Rosetta Resources: Acquisition Of Permian Basin Assets Boosts Reserve And Growth Potential

Mar.17.13 | About: Rosetta Resources (ROSE)

Shares of Rosetta Resources (NASDAQ:ROSE) ended the final trading session of the week flat after trading with gains of up to 6% during the session. The independent exploration and production company with operations in the "Eagle Ford" and the "Alberta Basin" announced the acquisition of the Permian Basin assets of Comstock Resources (NYSE:CRK).

The Deal

Rosetta Resources announced that it has agreed to acquire some 53,306 net acres in West Texas from Comstock. The company will pay some $768 million for the assets, subject to customary closing adjustments. The fields currently produce some 3,300 barrels of oil, of which some 73% is oil.

The fields have much greater potential according to Rosetta, as some 1,300 gross wells could be placed in the fields. The total risked resources potential of the field is roughly 145 million barrels of oil equivalent of which the majority are oil and liquids.

Shares of troubled Comstock Resources rose 12.8% in a reaction to the deal. CEO and Chairman Jim Craddock commented on the deal:

This oil-targeted acquisition is an important next step in Rosetta's strategy to pursue new growth opportunities and build our inventory of long-lived, oil-rich resource projects. These assets complement our Eagle Ford properties and are a good fit with the experience and technical knowledge of our operations team. This transaction provides entry into the prolific Permian Basin with both existing production and strong growth potential in proven delineated areas as well as prospective exploration targets on undeveloped acreage.

Based on a daily average production of 3,300 barrels, the activities would generate "plain" revenues of approximately $100 million per annum. This values the assets at roughly 7.7 times annual revenues. Risk potential reserves are valued around $5.30 per barrel.

The calculation above assumes that 73% of total daily production of 3,300 barrels will take place in oil, which yields a $100 per barrel. Another 10% is added to account for the revenues of other liquids.

The deal is expected to close on the 1th of May of this year. The deal is subject to common closing conditions, including environmental due diligence. Rosetta Resources has already secured a $700 million financing commitment for the deal.

Valuation

Rosetta Resources ended its fiscal year of 2012 with almost $37 million in cash and equivalents. The company operates with $410 million in long term debt, for a net debt position of roughly $373 million.

The company generated full year revenues of $613.5 million, up 37.5% compared to the year before. The company has been extremely profitable, as it grew annual profits by almost 59% to $159.3 million. Diluted earnings per share came in at $3.01.

The market currently values Rosetta Resources around $2.7 billion. This values the firm around 4.4 times annual revenues and 17 times annual earnings. Given the growth potential and the need for capital expenditures, Rosetta Resources is not paying a dividend at the moment.

Some Historical Perspective

Long term investors in Rosetta have seen decent returns on their investment. Shares were trading around $28 in 2008 when the US shale boom was boosting the prospects of onshore North American natural gas and oil producers. Shares fell to lows around $5 a year later during the recession, as oil and gas prices collapsed.

Shares quickly recovered and have been trading in a $40-$60 trading range over the past two years, currently exchanging hands around $50 per share.

Between 2009 and 2012, Rosetta Resources has more than doubled its annual revenues from $294.0 million in 2009, to $613.5 million over the past year. The company reported a large loss in 2009 followed by incremental improvements in profitability, coming in at $159.3 million over the past year.

Investment Thesis

Investors cautiously applaud the sizable deal which Rosetta made. The company is willing to spend up to a quarter of its current market capitalization to acquire Comstock's assets. As a result, total reserves could increase drastically by some 145 million barrels of oil equivalent. The roughly 70% increase in total reserves would boost total reserves to some 350 million barrels.

Based on reserves estimates, the price tag of $5.30 per barrel of oil-equivalent seems very cheap compared to Rosetta's own reserves being valued around $13.50 per barrel.

The main reason for the discount of the acquired assets are the much lower production rates of the activities. At the moment, the field produce some 3,300 barrels of oil equivalent per day, of which 73% is being high-yielding oil. As such current production will increase by merely 6-7% compared to Rosetta's production guidance for 2013 of roughly 49,000 barrels per day. Note that production as a result of the deal will increase some 9% compared to full year 2012s production of 37,200 MMBoe per day.

Revenues will increase much more substantial given the higher share of oil production. The acquired activities will add an estimated $100 million in annual revenues, valued at around 7.7 times revenues. This compares to Rosetta's valuation of 4.4 times annual revenues.

Overall the acquisition seems a decent deal. The new company will report annual revenues around $900 million for 2013, valuing the firm around 3 times annual revenues. Earnings could accrue towards $200 million, bringing the earnings multiple down towards 14 times annual earnings. The increase in leverage will boost the net debt position towards $1 billion, still acceptable given Rosetta's sizable operations.

Note that earnings multiples are acceptable and the deal will add significantly to the reserve position as well as Rosetta's growth potential. Rosetta estimates that it can increase the current number of 74 producing wells in the area towards 800 over time.

Rosetta is well lead, as the capable management team did not increase leverage to unacceptable levels during the 2008 shale boom. The company has consistently grown its operations in a profitable manner while boosting the reserve potential. At the same time, the valuation levels are extremely acceptable given the bright future prospects.

Rosetta Resources remains a long term interesting energy play in North America.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.