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In a previous article, I described how EV Energy Partners was preparing to sell its massive stake in Ohio's promising Utica shale formation. The market has priced EVEP's Utica stake as low as $5000 an acre. But recent sales have valued Utica acreage at twice that (or more), suggesting that a sale could boost EVEP's stock price by $15-$30.

In the company's last conference call Executive Chairman John Walker stated "I'm very comfortable that we are going to achieve our goal of closing the transaction by year end." Yet, no deal was closed by the end of the year. Instead, the company issued this terse statement:

EVEP has received bona fide offers to purchase its operated acreage in the Utica Shale, and is in substantive negotiations with potential purchasers to sell the acreage. However, EVEP does not expect to announce any agreements for the sale of the Utica Shale prior to the end of 2012.

In the four weeks since this statement was issued, the company has provided no other updates and the stock has dropped dramatically. Since my article was published, EVEP has been the worst performing MLP in the entire sector.

So what do we make of the failure to close a deal? There are many possible reasons for it and they all have different implications. The following are some of the more likely possibilities:

  1. The offers were all too low and management has been unable to negotiate them up to an acceptable level
  2. An offer was made but the buyer walked away and EVEP had to start over
  3. A good offer has been made and accepted, but the buyer's due diligence has dragged on longer than expected
  4. Multiple buyers have made overlapping offers and EVEP is negotiating out an intricate deal to optimize the overall pricing

The deadline for offers was a month before the conference call, so option #1 is unlikely. Walker would not have suggested a 2012 close if none of the bids was acceptable. I've followed Walker's career and met with him several times over the last few years. He has always managed expectations carefully and is not prone to rash claims. EVEP management have a reputation as some of the shrewdest dealmakers in the sector. So I think it's pretty unlikely that they would have failed to establish contractual assurances to protect themselves from possibilities 2 and 3.

That leaves possibility 4. Walker hinted at this issue during the last conference call:

The complexity is because we've had so many different bids, its sort of like putting a quote together to maximize what we are getting out of it... but as Jefferies have told us, we've had more interest in our package than any Shale deal that they've ever done, and of course they've done 80% to 85% of all the deals.

So the scenario sounds like EVEP might have very good bids that overlap each other. For example, Buyer A has bid $12,000/acre on 20,000 acres but Buyer B has bid $15,000/acre on a subsection of that. This could make for an extremely complex and time-consuming effort to negotiate and re-negotiate between the different buyers to maximize the overall sales price for the whole package. The Jefferies' claim that they've had more interest in this deal than any other shale deal also speaks volumes. This presumably includes at least one deal that went for $15,000/acre.

Updating EVEP's Utica Valuation

While we can only speculate about the reasons that EVEP has not closed the sale of its operated Utica acreage, it is instructive to recalculate the valuation of this acreage with updated data. The following are valuation metrics for EVEP's upstream MLP peers:

CompanyYieldPrice/DCFEV/EBITDA
Legacy (LGCY)9.03%11.328.41
Linn Energy (LINE)7.59%11.7610.37
Pioneer Southwest (PSE)8.16%12.259.79
Vanguard Natural Res. (VNR)8.37%8.439.30
EV Energy Partners (EVEP)5.37%17.6512.34
Non-EVEP average8.29%10.949.47

By adjusting EVEP's valuation to match the average metrics of its peers, we can estimate how much value the market attributes to its base assets and how much to the Utica acreage.

MetricImplied Base Asset ValueImplied Utica Value
(per share)
Implied Utica Value
(per acre)
Yield$37.15$20.22$5,702
EV/EBITDA$44.01$13.36$3,767
Price/DCF$35.55$21.82$6,152
Average$38.91$18.46$5,207

So taking the average, this implies the market is only pricing EVEP's Utica acreage at $5207/acre. A fairly small increase in this valuation means substantial upside for EVEP's share price.

Utica Price ($/Acre)Implied EVEP Share Price
$5,000$57
$7,500$66
$10,000$74
$12,500$83
$15,000$92

So is $5,207/acre reasonable? Comparable sales in the last year suggest it's far too low. In January 2012, Total bought a 25% interest in 619,000 acres owned by Chesapeake (CHK) and Enervest (EVEP's parent) for $2.3 Billion -- or roughly $15,000/acre. The most recent significant purchase in Decmber 2012: Gulfport bought 30,000 acres at $10,000/acre.

The most recent drilling results are also proving up the Utica shale. Many wells are producing very high percentages of liquids (70% or more) and relatively little dry gas. Last year, EVEP already reported that its Cairns 5H well generated an Initial Production (IP) rate of 1690 BOEPD, with 729 barrels in high-value condensate and 587 barrels of NGLs. Production from its Frank 2H well was likewise nearly 80% liquids.

Just two days ago, Gulfport reported another set of blockbuster wells. The Clay 1-4H had an IP rate of 2226 BOEPD, with nearly 70% liquids.

Summary

EVEP's failure to complete a Utica asset sale in the timeframe that management initially suggested has damaged the stock. Speculators and options traders who bought December and January Call options were sorely disappointed. The lack of communication from the company since its annoyingly laconic Christmas Eve press release has left even some long-term investors bewildered and frustrated.

Those who know John Walker and his track record know that he is a top-notch dealmaker and is unlikely to settle for a sub-optimal price. Ultimately, his responsibility is to long-term shareholders and not to options buyers or other speculators. And he has a massive personal stake in it, owning nearly 2 million units. From Walker's and the long-term investor's perspective, it's OK to wait a few months to get the best value for their Utica ownership. Patient unitholders will forgive the month (or several months) of news blackout, if they gain $15 or $30 a share in the end.

Source: EV Energy Partners: Potential $30 Upside For The Patient Investor