Conoco Inc. (NYSE: COCA) has made a decisive move to expand its upstream portfolio with a C$9.8-billion (US$6.3-billion) purchase of Gulf Canada Resources Ltd. (NYSE: GOU). The addition of the Calgary independent producer's more than 1 billion barrels of oil equivalent of proved reserves will raise the major oil's total worldwide reserves almost 40% to 3.7 billion BOE. Conoco's worldwide production will climb 32% to 335 million BOE once the deal closes during third-quarter 2001. "The transaction is consistent with our strategy to rapidly grow the natural gas portion of our portfolio," Conoco chairman Archie W. Dunham said. "It will increase Conoco's proved North American gas reserves and production by more than 50%. It also will establish Southeast Asia as a strong, fourth, core business area with the addition of Gulf Canada's interest in Gulf Indonesia Resources Ltd. (NYSE: GRL)." Initial market reaction was moderate. Conoco's A shares declined 21 cents to $31.25 and its B shares were unchanged at $31.40. Gulf Canada climbed $1.99, or 33.61%, to $7.91. Wall Street oil analysts were more enthusiastic. "Gulf Canada's assets are an excellent fit with Conoco's current operations," maintained Michael Mayer, who follows majors for Prudential Securities Inc. in Menlo Park, Calif. "The purchase price of $6.21 per BOE is a full, but reasonable, valuation in the present oil and gas price environment." Conoco's capital discipline and operational success, also give him a high degree of confidence that the company will deliver on its debt reduction and production growth targets during the next 18 months, he added. He maintained his Buy on Conoco and $35 target, with a $40 upside potential. He expects higher earnings and cash flow per share to offset the negative impact of a higher debt load and reduced free cash flow. Matthew Warburton of UBS Warburg LLC said it may take time for the market to digest the transaction and incorporate its complete potential, given its scale and balance-sheet impact. He is reviewing his Buy and $33 price target. "Conoco is paying what appears to be a full price of US$6.21 per BOE of proven reserves," said Warburton. "However, in the context of recent Canadian transactions, the metrics look much more favorable [C$7.40 per BOE versus C$10 to $11 per BOE]." Buying Gulf Canada will make Conoco North America's seventh largest gas producer-a 50% increase to 1.4 billion cu. ft. (Bcf) per day-while its proved North American gas reserves will increase 50% to 4.1 trillion cu. ft. (Tcf). Conoco said it will emerge with significant production and strategic gas positions in three of the continent's premier gas basins-western Canada, the San Juan Basin and the South Texas Lobo Trend. It expects Gulf Canada's 4 million undeveloped acres in western Canada and leading position in the Mackenzie Delta farther north to augment its existing North American gas development program in the longer term. "Gulf Canada's significant Canadian operations are a great fit with our current operations and consistent with our strategic direction," said Dunham. "During the past two years, we have acquired interests in gas-producing and -processing properties in Canada. Gulf Canada has greatly strengthened its operating portfolio and balance sheet during the last few years, and we consider the Gulf Canada management team and employees a major asset in this transaction." Gulf Canada president Richard Auchinleck will manage Conoco's Canadian business, which will maintain operations in Calgary, for a transition period. He also agreed to maintain his current position on Gulf Indonesia's board. The deal calls for Conoco to pay Gulf Canada shareholders C$12.40 (US$8.02) per share, or approximately C$6.7 billion (US$4.7 billion) in cash. It also will assume approximately C$3.1 billion (US$2 billion) of Gulf Canada debt, preferred stock and minority interests. The C$9.8-billion transaction price represents a 35% premium over Gulf Canada's preannouncement closing price of C$9.18 on the Toronto Stock Exchange. It is 19.7 times the independent's projected 2001 earnings per share, 4.1 times its estimated 2001 cash flow per share and 5.1 times its projected earnings before interest, taxes, depreciation and amortization (EBITDA). JP Morgan advised Conoco, while Merrill Lynch and Goldman Sachs advised Gulf Canada. -Nick Snow