The News Issue Week Day

RICH AMERICA, POOR AMERICA The split nature of today's economy has been great for stock like Coach, tough for ones like Wal-Mart. Why that won't change much, even as the Democrats gain clout in Washington. he New IBM

Big Blue's shareholders have been blue for the past few years. But the tech giant has a new strategy, focused on software. Best of all, it's working.

Randall Forsyth The buck may be real loser in Iraq ...

Review&Preview A vote keeps ASMI intact. Going more nuclear ...

Storming Ahead, After run-up, a few insurers look good ...and Direct TV

Smooth Style Polo stock will stay in fashion ...

Follow the Leaders Copying smart stockpickers is one way to build a best-ideas portfolio, and it saves on management fees. A look at Oracle, Sears, AutoZone,Wendy's and other top holding of five closely watched hedge funds ...

Coming Spinoff Duke Energy's powerful idea ...

The New Big Blue Cover Story: IBM investors may soon be smiling like CEO Palmisano, as Wall Street comes to realize that Big Blue's reinvention as a software giant gives it a steadier, more profitable business with plenty of potential for further improvement ...

Spreading Joy The four rules of good giving ...

Technology Trader Microsoft stock could be ready for takeoff, now that new version of Vista and office have launched ...

13 Great Gadgets Our pick for sleek and sophisticated gadget gifts include Sony TAV-L1 all-in-one home theater, a digital SLR camera, Logitech's Harmony 1000 universal remote ...

Tuesday

Target: Energy Takeovers


AT THE RISK OF BUTCHERING A ROLLING STONES lyric, acquisitive energy companies that can't get what they want can buy what they need.

With the cost of production rising, as oil and gas become more difficult to find and get out of the ground, smaller exploration companies have their hands tied. But larger players, which still have access to cheap capital, can grow by buying reserves.

There's been near-term uncertainty created by the big drops in petroleum and natural-gas prices; on several days recently, oil has fallen below $60 a barrel and the outlook is clouded (see page M13). Neverthe­ less, the amount anted up this year on energy merg­ ers and acquisitions could rival the more than $160 billion spent worldwide last year.

Canada's oil sands could look attractive to big for­ eign oil companies. And U.S. exploration companies could consolidate.

"A falling [price] environment ... still can spur M&A activity," says Rick Roberge, an energy merger-and­ acquisition consultant at PricewaterhouseCoopers. "Larger companies are very anxious to add to their asset base ... and sellers are anxious to sell out and get a good price."

State oil companies, especially China's, could be big players in global energy M&A in the coming year because demand for oil and gas so significantly out­ strips supply in that giant Asian nation, says Mitchell Silk, a partner at Allen & Overy, a law firm assisting Chinese companies in energy acquisitions.

Chinese oil outfits "will buy anything that equates to a price per barrel lower than what present prices are," Silk says.

Addressing a recent energy conference, Gregory Pipkin, the co-head of investment banking at Lehman Brothers' Houston office, said that Russian energy companies are looking for ways to sell their oil and gas production on a long-term basis in Europe. In addition, national oil companies in China and India "are acquiring reserves from all over the world to solve their domestic energy needs," he noted.

Canada's oil sands are. one place where national energy companies might look. Working the sands is costly because natural gas is needed to get the thick oil out of the ground. But big companies that consoli­ date smaller players in Canada or amass some proper­ ties there might find significant cost savings.

"My bet is, one giant company is going to say, 'We don't have enough oil sands in our portfolio,'" says Arthur Smith, the head of John S. Herold, an independent energy research and consulting firm.

Smith has three favorite oil-sands takeover targets, all with cheap valuations: EnCana, Canadian Natu­ ral Resources and Suncor Energy.

All three conduct exploration in the oil sands, and each has a stock-market value that exceeds $20 billion.

Suncor (ticker: SU), the most established player, produces and distributes gas and refines oil.

Canadian Natural (CNQ) conducts exploration in the North Sea and off the west coast of Africa.

EnCana (ECA) has a competitive cost advantage over its North American peers because it owns mil­ lions of acres of land, according to Stansberry & Associates Investment Research. It also has explora­ tion operations in the Middle East, Chad, Brazil, Greenland and France.

Shares in all three of these companies have dropped significantly since oil prices fell from their July highs. They now look cheap.

EnCana and Canadian Natural are the least expen­ sive. Divide the value of their assets by their cash flow (as measured by Ebitda-earnings before inter­ est, taxes, depreciation and amortization) and you get 5.9 and 6.7, respectively. Those are relatively modest numbers in their industry.

Buyers might be interested in purchasing assets or entire companies. Interested parties could include ConocoPhillips (COP), which has a significant pres­ ence in oil sands; Royal Dutch Shell (RDS-B), which has been buying leases in the region; and national oil companies, including ENI (E), the Italian oil giant, Smith says.

The potential to be acquired, of course, usually shouldn't be the only motive to buy a stock because even the most logical takeovers sometimes don't materialize.

C. Scott Baxter, the portfolio manager of Green River Energy Partners in New York, first ·looks for undervalued energy companies.

Three names that he thinks that are cheap and could be acquisition targets are Edge Petroleum (EPEX), Newfield Explora­ tion (NFX) and Grey Wolf (GW).

Edge is a small onshore exploration outfit with re­ serves in Texas and the Fayetteville Shale, a hot drilling play, mostly in Arkansas. Other firms with greater Fayetteville exposure trade at much higher valuations than Edge, he says. .

Newfield Exploration is another exploration company, and Grey Wolf is an onshore driller that owns rigs.

If a larger driller bought Grey Wolf, it would acquire rigs at a time when they're scarce and leasing rates remain high. And the purchase could pay for itself in less than three years, Baxter figures.

Newfield is a different story. It hasn't been generat­ ing the kind of returns that investors want to see, despite its significant reserves and profit potential. But a larger exploration and production company might jump at its bargain price with the possibility of improving production ilnd profitability.

Newfield and Grey Wolf each are trading around four times their enterprise value (stock-l1.1arket value, plus net debt), divided by Ebitda.

"A business peer could acquire these companies, fold them in, and it would be accretive to cash flow, given how cheap they are trading," observes Baxter.

Of course, with volatility in oil and natural-gas prices, some sellers might decide to hold out for better offers. That could slow M&A.

But the Exxon Mobils and BPs of the world, with very long-term views on commodity prices, won't let short-term blips affect acquisition decisions, says Rob­ erge at PricewaterhouseCoopers.

Comments Christopher Sheehan, director of M&A research at John S. Herold: "In a business where you need to keep replacing reserves, you need to turn to acquisitions."




by Dimitra DeFotis

Complete Archive Desember 2006

The New Cisco As technologies like Internet video take off, Cisco Systems, the king of computer networking, will be among the biggest winners. Why its shares could rally another 15%.

Survivor! GOP Will Hang On Despite a profusion of predictions to the contrary, the Republicans will keep control of Congress through just barely. So says our highly reliable seat by seat analysis of local political funding.

The New IBM Big Blue's shareholders have been blue for the past few years. But the tech giant has a new strategy, focused on software. Best of all, it's working.