Midstates Petroleum: Shareholders Fear Leverage Increase Due To Panther Energy Deal

| About: Midstates Petroleum (MPO)

Shares of Midstates Petroleum Company (NYSE:MPO) are trading with losses of up to 10% in Thursday's trading session. The independent exploration and production company announced the acquisition of oil-weighted properties in the "Western Anadarko Basin" from Panther Energy LLC. Investors were not too pleased with the announcement, which roughly doubles the company's debt position.

The Deal

Midstates Petroleum Company announced that it has agreed to acquire 140,000 net acres of developed and undeveloped assets in Texas and Oklahoma from Panther Energy LLC and its partners. The company will pay $620 million in cash for the activities.

The assets will add approximately 36.4 million barrels of oil-equivalent in reserves, of which 45% is based in oil. The fields produce some 8,000 barrels of oil equivalent per day at the moment, of which 67% is based in liquids.

The fields will increase the inventory of low-risk, repeatable horizontal drilling opportunities by some 700, and add some 280 producing wells at the moment.

CEO and Chairman John Crum commented on the deal:

"The acquisition we announced today greatly enhances our scope, scale and identified resource potential. On a variety of key metrics and in particular cash flow, the transaction is immediately accretive in 2013, and with a full year impact from the Panther assets is strongly accretive in 2014 and beyond."

Based on the daily average production of 8,000 barrels, the activities could generate "plain" revenues of approximately $225-$275 million per annum. This values the acquired assets around 2.5 times annual revenues. The proven reserves of 36.4 million barrels of oil-equivalent values the acquired assets at roughly $17 per barrel.

The estimated revenue calculation above assumes that two thirds of the total daily production of 8,000 barrels will take pace in oil, yielding a $100 per barrel. Another 25% is added to account for the proceeds of the other liquids being produced.

The deal will be immediately accretive to cash flows, earnings, EBITDA, proven reserves and production per share in 2013.

The deal is expected to close at the end of May of this year. The deal is subject to normal closing conditions, including regulatory approval.


Midstates Petroleum Company ended its full year 2012 with $18.9 million in cash and equivalents. The company operates with $705.5 million in short and long term debt, for a net debt position of roughly $687 million.

The company has already secured a $620 million bridge loan commitment to finance the deal. Permanent financing will be provided by issuing $725-$750 million in new debt and $100-$125 million in new equity.

Midstates Petroleum generated full year revenues of $247.7 million, up 18% on the year before. Income before taxes roughly halved to $7.8 million, on which the company reported a net loss of $150.1 million as a result of a large income tax expense.

Midstates Petroleum Company is currently valued at $456 million. This values the assets of the firm at 1.8 times 2012's annual revenues.

The company does not pay a dividend at the moment.

Some Historical Perspective

Midstates Petroleum has lost roughly half of its value in its first year as a publicly listed company. Shares peaked around $17 in April of last year and fell to $5 in November 2012. Shares bounced back to $9 in March of this year, but fell back towards $7 following the announcement of the Panther Energy deal.

Between 2009 and 2012, Midstates increased its annual revenues almost 10-fold from $30.1 million to $258.1 million. The company reported operating profits over the past two years.

Investment Thesis

Investors in Midstates Petroleum Company are not happy about the transformational deal, which significantly boosts the operations of the company. The main reason for the disappointment is the significant increase in leverage. Debt is already quite expensive for Midstates given its weak balance sheet. As recently as autumn 2012, Midstates borrowed $600 million at a rate of 10.75%.

Midstates produced some 10 thousands barrels per day on average in 2012, resulting in total revenues of almost $250 million. The production of 15.6 thousands barrels per day in the final quarter implies that Midstates is on track to generate annual revenues of $350-$400 million in 2013.

Based on the debt outstanding of Midstates, the company operates with a total enterprise value of a little over $1.1 billion. This values its 75 million barrels reserves of oil-equivalent at almost $15 per barrel, which compares to a price tag of $17 for the acquired assets.

Based on 2013's annual estimate of $350-$400 million, the market values Midstates at roughly 3.0 times annual earnings, compared to a 2.5 multiple for the acquired assets. There is little known about the profitability of the fields, except that the deal will be accretive to all key metrics.

Overall, the deal looks great, although the incremental profitability will most likely will be masked by the high cost of debt at the moment. Midstates' total production could grow toward 25 thousand of barrels of oil equivalent per day, generating approximately $600 million in annual revenues.

The $1.3 billion net debt position will prove an extreme drag on the shares, given the high leverage, making the equity of the firm almost a call option on growing revenues and high oil prices.

For opportunistic investors, the sell-off might provide an interesting entry point. Given the high leverage, one should expect significant volatility on a potential investment.

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.