domestic gas reserve life from 7.5 to 9.5 years. Its total proved reserves will grow 20%. Kerr-McGee chairman Luke Corbett said HS' D-J operation is "a gas machine" that will provide his company with predictable growth and consistent cash flow, and offset risk from its deepwater portfolio and other global assets. "The addition of the 1.3 Tcfe of proved U.S. gas reserves balances our product mix. It balances our U.S. versus international split. And it balances our onshore versus offshore exposure while providing low-risk development opportunities of substantial probable reserves," he told investors and Wall Street oil analysts in a conference call. After closing the transaction, Kerr-McGee's total daily production is expected to increase about 15%, with daily production of U.S. gas climbing more than 45%. Because of the low-cost operations in HS' core area, Kerr-McGee's total unit lifting costs are expected to decrease about 6%. The company expects the transaction to be immediately accretive to both earnings and cash flow per share. The companies plan to close the deal during the third quarter. One of the co-founders of HS is expected to join the Kerr-McGee board. HS chairman Nicholas J. Sutton said the company had initiated board-level discussions about strategic alternatives because of the drive for consolidation among independents and the ongoing value discounts faced by small-cap companies. Lehman Brothers acted as the company's financial advisor. "Frankly, the Shell tender for Barrett sent shock waves through our sector," Sutton said, referring to the high-profile attempt by Shell Oil Co. to acquire Rockies gas producer Barrett Resources and the winning bid from The Williams Cos. HS' stock jumped $11.15 to close at $64.43 the day the merger was announced. Kerr-McGee shares dropped 48 cents to close at $70.09. Mike Scialla, an analyst with A.G Edwards & Sons who used to work for HS Resources, said the Kerr-McGee offer of $66 a share was within his net asset value estimate of $65 to $70 per. "I think it was a good deal for HS shareholders in that the market wasn't giving them full value for their reserves, and that was the quickest way to realize that value," he said. Scialla mentioned Patina Oil & Gas Corp. (NYSE: POG), Tom Brown Inc. (Nasdaq: TMBR), Prima Energy Corp. (Nasdaq: PENG) and Evergreen Resources Inc. (NYSE: EVG) as other gas-focused, potential takeover targets. Steve Enger, who covers Kerr-McGee for Petrie Parkman & Co., did not change his $85 price target for the company or his Buy rating, citing only a small impact on near-term earnings. He said the company paid a fair price to get some nice, long-lived assets. "Really what this does for Kerr-McGee in the end is it increases the gas content of their production and reserve mix," he said. "And I think another important element strategically is it provides Kerr-McGee long-lived assets in the D-J basin that I would expect to provide free cash flow for a long period of time." Jay Wilson, who covers Kerr-McGee for JP Morgan Securities, said the company got a better deal for HS than Williams did for Barrett. "HS has a lot of upside that comes with the transaction that should accrue to the Kerr-McGee shareholders. The 800 Bcfe in possible and probable reserves could reduce the purchase price to well below $1 per Mcf," he said. Wilson raised his target for Kerr-McGee to $80 from $77. -Jodi Wetuski

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