Shares of Sanchez Energy (SN) ended Monday's trading session unchanged after trading with gains of up to 3%. The independent oil and natural gas exploration and production company announced the acquisition of "Eagle Ford" assets from Hess Corporation (HES). Investors lost some of their enthusiasm about the deal as shares fell back towards $19 on Tuesday and Wednesday.
The Deal
Sanchez Energy announced that it has agreed to acquire 43,000 net acres of operating assets in the Eagle Ford shale field in Texas. The company will pay $265 million for the assets which have 13.4 million barrels of oil equivalent in proven reserves, of which 70% is oil. Currently the fields produce 4,500 barrels of oil equivalent per day. The acquired properties have 50 gross operating producing wells and 72% of the production is oil.
CEO Tony Sanchez, III, commented on the deal, "The Eagle Ford assets we are acquiring are highly strategic and accretive on a variety of metrics, and provide critical mass and scale for the Company by significantly increasing our reserves and more than doubling our current production rate. Pro forma for the acquisition, our percentage of proved developed reserves, total producing wells and low risk development drilling locations will each increase substantially, increasing our near term growth opportunities, growing our resource potential while also increasing our financial flexibility and funding capacity."
Based on daily average production of 4,500 barrels, the activities could generate "plain" revenues of approximately $125 million per annum. This values the acquired assets around 2.1 times annual revenues. The proven reserves of 13.4 million barrels, value the acquired assets at $19.70 per barrel.
The estimated revenue calculation above assumes that 70% of total daily production of 4,500 barrels will take place in oil, yielding a $100 per barrel. Another 10% is added to account for the proceeds of the other liquids.
The company is expected to close in the second quarter of this year. The deal is subject to normal closing conditions including regulatory approval.
Valuation
Sanchez Energy ended its full year of 2012 with $50.3 million in cash and equivalents. The company does not operate with any debt, for a favorable net cash position. The company has already secured $325 million in debt financing commitment to finance the deal. On Tuesday, Sanchez Energy announced that it has placed a $225 million 6.5% cumulative perpetual convertible preferred bond.
Sanchez Energy generated full year revenues of $43.2 million in 2012, triple the amount compared to the year before. The company reported a $18.4 million loss for the year on the back of $25.5 million in stock-based compensation expenses.
Sanchez Energy is currently valued around $650 million, which values operating assets at $600 million. This values operating assets around 14 times 2012's annual revenues.
The company does not pay a dividend at the moment.
Some Historical Perspective
Sanchez Energy has only been public for little over a year. Shares were sold to the public at $22 per share and fell back to the high-teens before peaking towards $25 per share in May of 2012. Shares fell back in July and have traded in a $18-$21 trading range ever since.
The company did not even generate revenues in 2008 and 2009 but has rapidly boosted its revenues in the years thereafter, through an aggressive acquisition strategy. The company has been roughly breaking-even during most of those years, but has reported a large loss in 2012 on stock-based compensation expenses.
Investment Thesis
Investors of Sanchez are hardly reacting to the deal, which is transformational for Sanchez Energy. This comes as a great surprise to me given the quality of the acquired assets, compared to its existing operations and similar deals. A great article from Seekingalpha colleagues "Oil & Gas 360" also applauds the deal which management has made. They even expect an upgrade to the full year guidance for the year as a result of the deal. Additionally, shares of Hess fell some 3% in Tuesday's trading session and investors were disappointed with the fetched sale price.
The added production rate of 4,500 barrels of oil equivalent more than doubles Sanchez's existing production rates to 8,300 barrels per day. Earlier the company already guided to end the year of 2013 with a production rate of 9,000 barrels per day, excluding the impact of the acquired assets. The company will furthermore increase its number of producing wells by 50 to 84. The acquisition, which values the acquired 13.4 million estimated reserves at $19.70 per barrel, compares to Sanchezs' own valuation of its 21 million barrel in proven reserves around $31 per barrel.
Recently a lot of deals have taken place in the US onshore oil and gas industry. Last week, Rosetta Resources (ROSE) announced the acquisition of Permian Base assets from Comstock Resources (CRK). That $768 million deal was executed at much higher valuation multiples. That deal valued acquired assets at 7.7 times annual revenues compared to just 2.1 times annual revenues for the deal which Sanchez made. Sanchez did pay a premium for proven reserves compared to that deal, but the valuation is still below Sanchez's own valuation.
As such the deal seems favorable. Sanchez Energy could generate annual revenues of approximately $120 million on a stand alone basis in 2013, based on its fourth quarter performance and its 9,000 barrels per day production target. Adding to that the estimated production from the acquired assets, and 2013 full year revenues could come in around $250 million. The current valuation at $650 million values the firm at only 2.6 times 2013's expected annual revenues, or little over 3 times 2013's expected annual revenues if the convertible bond will be converted and dilute the shareholder base.
The deal seems very appealing and brings additional scale to Sanchez Energy at acceptable prices. Financing has already been committed and the convertible bond has already been placed. Sanchez Energy seems like an excellent investment to benefit from the long term growth opportunities in the North American energy sector.
Please diversify your holdings if you invest in small capitalization stocks like Sanchez Energy.
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.
