Two years ago, prior to writing for Seeking Alpha, I entered into a pair trade and wrote a short explanation of it up for clients and friends. That pair trade was long Cabot (NYSE:COG), short EXCO (NYSE:XCO). At the time, COG had traded off due to air quality permit issues, and there were rumors swirling that XCO would go private. Over the past two years, that has proven to be one of the more successful pair trades in mid-cap oil and gas in that time period, as COG has outperformed and XCO's management failed to execute on the attempted take-private.
The thesis was the following: Very similar companies. COG has more production, more Marcellus acreage that is better situated and more "blocky", higher % oil production, similar Haynesville acreage, longer lived reserves, similar quantity of reserves, better shareholder base, more potential to do a JV deal, and 100k acres of Heath shale. All literally the same market cap and very close enterprise value.
After tremendous outperformance by COG, a similar opportunity has opened up to short COG and go long Southwestern (NYSE:SWN). SWN is not as similar to COG as XCO was two years ago. However, it does have a few major factors in common that could drive SWN stock to substantially outperform COG over time.
First and most important, SWN's 12 month trailing EBITDA is $1.62 billion, versus COG's of $633 million. SWN has a $13.22 Billion Enterprise Value, versus COG's of $12.42 Billion. So for a very similar price, SWN yields twice as much EBITDA as COG.
Next, both companies are growing, although Cabot is growing faster. Cabot projects that it will grow by ~42% in 2013, to ~370 BCFE in production. Southwestern projects that it will grow by 12% in 2013, to ~640 BCFE in production. While Cabot is growing faster, it would have to grow at the same 42% pace for over 2 years after the end of 2013 just to "catch up" to Southwestern's production level. This will be increasingly difficult over time as new production is added at very high decline rates, and that declining production will need to be replaced just to stem declines prior to achieving any production growth.
Next, while Cabot has had incrementally more success in oil exploration than Southwestern, for both companies oil represents a small portion of production, revenues, and cash flows. Also, Cabot has already joint ventured much of its oily exploration acreage, and that joint venture capital is factored into its projected growth. Southwestern could potentially joint venture its oily acreage and similarly accelerate its growth.
Finally, Southwestern owns a high value midstream system in the Fayetteville. This system generated over $315 million in Ebitda in 2012. At current midstream valuations of 12-15x Ebitda, this represents a substantial "hidden" asset that could be unlocked and could provide further value to Southwestern investors. It does not appear that Cabot has a comparable asset.
In summary, COG trades at over 2x the trailing EV/EBITDA as SWN, produces half as much as SWN, is growing faster but may have trouble sustaining its pace of growth, and does not have the same disclosed embedded midstream asset base. After substantial outperformance by COG over the past two years, perhaps there will be a valuation reversion and perhaps SWN will outperform.