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June 2006

Vol. 11, No. 26 Week of June 25, 2006

Energy Partners $2.2B bid trumps Plains

Small E&P independent agrees to acquire troubled Stone Energy following bidding war with upwardly mobile, Houston-based Plains

By Ray Tyson

For Petroleum News

Energy Partners Ltd, a small exploration and production independent in a hurry to get bigger, has agreed to acquire troubled Stone Energy for $2.2 billion in cash, stock and debt assumption, following a spirited bidding war with another upwardly mobile E&P independent, Plains Exploration & Production.

The deal purportedly would elevate New Orleans-based Energy Partners to the third most active driller of operated wells in federal and state waters in the Gulf of Mexico. The company’s market value would rocket to $1.95 billion from $696 million, a nearly 180 percent increase based on the value of each company’s closing share price on June 21.

June 23 deadline

Meanwhile, Stone notified Houston-based Plains that it had until June 23 to top Energy Partners’ bid or it was prepared to terminate an existing merger agreement between the two companies and accept the offer made by Energy Partners.

Energy Partners was clearly in the driver’s seat on June 21 going into PN’s weekly deadline. Stone’s board of directors considered Energy Partners’ offer to be a “superior proposal” to Plains’ $1.46 billion stock-for-stock bid and $483 million in debt assumption.

Tainted past

Regardless, Energy Partners or Plains would inherit Stone’s tainted past – in particular the company’s run in last year with the U.S. Securities and Exchange Commission for “overbooking” proved reserves, a definite no-no when it comes to the SEC, a conservatively-minded federal agency responsible for overseeing the affairs of publicly-traded companies.

Stone was forced to write down a significant portion of its 171 billion cubic feet of gas-equivalent proved reserves, a revelation that caused Stone shares to plummet almost 14 percent, resulting in a shareholders’ lawsuit against the company. Moreover, based on an internal review, Stone decided to revise company financial statements for the periods from 2001 to 2004 and for the first six months of 2005.

Stone insisted that the SEC decided to conduct an “informal inquiry” into the company’s affairs only after Stone management issued press releases in October and November 2005 announcing the reserve write-down and the decision to revise its financial statements.

Auditor critical of Stone

Nevertheless, Davis Polk, a member of a law firm retained by an audit committee to assist in its investigation of Stone reserve revisions, was highly critical of Stone management and the company’s relationship with the SEC.

In his final report to the audit committee and board of directors last December, Polk said he found evidence of an “optimistic and aggressive ‘tone from the top’ with respect to estimating reserves,” according to a press release issued by Stone. Polk also said the company “lacked adequate internal guidance or training on the SEC standard for estimating reserves.”

“There is evidence that some former members of Stone management failed to fully grasp the conservatism of the SEC ‘reasonable certainty’ standard of booking reserves,” according to the press release.

In addition to adopting Polk’s recommendations, including a pledge to provide training for its employees on SEC requirements, Stone said it would hire outside consulting firms to independently evaluate 100 percent of company reserves.

Canty resigns

On delivery of Polk’s final report, D. Peter Canty resigned from the company’s board of directors, Stone said, adding that the board directed management to “request the resignations” of an unidentified officer and a senior manager associated with the company’s reserve estimation process.

Adding to an already difficult situation, Stone’s Gulf of Mexico production was trashed by hurricanes Ivan, Katrina and Rita in 2004 and 2005. Stone reported that daily production of 194 million cubic feet of gas equivalent during the 2006 first quarter was down 25 percent compared to the same period last year due to hurricane downtime. However, 2006 first-quarter output was up 24 percent versus the 2005 fourth quarter due to partial restoration of shut-in production, the company added.

Nevertheless, Stone’s 2006 first-quarter profit of $24 million was down from the $33.4 million the company earned in the year-ago period, while revenues for the two quarters were fairly even at $158.4 million and $156.2 million.

Ideal takeover target

Stone evidently represented an ideal takeover target in the eyes of two suitors looking to further expand their growing businesses, Energy Partners and Plains. Actually, Plains was the first to step up to the plate with its $1.46 billion stock-for-stock deal, plus the assumption of $483 million in Stone debt.

In fact, Stone management liked the Plains offer so much it entered into a merger agreement with the company in April, complete with a pricey $43.3 million termination fee that would be paid by the company who broke the deal. “Stockholders of both companies will benefit from the robust portfolio of near term and long term growth opportunities,” asserted Dave Welch, Stone’s chief executive officer.

The Stone-Plains engagement held until mid-June when Energy Partners made its 11th hour, “definitive” $2.2 billion marriage proposal, consisting of $1.4 billion in cash and stock and the assumption of about $800 million in Stone debt. Energy Partners even agreed to pay Stone’s $43.3 million breakup fee.

Stone’s board of directors said Energy Partners’ offer was a “Target Superior Proposal” and that it would move to terminate Stone’s merger agreement with Plains, unless Plains came up with a better offer by the close of business on June 23.

“We are confident that the combination of Stone and EPL will create a premier E&P company capable of generating considerable upside value for shareholders of both companies based on our complementary fit and the significant cost synergies we have identified,” Energy Partners said in a June 19 statement.

Stone plans additional GOM buy

Meanwhile, Stone said June 20 it planned to buy additional stakes in two Gulf of Mexico blocks for $190.5 million, adding that it expected the deal to close in late June or early in the third quarter.

The acquisition would give Stone a 100 percent working interest in Mississippi Canyon Block 109, up from 33 percent, and a 25 percent working interest in Mississippi Canyon Block 108, up from 17 percent. Stone also would become operator of the field.

Production from the two blocks is currently shut in, awaiting repairs to an oil pipeline damaged during Hurricane Katrina, the company said. Repairs are expected before the end of the year. Stone said it plans to finance the deal with floating rate debt. If the purchase falls through, Stone plans to use cash raised from the floating rate debt to reduce borrowings under its credit facility.






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