Arco/40"/mike1st/mark2nd

By JASON BOOTH

Staff Reporter

Arco could have been a contender.

A decade ago, Atlantic Richfield Co. was considered among the most aggressive, innovative energy players in the world.

It fiercely battled British Petroleum in 1988 for control of Britoil and ultimately lost but then it turned right around and used the profits from Britoil stock to launch another takeover of a similar company, this time succeeding.

Arco's aggressive performance and strong earnings in the late '80s prompted Forbes magazine to write: "By several key indicators, Arco may well be the best-run major oil company in the U.S. today."

"We were going to own the world," said George Babikian, retired president of Arco Products Co. and mastermind of the company's highly successful low-price marketing strategy. "How things have changed."

Indeed. Having agreed this month to be acquired by BP Amoco PLC, Arco is expected by year end to become the latest L.A.-based company to fade into extinction.

So how did once-voracious Arco end up as the prey?

There is no single factor, but rather a series of decisions and events that span three decades. They include an ill-fated diversification into mining, an over-reliance on Alaskan production, complacency about developing oil and gas resources overseas, overly generous dividend payouts, and a big investment in Russia that went sour.

There was also the plunge in world oil prices.

Faced with a consolidating industry dominated by global giants, Arco Chairman Mike Bowlin felt compelled last year to study three distinct options: remain independent, buy another oil company, or seek a larger acquirer.

"The result was clear," Bowlin said in an interview late last week. "If the deal was good, the best option for shareholders and employees was to join BP."

The loss of Arco, yet another in a line of major L.A.-based corporations taken over by out-of-towners, is especially striking because the company was, in many ways, a model corporate citizen. It contributed untold millions to local charitable and cultural causes. Its executives, managers and administrative staff members were constantly exhorted to volunteer and they did. Its name and distinctive red diamond logo were ubiquitous on the L.A. scene, most notably atop Arco Plaza, the tallest building in Southern California when it was built in 1971.

Arco became the West's No. 1 gasoline retailer in 1984, as drivers flocked to its low-price stations and bought snacks at its AM/PM mini-markets. Arco's visionary chairman, Robert O. Anderson, was intent on building an L.A.-based global empire.

But now that is gone, or going away. The company already has vacated Arco Plaza, throwing 250,000 square feet onto the already-soft downtown office market. Hundreds of Arco's 3,000 L.A.-area employees are expected to lose their jobs. The Arco name itself is likely to disappear under the cloak of London-based BP, which is in the process of dismantling its other U.S. acquisition, Chicago-based Amoco.

Could this scenario have been avoided? Arco officials, both past and present, say yes. So do many industry analysts.

"Not only could Arco have survived, it could have prospered," said Bowlin himself.

So why didn't it?

Former Chairman Lodwrick Cook said a key turning point goes back more than 20 years ago, when the company diversified into mining with its 1977 acquisition of Anaconda Co., a large copper and aluminum manufacturer. It was a move made during Anderson's empire-building days, when many major corporations were assembling widely diversified conglomerates.

"I do fault management for Anaconda," said Cook, now co-chairman of Global Crossing, a fast-growing telecommunications company. "In hindsight, the diversification into mining was a mistake. Management at the time felt there was synergy, but there wasn't. Plus, there were environmental problems. If we had diversified into oil and gas instead, we may have been a stronger company. If I had to pick a moment in time when the company got off track, it was then."

The legacy of Anaconda lives on. Last year, Arco agreed to pay the state of Montana $215 million to clean up mining sites that were part of the Anaconda deal.

Ironically, Arco's misguided venture began just as the company was celebrating its greatest triumph, the opening of the Trans Alaska Pipeline in 1977.

While its Alaskan operations long have been held up as Arco's crown jewel, supporting the company through the '70s and '80s, they also contributed to Arco's weakness in the '90s, analysts said.

Excess optimism about oil reserves at Prudhoe Bay in Alaska made management somewhat complacent about developing oil and gas resources elsewhere, particularly overseas. Today, around 80 percent of Arco's production and 72 percent of its reserves are in the United States, making the company far more dependent of domestic sources than most of its competitors.

That's a problem, analysts said, because the United States is among the most expensive regions to drill for oil. Furthermore, pumping oil through the 800-mile-long Trans Alaska Pipeline can add as much as $4 to the cost of producing a barrel of crude. Meanwhile, reserves at Prudhoe Bay have been declining since the early '90s, forcing Arco to spend more money on exploration and development in the area.

"I think that big asset in Alaska constrained them," said John Parry, an analyst at securities firm John S. Herold Inc. "They diverted a lot of resources up there money that could have been used elsewhere. So they didn't make the right kind of moves early enough. They didn't go overseas early enough. They didn't get into gas early enough."

Cook agreed.

"Both Mike Bowlin and I would say, if we had moved more successfully overseas sooner, we would have had a stronger base," he said. "It was combination of starting late and the difficulty of successfully finding oil."

When Arco finally made its move, starting in the late '80s and reaching a peak in 1998, it was too late and too unfocused.

"Three or four times they decided to make a big push overseas," said Albert Anton at Carl H. Pforzheimer & Co. in New York. "The first few efforts were unsuccessful, and they spent a lot of money without results."

The company's recent acquisitions in lower-cost regions were ill-timed.

Because of Russia's depressed economy and stock market, Arco may be forced to write down much of the $340 million investment it made two years ago in Russian oil giant Lukoil. And a $3 billion Venezuelan refinery project is on hold indefinitely because Arco's partner has been unable to meet its financial obligations due to the collapse in oil prices.

Another poorly timed deal was last year's $2.5 billion acquisition of Union Texas Petroleum Holding Inc. With operations in many of the same overseas regions as Arco, Union Texas was seen as a quick way to boost the company's international muscle. But the deal was made when oil was at about $20 a barrel, prompting analysts to conclude that Arco overpaid.

"Union Texas turned out to be an ill-timed deal," said James Van Alen, an analyst at Janney Montgomery Scott Inc. in New York.

Even Arco's recent overseas triumph a natural gas bonanza in Indonesia, the third-biggest hydrocarbon discovery in company history has been muted by the Asian economic crisis. As a result, those reserves will not come on line until at least 2003.

Besides lagging overseas exploration efforts, another consequence of Arco's heavy reliance on Alaska was excessive generosity with shareholders.

Flush with cash and confidence in 1991, the company increased its annual dividend to $5.50 per share. Analysts said that with today's lower oil prices, Arco could not sustain such a generous payout. Expectations that the dividend would be cut contributed to the share price remaining depressed, some analysts say, in turn putting pressure on Bowlin to sell.

Bowlin disagreed with that assessment, noting that if the company had remained independent he fully intended to defend the dividend. That point is now moot.

In raising the specter of "what might have been," analysts and others in the industry point to perhaps the biggest source of debate: Whether management was aggressive enough, especially after Anderson retired in 1986.

They note that both Bowlin and Cook came from conservative human resources backgrounds unlike Anderson, who was an oil wildcatter. "Under Anderson the company had some visionary leadership," said Parry.

It was Anderson who, just a year after being named chairman of Atlantic Petroleum Storage Co., orchestrated the 1966 acquisition of Richfield Oil Corp., which created Arco. Under his leadership, the company bought Sinclair Oil Corp., moved its headquarters to Los Angeles and initiated the discount marketing policy that made Arco the biggest gasoline retailer on the West Coast.

While Anderson's expansionary moves were not all brilliant he was the one who green-lighted the Anaconda deal, and other '70s-era diversification the man did believe in size. And in today's oil market, where bigger is better, such leadership may have kept Arco independent. With oil prices remaining depressed and the cost of finding and tapping oil around the world remaining high, it is only the largest companies that have enough resources to survive.

That was certainly the conclusion Bowlin reached before he contacted BP to arrange the sellout.

"Arco could have survived as an independent," he said. "But my assessment was that a combination with BP would make a stronger entity one of the greatest oil companies in the world."

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