Pricing Shares for the Framco Resources IPO (Mini Case)

Framco Resources is an independent oil and natural gas company that engages in the acquisition,
development, and exploitation of onshore North American oil and natural gas properties. The
company has followed a strategy of growth through the development of its inventory of drilling
locations and exploitation projects, and selectively pursuing acquisitions. The firm’s current
management team first purchased a significant ownership interest in Framco (which was a public
entity) in December 1997 and since then has achieved substantial growth in reserves and
production. In 2003, the company was taken private through a buyout financed using debt capital
and equity capital provided by a private equity partner. Late in 2005, Framco’s board decided that
the time was right for the firm to become once again a public entity by doing an IPO of its shares.
Framco’s board selected an investment banker, who prepared a preliminary analysis of possible
offering prices for Framco’s shares, found in below Exhibits:
Exhibit 1
Firm Characteristics (Millions) Firm Valuation Ratios
Company EV 2005 E 2006E 2007E Firm free 2005 2006E 2007E Firm
Reserves EBIT- EBIT- cash flow E EBIT- EBIT- free cash
DAX DAX Reser DAX DAX flow
ves
Company 1 $20,5 7,311 $3,210 $2,873 $2,940 $2.81 6.40 7.15 6.99
47
Company 2 21,28 7,220 3,806 3,299 3,502 2.95 5.59 6.45 6.08
0
Company 3 4,781 1,411 601 602 450 3.39 7.96 7.94 10.62
Company 4 2,508 1,222 380 342 252 2.05 6.60 7.33 9.95
Company 5 2,355 798 460 399 241 2.95 5.12 5.90 9.77
Mean 2.83 6.33 6.96 8.68
Median 2.95 6.40 7.15 9.77
Firm free cash flow is calculated in the usual way and includes company estimates of maintenance
capital expenditures.

Exhibit 2
Enterprise value estimates for Framco Based on Alternative IPO share prices
$20 $22 $24 $26 $28 $30
Diluted Shares O/S 51.60 51.60 51.60 51.60 51.60 51.60
(Millions)
Equity Value $1,032 $1,135 $1,238 $1,342 $1,445 $1,548
(Millions)
Plus: Net Debt 740 688 637 585 534 482
(Millions)
Enterprise value $1,772 $1,824 $1,875 $1,927 $1,978 $2030
(Millions)
 Net debt equals interest-bearing debt less cash ($250,000). The interest-bearing debt total
declines with increasing IPO share prices because half the additional proceeds resulting from a
higher price are used to retire Framco’s debt.

The valuation analysis utilizes valuation ratios based on the current enterprise values of five
independent oil and gas companies and three key valuation metrics that are commonly used in the
industry: estimated reserves; estimated earnings before interest, taxes, depreciation, amortization,
and maintenance capital expenditures (EBITDAX) and firm free cash flow.
The second exhibit above contains estimates of Framco’s equity and enterprise valuation that
would correspond to different IPO share prices. This analysis is based on the assumption that
Framco will sell 51.6 million shares of stock for a price of $20 to $30 per share. To complete the
comparative analysis. Framco’s CFO provided the investment banker with the necessary estimates
of his firm’s proved reserves for 2005, EBITDAX for 2006 and 2007, and free cash flow:
Valuation Metric Framco Estimates
2005E Proved reserves $700 million
2006E EBITDAX $302 million
2007E EBITDAX $280 million
Firm free cash flow $191 million

a. Calculate the valuation ratios found in Exhibit 1 using Framco’s valuation metrics for each
of the alternative IPO prices found in Exhibit 2.
b. Based on your calculations (and assuming the valuation metrics are used by investors to
make value comparisons among independent oil and gas firms), what price do you think
Framco’s shares will command at the time of the IPO?

Valuing Conco Phillips Acquisition of Burlington Resources (Mini case)

Suppose that you were working as an equity analyst in 2005 and were assigned the task of valuing
the proposed acquisition, which is described in the following press release:

Houston, Texas (December 12, 2005)-ConocoPhillips (NYSE:COP) and Burlington Resources Inc.
(NYSE: BR) announced today they have signed a definitive agreement under which ConocoPhillips will
acquire Burlington Resources in a transaction valued at $33.9 billion. The transaction, upon approval by
Burlington Resources shareholders, will provide ConocoPhillips with extensive, high-quality natural gas
exploration and production assets, primarily located in North America. The Burlington Resources port-
folio provides a strong complement to ConocoPhillips' global portfolio of integrated exploration,
production, refining, and energy transportation operations, thereby posi- tioning the combined company for
future growth. (Source: http://www.conocophillips .com/NR/rdonlyres/86E7B7A6-B953-4D0D-9B45-
E4F1016DD8FD/0/cop_burlington pressrelease.pdf)

In his letter to ConocoPhillips shareholders contained in the company's 2005 annual report, CEO
Jim Mulva described the rationale for the proposed Burlington acquisition as follows:
Burlington's near-term production profile is robust and growing, plus Burlington pos- sesses an
extensive inventory of prospects and significant land positions in the most promising basins in
North America, primarily onshore. With this access to high-quality. long-life reserves, the
acquisition enhances our production growth from both conven- tional and unconventional gas
resources.

Specifically, our portfolio will be bolstered by opportunities to enhance production and gain
operating synergies in the San Juan Basin of the United States and by an ex- panded presence and
better utilization of our assets in Western Canada. In addition to growth possibilities, these assets
also provide significant cash generation potential well into the future.

Beyond adding to production and reserves, Burlington also brings well-recognized technical
expertise that, together with ConocoPhillips' existing upstream capabilities, will create a superior
organization to capitalize on the expanded asset base. We do not anticipate that the $33.9 billion
acquisition will require asset sales within either ConocoPhillips or Burlington, nor should it change
our organic growth plans for the company. We expect to achieve synergies and pretax cost savings
of approximately $375 million annually, after the operations of the two companies are fully
integrated. We anticipate immediate and future cash generation from this transaction that will aid
in the rapid reduction of debt incurred for the acquisition and go toward the redeployment of cash
into strategic areas of growth. Burlington shareholders will vote on the proposed transaction at a
meeting on March 30, 2006. (Source: http://wh.conocophillips.com/about/reports/ar05/letter.htm)

Given
Exhibit P6-11.1 Income Statement and Balance Sheet values are in Thousands
XTO Chesapeake Devon Apache Burlington
Energy Energy Energy Resources
Ticker XTO CHK DVN APA BR
PERIOD ENDING 31-Dec-04 31-Dec-04 31-Dec-04 31-Dec-04 31-Dec-04
Income Statement ($000)
Total Revenue 1,947,601 2,709,268 9,189,000 5,332,577 5,618,000
Cost of revenue 436,998 204,821 1,535,000 946,639 1,040,000
Gross Profit 1,510,603 2,504,447 7,654,000 4,385,938 4,578,000
Operating Expenses
Selling, general, and administrative 165,092 896,290 1,616,000 173,194 215,000
Depreciation, depleletion, and amortization 414,341 615,822 2,334,000 1,270,683 1,137,000
Others 11,880 - - 162,493 640,000
Operating income or loss 919,290 992,335 3,704,000 2,779,568 2,586,000
Income from Continuing Operations
Total other income/expenses (net) - (20,081) 64,000 857 -
Earnings before interest and taxes 919,290 972,254 3,768,000 2,780,425 2,586,000
Interest expense 93,661 167,328 475,000 117,342 282,000
Income before tax 825,629 804,926 3,293,000 2,663,083 2,304,000
Income tax expense 317,738 289,771 1,107,000 993,012 777,000
Net income from continuing operations 507,891 515,155 2,186,000 1,670,071 1,527,000
Nonrecurring Events
Effect of accounting changes - - - (1,317) -
Net income 507,882 515,155 2,186,000 1,668,754 1,527,000
 - - -
Preferred stock and other adjustments (10,000) (5,680)
Net income applicable to common shares 507,882 515,155 2,176,000 1,663,074 1,527,000
Balance Sheet ($000)
Assets
Current Assets
Cash and cash equivalents 9,700 6,896 1,152,000 111,093 2,179,000
Short-term investments 14,713 51,061 968,000 - -
Net receivables 364,836 477,436 1,320,000 1,022,625 994,000
Inventory - 32,147 - 157,293 124,000
Other current assets 47,716 - 143,000 57,771 158,000
Total current assets 436,965 567,540 3,583,000 1,348,782 3,455,000
Long-term investments - 136,912 753,000 - -
Property, plant, and equipment 5,624,378 7,444,384 19,346,000 13,860,359 11,033,000
Goodwill - - 5,637,000 189,252 1,054,000
Other assets 49,029 95,673 417,000 - 202,000
Deferred long-term asset charges - - - 104,087 -
Total assets 6,110,372 8,244,509 29,736,000 15,502,480 15,744,000
Liabilities
Current Liabilities
Accounts payable 425,173 872,539 1,722,000 1,158,131 1,182,000
Short/Current long-term debt 75,534 91,414 1,378,000 21,273 2,000
Other current liabilities 259 - - 103,487 415,000
Total current liabilities 500,966 963,953 3,100,000 1,282,891 1,599,000
Long-term debt 2,053,911 3,076,405 7,796,000 2,619,807 3,887,000
Other liabilities 199,753 107,395 366,000 1,022,880 851,000
Deferred long-term liability charges 756,369 933,873 4,800,000 2,372,481 2,396,000
Total Liabilities 3,510,999 5,081,626 16,062,000 7,298,059 8,733,000
Stockholders' Equity
Preferred stock - 490,906 1,000 98,387 -
Common stock 3,484 3,169 48,000 209,320 5,000
Retained earnings 1,239,553 262,987 3,693,000 4,017,339 4,163,000
Treasury stock (24,917) (22,091) - (97,325) (2,208,000)
Capital surplus 1,410,135 2,440,105 9,087,000 4,106,182 3,973,000
Other stockholders' equity (28,882) (12,193) 845,000 (129,482) 1,078,000
Total stockholders' equity 2,599,373 3,162,883 13,674,000 4,098,239 7,011,000
Total liabilities and stockholders' equity 6,110,372 8,244,509 29,736,000 11,396,298 15,744,000
Other Financial Data
Exploration expenses (thousands) 599,500 184,300 279,000 2,300,000 258,000
Shares Outstanding (millions) 332.9 253.2 482.0 327.5 392.0
Year-end 2004 Closing Price $ 35.38 $ 16.50 $ 38.92 $ 50.57 $ 45.00

Market Capitalization (millions) $11,778.00 $ 4,177.80 $18,759.44 $16,561.68 $17,640.00

(Note: prices for BR is not the year-end price for BR. It is an estimate based on the 2004 price
range.)
Your task is to answer the following basic question: "Is Burlington Resources worth the $35.6
billion offered by ConocoPhillips?" Although you are new to the exploration and production
(E&P) industry, you have quickly learned that the method of multiples, or market-based
comparables, and specifically the ratio of enterprise value (EV) to EBITDAX are typically used
as benchmarks to value E&P companies. In this context, EBITDAX stands for "earnings before
interest, taxes, depreciation and amortization, and exploration expenses." EBITDAX differs from
EBITDA in that it adds back exploration expenses in addition to depreciation and amortization-
hence the term EBITDAX.

a. Using the method of multiples based on enterprise value to EBITDAX, the P/E ratio, and the
enterprise value to EBITDA ratio, what should the acquisition price be for Burlington Resources
shares? Use the following companies as comparables for your analysis: Chesapeake Energy, XTO
Energy, Devon Energy, and Apache. Year-end 2004 balance sheets and income statement
summary information as well as market capitalization data are provided in Exhibit P8-13.1 (pp.
307-310) for Burlington Resources and each of the comparable firms.