In a dramatic illustration of just how important natural gas reserves are to power generators, The Williams Cos. Inc. is buying Barrett Resources Corp. for about $2.8 billion, or about $13 more per share than Shell Oil Co. had last bid. The deal value includes the assumption of roughly $300 million of debt. Williams, long on power-generation plans and short on gas supply, is offering $73 per share for half of Barrett common and 1.767 Williams shares per each of the rest. The deal is expected to close this summer, nearly tripling Williams' gas reserves and production. Shell executives, who had initially bid $55 a share for Barrett and then increased it to $60, declined to trump Williams. "We have no intention of abandoning our economic discipline and pursuing an acquisition at price levels that cease to add value for our shareholders just for the sake of making a deal," Walter van de Vijver, Shell Exploration & Production Co. president and chief executive officer, responded. Analysts say Williams paid a relatively high price for Barrett. In terms of firm value/pre-interest cash flow metrics, the transaction values Barrett at 8.6 and 9.4 times Lehman Brothers ' 2001 and 2002 estimates, according to Jeffrey Robertson, E&P analyst with the firm. In comparison, the small-capitalization producer group is trading at 4.4 and 4.8 times the estimates. "Williams is paying a premium price for Barrett," he says. On the basis of reserves, the offer values Barrett's 2.1 trillion cu. ft. equivalent (Tcfe) of proved reserves at $1.34 per thousand cu. ft. equivalent (Mcfe). In comparison, Houston-based investment banking firm Cornerstone Ventures LP reports the 22 first-quarter 2001 U.S. domestic transactions, for which reserves and price were reported, had a median value of $1.11 per Mcfe. M&A advisory firm Randall & Dewey Inc. , Houston, calculates $1.32 per Mcfe for the 26 first-quarter transactions it evaluated. What makes the Williams offer especially optimistic is that some 60% of Barrett's reserve base is proved undeveloped. "Using a 65-cents-per-Mcfe finding and development cost for the Piceance Basin and 30 cents for the Powder River Basin, along with the year-end reserve report capital, we estimate an incremental development cost of 38 cents per Mcfe," Robertson says. "Williams appears to have ascribed significant value to Barrett's large inventory of probable and possible reserves." Irene Haas, who follows Barrett for Sanders Morris Harris in Houston, believes there is much potential upside in Barrett's probable reserves. "I've been following the Powder River coalbed-methane play for a long time now, and I believe they could have almost 1 Tcf or more that can be developed and it's not yet on the books," she says. "And coalbed methane is a lot lower in terms of geologic risk." Ronald Barone, E&P analyst with UBS Warburg , says Williams management believes the value from the risk-adjusted probable and possible reserves could lower the effective cost per Mcfe by 50% or more. John Olson, who covers Williams for Sanders Morris Harris, echoes that assessment, estimating that by including probable reserves, Williams paid about 62 cents per Mcf. Williams' stock price took a hit, falling 6% on announcement day to close at $39.28 and a total 9% decline from $43.45, where it stood prior to a Williams announcement that it was considering bidding for Barrett. The revelation was involuntary, as callers for a Williams Communications earnings conference call were mistakenly patched into a private Williams Cos. board meeting where the Barrett bid was being discussed. At press time, the stock was $40.70. Barone says, "As the market develops a better understanding of the company's actual strategy and method of operation within energy marketing and trading, which goes well beyond locking in supplies with financial hedges, the fit and risk reduction nature of this deal will be well apparent." Ultimately, Barrett's reserves will help Williams profitably grow its power business. "Williams has a big plan to expand its marketing control of power assets and they are finding themselves, like everyone else in this game, long power but short natural gas," Olson says. "This ultimately will make good sense for Williams." Williams had 1.2 Tcfe in reserves at year-end 2000. With Barrett's 2.1 Tcfe, Williams will be the 10th-largest gas company in the U.S., up from No. 25. Barrett currently produces approximately 345 million cu. ft. of gas equivalent (MMcfe) a day, while Williams produces 210 MMcfe a day. Williams' goal is to have enough physical gas supply to fuel 25% to 50% of its generation portfolio's capacity, Barone says. At its current capacity of 15,000 megawatts, the Barrett deal brings it to about 50%. However, Williams will likely surpass 25,000 megawatts before year-end 2003 and 40,000 megawatts before year-end 2005. Keith Bailey, Williams chairman and chief executive officer, says, "It is a very significant strategic acquisition in that it balances the risk profile of our rapidly growing power portfolio by enabling us to add significant additional new gas reserves so that we have a physical hedge and natural hedge against the short position that's created as we add additional power generation facilities." Also, the Rocky Mountain location of the reserves fits well with the gas and gas-liquids pipelines that Williams has in the region, he adds. Williams plans to maintain Barrett's Denver headquarters as its principal office for Rocky Mountain E&P operations. Ralph A. Hill, Williams senior vice president of E&P, will lead the combined company. The majority of Barrett's employees will remain in Denver. Because there is little overlap of the companies' operations, executives expect only $10- to $20 million in synergistic savings. Two major debt-rating agencies immediately weighed in on the deal. Moody's Investors Service confirmed the ratings of Williams and its subsidiaries with a stable outlook. Because the acquisition is half-cash and half-stock, Moody's expects a neutral to slightly positive effect on William's leverage and coverage measures. Fitch , which currently rates Williams' debt BBB with a stable outlook, anticipates modest near-term improvement to key debt leverage and interest coverage ratios. Gordon Howald, natural gas and power-producer analyst for Credit Lyonnais Securities (USA), has a Buy on Williams and a 12-month target of $63. "The biggest risk we see relative to this acquisition is that if gas prices decline, it could hurt results from the unhedged portion of the company's E&P business. However, declining natural gas prices would improve the company's power generation margins by increasing the spark spread of its unhedged generation portfolio." Williams management expects the deal will be immediately accretive to earnings and improve the company's debt to total capitalization by 1%. Goldman, Sachs & Co. and Petrie Parkman & Co. were Barrett's financial advisors and provided fairness opinions. Merrill Lynch & Co. was Williams' financial advisor.