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Some privately owned independent oil and gas producers recently have used "reverse mergers" as a fast-track alternative to the traditional initial public offering as a means of going public by being acquired by a publicly traded company that has virtually no business and usually limited assets.
The private company then "reverse merges" into the public company "shell," forming a new operating entity in the stock market.
The process—also known as a reverse takeover or a "blind pool" merger—has been around for many years. Oilman Armand Hammer is credited by some for inventing the reverse merger through his investment in a shell company in the 1950s, into which he merged Occidental Petroleum Corp.
Reverse mergers are more prevalent as a means for going public than many realize. But the number of reverse mergers dropped off in the 1990s as Wall Street investment bankers favored IPOs. "It was easier in the early 1990s for energy companies to go public, but the '98 crash of oil prices dried up funding for energy company IPOs," said Greg Barnett, president of EnerCom Inc., Denver.
SEEKING A SHELL
"There's no one central spot for someone to go who is looking for a publicly traded shell company for a reverse merger," he said. "Anyone looking for one should start by talking to investment bankers. But there are a few people who actively market publicly traded shells."
Many of the shells now available are "failed dot-com companies," Barnett said.
Usually, the shell company's only value is its publicly traded status. A "clean" shell company will have little or no outstanding debt, will have kept its regulatory filings up to date, with its stock listed at pennies per share and majority control in the hands of relatively few shareholders. As one analyst described it, it is "a company that has passed into a coma, rather than dying a violent death."
In the usual process, owners of the private company first must get the controlling shareholders of the shell company to agree to the proposed merger. In some cases, a broker has already prepared the shell company for such an opportunity and has an agreement is in hand.
Usually the merger is done through a stock swap. Owners of the private company acquire a majority of the shell's stock for a nominal amount, or the shell's shareholders may authorize issuance of a highly dilutive block of shares. Either way, the controlling shares of the shell company obtained by the private company's investors are then swapped for the private company's stock. The shell company then owns the private company—including its name, which it usually assumes. Investors in the private company then control the resulting combination and can market stock through the exchange where the shell firm is listed—"often free of nasty items like lockup and standoff agreements," one analyst said.
Compared with a traditional IPO, a reverse merger has numerous benefits for taking a private company public. "Most IPOs need to be in an industry with public investor sex appeal. But any type of company can complete a merger to become publicly held," one analyst said.
SPEED ADVANTAGE
"The main advantage of a reverse merger is speed," said Barnett. "It's not necessarily easier than an IPO, but it can be quicker."
Reverse mergers usually can be completed in a minimum 3-6 months, compared with 6-9 months for an IPO, at a cost of $100,000-300,000—usually under the cost of a traditional IPO, without underwriter commissions or fees, said analysts. According to Venture Associates, Denver, reverse mergers also are a simple method for foreign-based companies to get control of a US publicly traded company without subjecting its foreign operations to US tax.
But there are disadvantages, as well. Shell companies may have "a clouded past" operationally or financially. They may be on the verge of bankruptcy or have a large number and amount of outstanding liabilities. New shareholders may run a risk of assuming past problems, old liabilities, and an unhappy shareholder base.
Also, a reverse merger doesn't immediately bring any new capital into the combined company, which is the primary purpose of an IPO. Instead, it consumes money through fees, share purchases, and marketing of the company's stock that may weaken the company in the process.
Although the stock of the newly merged company is tradeable, it's initially illiquid, analysts said. With a majority of the merged company's stock in the hands of the private company's investors, its float is thin. Moreover, the shell company was generally known as a moribund firm, sometimes in a different business, that analysts and business writers had long given up on. To get anyone to buy its shares, the company now must market its new identity, something normally done by the underwriter in a traditional IPO.
However, Barnett claimed, a company with "a good enough story"—a good staff with a proven record or a portfolio of assets—will likely "attract enough capital to find more capital."
ENDEAVOUR INTERNATIONAL
Barnett cited Endeavour Interna-tional Corp., Houston, as a good example of a privately owned firm with good management that found "a shell with assets" to take it public. Endeavour was created in February through a stock merger by which Continental Southern Resources Inc. acquired NSNV Inc., a privately held Texas corporation majority-owned by William L. Transier and John N. Seitz, who are co-CEOs of the newly restructured company. The restructuring involved issuance of a private placement of $50 million of common stock.
Transier was formerly executive vice-president and chief financial officer of Houston-based Ocean Energy Inc. prior to its merger with Devon Energy Corp., Oklahoma City. Seitz was previously CEO, chief operating officer, and president of Anadarko Petroleum Corp., also of Houston. Several former officers of Ocean Energy and Anadarko subsequently joined Endeavour's management team.
"Endeavour is positioned to take advantage of the exploration and acquisition opportunities that are being created as the major integrated companies reduce their commitments to the North Sea and refocus their resources into other parts of the world," said Transier. "The situation is very similar to the Gulf of Mexico in the 1980s when the independents entered the region and began to profitably develop the area's remaining potential."
WHITTIER ENERGY
In September 2003, Houston-based Whittier Energy Corp. completed a reverse merger with Olympic Resources Ltd., "a small Wyoming independent recently migrated from Canada," to go public, said Bryce Rhodes, president and CEO.
"It was a clean company, with few employees, cash, some nonoperating working interests in the Sacramento basin, and no social issues," he said. "It was brought to us by a boutique investment banker after we had put the word out that we were interested" in going public.
The cost of the reverse merger "turned out a little higher than expected," although still relatively small. "We looked at it as an equity investment with additional benefits," Rhodes said. The shell company also "came with an existing shareholder base" familiar with oil and natural gas operations, he said. "It's worked out reasonably well."
At the end of 2003, Whittier Energy had total proved reserves of 1.96 million boe, including 1.46 million bbl of oil and 2.99 bcf of gas.
This year it plans to pursue its growth strategy through "one or more" producing property acquisitions, several development projects, and participation in "three or four" new third-party-generated exploration projects.
