Devon may have problem selling assets

HOUSTON -- Devon Energy is about to complete the last of the takeovers that have made it one of the largest independent oil companies, but now it has another mountain to climb.

The company wants to sell some $1.5 billion worth of properties at a time when oil and gas prices are predicted to be flat or declining, and demand for such properties is weak. Devon also has scaled back its drilling program because of weak prices.

Those should help it work off the mountain of debt it took on during its acquisition binge, including the most recent, Mitchell Energy & Development. The company's purchases also included Anderson Exploration of Canada, and PennzEnergy and Santa Fe Snyder, both of Houston.

"For years this company could do no wrong, but I did not like the Anderson deal," said Fadel Gheit, oil analyst with Fahnestock & Co. in New York. "I think they kind of tripped over themselves and bloated the balance sheet to a level that makes me very uncomfortable. "It is going to be very difficult for them to regain financial flexibility, given the outlook for oil and gas prices," he said.

But Larry Nichols, Devon's chief executive, said none of these difficulties has changed his estimation of the value of acquisitions the company has made over the past two years.

"Gas prices are a volatile commodity. They always have been, or at least for the past decade they have been, and they will continue to be," Nichols said. "No one buys long-term properties based on what you think gas prices are going to be in the next six months."

The next six months may be trying for Devon. It has the tricky job of absorbing new businesses, such as Mitchell's extensive gas processing business, while trying to sell oil and gas properties into a buyer's market.

"We will be selling some properties both to clean up the asset mix and to pay down debt," Nichols said in a recent interview. "Having had the rapid growth we have had, there are properties that used to fit Devon, or Mitchell or Anderson that no longer do, particularly Anderson." Selling off $1.5 billion of assets will lower Devon's debt by only 18 percent. Gheit said that is not enough to give the company the breathing room it needs in a declining market.

"They are not leaving any slack for any deterioration in the industry, and gas prices have a high probability of collapsing once the home heating season is over," Gheit said.

The company has watched its stock price drop almost by half, from about $55 per share in early summer to around $33 per share now. The company's stock has lost about 40 percent of its value this year, which is high compared to its peers such as Anadarko Petroleum, Apache and Burlington Resources, which have all lost about 25 percent.

Despite its heavy debt and sagging share price, Devon continues to enjoy a reputation as an astute acquirer and nimble operator. Analysts across the board think the Mitchell deal is the right kind of acquisition for Devon because Mitchell's properties and prospects are tailor-made for Devon's strategy of getting the most out of existing production.

"Devon is just a wonderful executor of moves in the consolidation arena in terms of underpromising and overdelivering," said David Bradshaw, energy analyst with Deutsche Bank. "We are looking for them to have a similar success with Mitchell."

Company officials are telling investors they increase their cash flow to help cover their debt obligations because they see a huge upside in the properties Devon has acquiring.

"Before, I had the impression that they needed $3 gas to give them a 15 percent rate of return, but they are now saying there is a material amount of reserve additions that could turn this into a home- run transaction," said David Khani, energy analyst with Friedman, Billings, Ramsey & Co. Many analysts, though, felt Devon overpaid in the Anderson deal, paying a 51 percent premium for the company and adding debt when gas prices were going soft. Devon took out a five- year, $6 billion loan to help finance the deal, and also assumed $1.2 billion in Anderson's debt.

For now Devon will have to prove its skills as an operator. While the company was founded and based in Oklahoma City, it has quietly become one of the largest oil companies in Houston. After the Mitchell deal closes, Devon's work force in Houston could almost double.

Devon's higher profile in Houston will soon be obvious after a downtown skyscraper is renamed for the company. The 36-story Two Allen Center will be renamed Devon Energy Tower because the company signed a lease for 193,000 square feet of space.

Devon has about 335 employees in Houston now and will be adding an undetermined number of Mitchell's 370 workers. There will be layoffs, but no specifics have been offered as to how many. Devon plans to keep Mitchell's office building in The Woodlands in suburban Houston, which will give it a total of 559,000 square feet of office space in the Houston area.

The company has come a long way in a short period. Nichols likes to joke that he and his father started Devon Energy in 1971 with three and a half people.

"We shared a receptionist with another company," he said.

Devon was founded in 1969 by John W. Nichols, who helped discover a major natural gas field in the San Juan Basin of northwestern New Mexico in 1950. But its growth story has been one of acquisitions.

The company was a pioneer in coal bed methane development -- finding and producing gas from seams of coal -- and went public in 1988. In 1992, Devon bought the oil and gas properties of Hondo Oil & Gas Co. for $126 million, followed by deals to buy Kerr-McGee Corp.'s North American onshore oil and gas properties in 1996 and Northstar Energy of Canada two years later, moving it into the top 15 U.S. independent oil companies.

Then Devon more than doubled in size with the $2.6 billion acquisition of PennzEnergy, the oil and gas exploration arm of Pennzoil, in 1999. That deal gave it a major presence in the Gulf of Mexico as well as international reserves in Azerbaijan in the Caspian Sea.

Last year the company bought Santa Fe Snyder Corp., creating a top five independent with proved reserves of 1.1 billion barrels. This year it bought Mitchell and announced plans to buy Anderson in September for $3.4 billion in cash.

With the Mitchell acquisition, Devon essentially will own the Fort Worth basin. Even though the company has some interests in the deep- water Gulf of Mexico, it plans to stick mainly to its core areas and low-risk prospects, much like the successful strategy Mitchell pursued.

In response to lower prices, the company is scaling back its drilling program. It has 111 rigs operating in the United States and will pick up another 19 in the Mitchell deal. Its most active drilling area now is Canada, where many wells have to be drilled in winter months when the ice pack is in place to allow workers to move heavy equipment.

There has been some speculation that if the company is able to sell off enough assets to pay down a substantial portion of its debt, it could become an attractive takeover target for major oil companies that want to increase their U.S. gas production. The major oil companies also are loaded with cash.

"As a production acreage company, it could appeal to a large number of companies, and it would not have the Federal Trade Commission antitrust problems that companies with downstream refining assets have," said Tom Burnett, president of Merger Insight, the research arm of Wall Street Access. "I think Devon is going to put itself in a situation where it could be a juicy morsel for a major or a big European company." Gheit, who also follows the major oil companies, believes such a scenario is highly unlikely.

"Larry Nichols wants Devon to be the largest independent," Gheit said. "He does not want to take the money and go play golf the rest of his life."

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