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Vol. 12, No. 2 Week of January 14, 2007
Providing coverage of Alaska and northern Canada's oil and gas industry

Forest buys Houston Exploration in $1.5B deal

Company antes up cash and stock, making fifth acquisition in three years, securing onshore natural gas in Texas and Rockies

Ray Tyson

For Petroleum News

Denver-based exploration and production independent Forest Oil, for the fifth time since changing its growth strategy three years ago, has gone to the acquisition well to secure and expand its U.S. onshore natural gas positions, primarily in Texas and the Rocky Mountains.

This time Forest is pursuing E&P independent Houston Exploration in a friendly stock-and-cash deal valued at $1.5 billion that calls for Forest to pick up about $100 million in Houston debt, bringing the total to $1.6 billion. It represents Forest’s largest acquisition to date.

“This is a significant transaction and major step for Forest Oil,” Craig Clark, Forest’s chief executive officer, said in a Jan. 8 conference call with industry analysts explaining the deal. “We’re firmly entrenched as a North American producer with multiple growth platforms — a huge contrast to where we were three years ago.”

Houston Exploration and Forest have gone through similar transitions, “with an asset base moving from offshore to onshore,” Clark added, noting last year’s successful spin-off of Forest’s Gulf of Mexico subsidiary to Mariner Energy.

Reduction in exposure began three years ago

Three years ago, under new management with Clark at the head, Forest began reducing its exposure to frontier exploration and began to concentrate more on less risky ventures closer to home and reducing costs. Clark said then the company would continue to look for acquisitions near Forest’s existing properties.

So, it comes as no surprise that Forest said it now intends to sell its Alaska assets, which presumably include the company’s ill-performing offshore Redoubt Shoal oil field in Cook Inlet, to help pay down $600 million of $1.9 billion in total Forest debt, at least in part stemming from the pending Houston Exploration acquisition. (See related story on page 1 of this issue.)

“In order to reduce our leverage and to further narrow our geographic focus, we will seek to sell our Alaskan entity in 2007,” Clark said in a prepared statement.

David Keyte, Forest’s chief financial officer, said during the conference call that Forest intends to use the same cost-reducing tactics with Houston Exploration that it has with other recent acquisitions such as Wiser Oil, including plans to “weed out underperforming properties.”

“You can expect this kind of a model to be employed in the first year of operation,” Keyte told analysts. “Forest’s cash-cost structure should be reduced by 10 to 15 percent with the combination.”

The addition of Houston Exploration would increase Forest’s proved reserves from 1.340 trillion cubic feet of natural gas equivalent to 1.995 tcfe.

Capital expenditures to be decreased

Forest said it intends to decrease overall capital expenditures in the combined company and to reallocate capital expenditures being spent on Houston Exploration assets. Under Forest’s pro forma business plan, 2007 capital expenditures for the combined company would be about $900 million, and 2007 estimated daily production would be around 540 million cubic feet of gas equivalent, up from Forest’s current average daily output of about 313 million cfe.

The acquisition, which would add in excess of 3,200 drill sites to Forest’s existing inventory, also would create a highly concentrated and complementary set of oil and natural gas assets focused in all regions of Texas. Furthermore, Houston Exploration’s assets are located in tight gas sand basins in which Forest has extensive experience, the company said.

Specifically, the combined Forest-Houston Exploration positions in the South Texas and Greater Carthage Areas (East Texas) represent two premier operated core tight gas assets with significant exposure to recent horizontal drilling opportunities, Forest said.

Additionally, the new company would provide a strong production base and acreage position in the Arkoma Basin that is near the emerging Fayetteville Shale play.

Moreover, the combination increases Forest’s exposure to the Rockies with a significant acreage position and about 1,900 identified drilling locations in the Denver-Julesburg Niobrara, Forest said.

Deal has unanimous approval of boards

The boards of directors of Forest and Houston Exploration have each unanimously approved the transaction. The deal is subject to regulatory and shareholder approvals, but is expected to close in this year’s second quarter. Jana Partners, holder of 14.7 percent of the outstanding shares of Houston Exploration, already has agreed to vote in favor of the transaction.

Jana, said to be one of the largest “activist” hedge funds, offered to buy Houston Exploration last June for $62 a share in what analysts said appeared to be an effort to put the company into play, or generate buyer interest. However, that was before natural gas prices fell by nearly half between August and October, dragging down Houston Exploration’s share price. Now Jana said Forest can improve the assets.

Jana appears satisfied that it will end up with some cash plus shares in what it believes to be the better-run Forest Oil, rather than have to pay up to buy all of Houston Exploration to see its policies changed.

Upon completion of the transaction, it is anticipated that Forest shareholders would own about 73 percent of the combined company, and Houston Exploration shareholders would own around 27 percent.

Forest expected to create Houston business unit

Forest management and its board of directors will continue in their current positions with Forest, and it is anticipated that Forest will create a new business unit to be located in Houston.

Under the terms of the agreement, Houston Exploration shareholders would receive 84 cents per share of Forest common stock and $26.25 in cash for each share of Houston Exploration stock outstanding, or an estimated 23.6 million shares of Forest common stock and cash of $740 million. This represents $52.47 per share received by the Houston Exploration shareholders based on the closing price of Forest shares on Jan. 5.

The exact amount of the total cash and stock consideration to be received by each Houston Exploration shareholder would be determined by elections and an equalization formula, Forest said, adding that it is anticipated that the transaction will be tax free to Houston Exploration and the stock portion of the deal also would be received tax free.

Forest said the cash side of the acquisition is expected to be financed with a new $1.4 billion revolving credit facility underwritten by JP Morgan Chase Bank, N.A.

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