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Investors can glean a bushel of information from an acquisition.
For instance, Anadarko Petroleum's (APC, news, msgs) recent purchase of Kerr-McGee (KMG, news, msgs) and Western Gas Resources (WGR, news, msgs) for $21 billion in cash tells you that Anadarko Petroleum thinks its stock is undervalued, that oil isn't headed back to $20 a barrel EVER, that North America, particularly the unconventional gas deposits in the Rockies and the reserves under the deep waters of the Gulf of Mexico are where the action is, and that it's cheaper to buy than to find new oil and gas. And that's a good roadmap for investors looking to buy natural-gas stocks this fall as they come off the bottom they've established in the second quarter of 2006.
Let's look at exactly what the Anadarko Petroleum buying binge tells us about oil and gas stocks.
- Anadarko Petroleum is paying cash -- for stock -- for Kerr-McGee and Western Gas Resources. Acquirers always have a choice of what currency to use in a deal and they always choose the currency that they think is cheaper. If Anadarko Petroleum thought its stock was fully valued or, better yet, over-valued, you can bet the company would have paid in stock, not cash. Anadarko Petroleum has been on an upswing with exploration and drilling projects since 2003, showing much better returns. Return on invested capital climbed to 16% in 2005 from a low of -3.2% in 2001. The structure of the deal says that Anadarko Petroleum's management feels that the stock market hasn't yet recognized the full value of that improvement (Anadarko's shares trade at a price-to-earnings ratio of just 7.8, compared to 10.3 for its average industry peer) and that better news is still to come (return on invested capital still lags the industry average 17.7% to 18.4%).
- Anadarko Petroleum is paying a price equal to about $20 a barrel of oil-equivalent proven reserves for Kerr-McGee and about $24 a barrel of oil-equivalent reserves for Western Gas Resources. Anadarko clearly believes the days of $20 oil are gone forever. On the other hand, Anadarko Petroleum just as clearly believes that we're not likely to see a huge spike in oil and gas prices over the next 18 months or so: The company has said it will hedge (locking in current prices) about 75% of the oil and gas production it will acquire in this deal through the end of 2008.
- Anadarko is paying much less per barrel of oil and gas if you add probable and possible reserves to proven reserves -- and there are a lot of reserves in those categories in these deals. According to the company, probable and possible reserves--categories that carry much less certainty than "proven" -- total 2.8 billion barrels of oil equivalent at the two companies being acquired. Put those reserves into the equation and Anadarko Petroleum is paying something like $12 -- not $20 or $24 -- a barrel of oil equivalent.
- Anadarko is buying gas reserves in Colorado, Utah, and Wyoming, and unconventional gas reserves in Wyoming -- coal-bed methane in the Powder River Basin and tight gas in Pinedale. Along with the purchase of Kerr-McGee's 504 deepwater blocks in the Gulf of Mexico, the deal constitutes confirmation that the Rockies are the hottest area for onshore gas exploration in the United States, and that oil and gas prices will stay high enough to justify the higher development and production costs that come with unconventional and deepwater Gulf of Mexico oil and gas reserves.
That's the profile of the assets that Anadarko Petroleum is buying, and with the company paying a 40% premium to the pre-deal share price, I think it's worthwhile to look for other potential acquisition candidates that fit this description.
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