Thirteen years ago, Newfield Exploration Co. was formed as an offshore producer with a Gulf of Mexico focus. The Houston independent is returning to its roots-with a vengeance-as it acquires EEX Corp. and extends its reach into the Gulf's deep water for the first time. Wall Street oil analysts are enthusiastic about the prospect of combining Newfield's strong balance sheet with EEX's portfolio of prospects. "They've loaded up with some big, raw material-and I love it!" says Robert L. Christensen Jr. of First Albany Corp., New York. "Basically, EEX ventured into deep water before any other independent in the early 1980s. Its success was limited for a variety of reasons, and its premier deepwater acreage went untested. The industry was waiting to get it on the cheap, and lo and behold, along comes an offshore producer that already had formed its own deepwater team and is ready to exploit it." The combination includes several complementary onshore assets along the Louisiana and Texas Gulf Coast. EEX's South Texas properties include the prolific Bob West Field, which it bought from Tesoro Petroleum Corp. Newfield's $640-million all-stock purchase will include the assumption of approximately $360 million of debt, net of cash, and other existing obligations. This means Newfield effectively is paying some $1.92 per thousand cubic feet equivalent (Mcfe) for EEX's 334 billion cubic feet equivalent (Bcfe) of reserves, according to Larry Benedetto, who follows independents for Howard Weil & New Orleans. The price may seem high, relative to other transactions, but the figure does not include reserves for Jason, Devil's Island or the royalty interest in Llano, which have not been estimated or booked. The acquisition also includes a floating production system (FPS) Newfield plans to sell promptly. "EEX has $360 million in net operating losses (NOL), which have an approximate net present value of $30 million to Newfield," says Benedetto. "If we adjust the purchase price for the sale of the FPS (at its $70-million book value) and the NOL, the purchase price per Mcfe falls to a more reasonable $1.62." He considers EEX a good purchase overall for Newfield, maintains his Accumulate rating on Newfield's common stock (NYSE: NFX) and has raised his target price to $41 per share. Brad Beago of Credit Lyonnais Securities USA Inc. & reiterates his Buy recommendation for Newfield, with a 12-month target of $45 per share. EEX's properties provide Newfield with long-lived assets to complement its current offshore, short-lived holdings, Beago notes. He expects the acquisition will be accretive to earnings and cash flow per share in 2002 and 2003, while net asset value is unchanged. "However, our net asset value estimate is conservative as additional upside from EEX's deepwater portfolio and South Texas properties...remains a possibility," he says. Andrew T. Lees of Stifel, Nicolaus & Co. Inc. in Denver estimates Newfield is paying $1.81 per thousand cubic feet for EEX's proved reserves, which seems expensive. But he also sees considerable upside because the acquisition (which includes more than 63,000 undeveloped acres in South Louisiana in which EEX holds a fee mineral interest) will nearly quadruple Newfield's undeveloped acreage along the Gulf Coast. Newfield also will gain 36 Gulf of Mexico shelf blocks (it already has 190) and 68 deepwater Gulf blocks (where it previously had none). "Thus, while EEX provides strategically desirable diversity from the Gulf-dropping to 53% of production from roughly 66%-it also provides an insurgence of deep shelf and deepwater potential. In our opinion, Newfield couldn't have found a better fit," says Lees, who raised his rating for Newfield common to Buy from Market Perform. "Our assets fit together extraordinarily well," Newfield president David A. Trice says. "This deal has overlapping strategic benefits. It transforms our company, makes us a much larger player in South Texas, gives us an entry into the deepwater Gulf of Mexico and extends our reserve life. EEX operates or owns an interest in some of the largest fields along the Gulf Coast. Big fields tend to get bigger, and we believe this is true of EEX's properties." Newfield plans to issue approximately 7.1 million common shares in the transaction, or approximately 12.4% of its outstanding common on a fully diluted basis. Moody's Investors Service; affirmed ratings, citing Newfield's history of sound funding and business strategies, acceptable leverage for the ratings (as long as Newfield reduces effective debt materially in 12 months), increased longer-lived onshore production and property base, and Newfield's ability so far to internally fund its high reserve replacement costs with effective up-cycle hedging to bolster down-cycle cash flow. The combined company will be the nation's 15th largest independent, with approximately 1.3 trillion cubic feet of natural gas equivalent (Tcfe) in proved reserves, 82% gas and 86% proved and developed. Geographically, reserves will be 54% onshore U.S., 43% Gulf of Mexico and 3% in Australia. Newfield will be left with a total enterprise value of approximately $2.8 billion (based on its May 29 closing price). It expects the transaction to be accretive immediately to cash flow and earnings. Morgan Stanley and J P. Morgan Securities Inc. advised EEX and UBS Warburg LLC advised Newfield in the deal. EEX common shareholders also will have an option to receive units in a new trust that will own overriding royalty interests in future production from intervals generally below 20,000 feet from certain Gulf of Mexico blocks in which EEX owns or may acquire an interest. There is no production currently associated with the royalty interests. EEX preferred shareholders, who have signed an irrevocable proxy to vote for the merger, will receive 4.7 million Newfield common shares. "This merger combines two strong onshore U.S. production companies and will provide significant economies of scale in their operation," says EEX chairman and president Tom Hamilton. "The combined companies will have the strong balance sheet necessary to realize the potential value represented by EEX's Llano-area assets and Gulf of Mexico deep prospect exploration inventory. In addition to the Newfield shares, the royalty trust arrangement provides the EEX shareholders an opportunity to realize incremental value from the exploration potential of our deep shelf program." The combined company's $1.9 billion of pro forma capitalization will be 50% shareholders' equity, 42% debt and 8% convertible QUIPS. The deal will leave Newfield with a 42% ratio of debt to total capitalization. Trice emphasizes the complementary aspects of the two independents' onshore properties. "Our combined operations will make us one of the largest independent producers in the prolific South Texas natural gas basin. EEX's reserves have been added almost exclusively through the drillbit by a group of talented employees in its San Antonio office. We will be extremely pleased to have them join Newfield," he says. But the deal's most intriguing feature is the push into deeper water that EEX will provide Newfield. The combined company will have more than 220 blocks on the Gulf's shelf and 60 more in deep water, 49 of which will be in partnership with 1Shell Oil òò (pro forma completion of its acquisition of Enterprise Oil Plc). EEX also developed an intriguing deep play on the Gulf of Mexico shelf and recently formed a joint venture with BP Plc, which will lead the development effort. "This acquisition provides a significant property base for the deepwater team we have recruited and developed at Newfield during the past year," says Trice. "It will take a systematic approach, rather than just jump out, and consider factors such as infrastructure that can help generate cash flow fairly quickly." Newfield's strategy will be to implement its operating culture at EEX; conduct detailed analyses of its fields and build inventory; infuse capital into quality onshore projects that can create growth; monetize certain assets and cut costs; and study deepwater assets, opportunities and select investment areas. "Because of our high-margin Gulf of Mexico operations, it has been hard to find an acquisition that truly would be accretive," Trice says. "We started talking to EEX about 18 months ago. Negotiations would fade away, then fire back up. It took us about six months of hard work to do the evaluations, reach an understanding and come to a good deal. It was an arduous process that involved several people from both companies." The deal that results creates critical operating mass, he says. "Most importantly, it fits!"