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Devon Lands Santa Fe

By Richard McCaffery (TMF Gibson)
May 26, 2000

It's not every day we at the Fool write about oil and gas exploration, development, and production companies. With the technology boom, oil isn't as vital a part of the world's economy as it was throughout most of the 20th century. Add to this the oil industry's limited head room (there are only so many oil deposits and most have been found) -- and that it's a volatile business based on commodity prices -- and it's easy to see why many Fools steer clear.

Nevertheless, oil, gas, and exploration company Devon Energy (AMEX: DVN) has become a player in this market through acquisitions. Today it stepped forward and swallowed another competitor: Devon announced plans to merge with Santa Fe Snyder (NYSE: SFS) for about $2.3 billion in stock plus nearly $1 billion in long-term debt. Under terms of the agreement, Santa Fe shareholders will receive 0.22 shares of Devon for each share they own. The deal values Santa Fe at about $12.91 per share, a 17% premium over the closing price last night. Devon shares dropped almost 5% to $55 15/16 in early trading, perhaps due to fears the company is taking on too much debt.

What the deal adds to the mix is an additional 386 million barrels of oil equivalent to Devon's proved reserves, a 58% boost. It strengthens Devon's operations in the U.S. and gives the company access to international markets in Southeast Asia, South America, and West Africa.

One way to judge acquisitions is by taking a look at the acquiring company's track record, and Devon has gone about its business swiftly. It has bought three companies in the last 18 months and added 897 million barrels of oil equivalent to its proved reserves. The company has been successful at building size in an industry that relies heavily on economies of scale, and, of course, is focused on the most profitable sector of the oil and gas industry -- exploration and development. The farther down the food chain you go -- meaning the closer you get to the gas pumps -- the less profit you'll find.

Devon has reported three quarters of estimate-beating results thanks to rising oil and natural gas prices, as well as increased production from its acquisitions. That's impressive performance considering the number and size of the acquisitions. At the same time, operating costs have grown almost as fast as profits. In the latest quarter, lease and operating expenses more than doubled, general and administrative expenses more than doubled, and interest expense jumped to $25.2 million from $6.6 million a year ago. Those costs may well increase again as a result of the Santa Fe deal, though management expects to cut up to $35 million in expenses through the combination.

While it looks like the company has put itself in a better position to earn a market-beating return, investors might want to let the acquisitions settle before drilling deeper.

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