In the majority of my recent articles, I analyzed all sixty companies of the midstream sector (major, intermediate, small, new entrants). The income seekers will find many interesting plays and the shorts will detect several excellent short candidates. Moreover, the proactive investors will spot some undervalued players that could also be acquisition targets. The results from this extensive analysis are here and here.
In this article, I return back to the E&P sector and I discuss the upcoming asset sale of Halcon Resources. The contribution of this asset is material to Halcon, because this asset produces ~12% of the company's total production. The thing is whether this asset sale, if materialized, will be material for the company's balance sheet and its fundamentals too.
In one of my recent articles, I analyzed Halcon Resources (NYSE:HK). I explained why there is a gross mismatch between Halcon's valuation and its fundamentals. In fact, a ton of hype has been priced into the company's current staggering valuation as I discussed here.
I am one of those who believe that an investor must not fight the Fed. I also believe that any prudent and knowledgeable investor has to fight the hype and the speculation in order to preserve his capital and hit good returns for his portfolio. In fact, Halcon reminds me of a cake that contains less semolina than required before baking. Semolina is a fundamental ingredient for any cake. The cake that contains less semolina than necessary before baking, falls significantly once it comes out of the oven. Halcon contained more air than fundamentals at $8 where I first pointed out how pricey it was. That article is here.
I believe Halcon's stock still has a way to implode. I know I sound contrarian, but I sounded contrarian when I also pointed out here and here how overvalued Africa Oil (AOIFF.PK), GMX Resources, BPZ Resources (NYSE:BPZ), and AK Steel (NYSE:AKS) were at $10.5, $5, $2.7 and $3.8 respectively. All of them have dropped from 20% to 300% during the last 3 months, and these stocks are just a sample. My followers have a big list with stocks that have confirmed my bearish or bullish calls during the last 6 months.
Halcon holds ~24,000 net acres in Fayette and Gonzales Counties, Texas that are prospective for the Eagle Ford and other formations. According to the company, a marketing process is underway to sell this property. These assets are currently producing ~2,000 boepd (~93% oil and liquids) and have 3.6 MMboe (97% oil and liquids) proved reserves as of December 2012.
Halcon produced 18,348 boepd (81% oil and liquids) in Q4 2012, and it had 108.8 MMboe proved reserves as of December 2012. With Enterprise Value at almost $5 billion currently (including the recent additional debt), Halcon trades at $273,000 per flowing barrel and $45.96/boe of proved reserves. The company is also highly leveraged, because it has a meaty D/CF (annualized) ratio at 6x. The long term debt stands at $2.45 billion currently.
How much money can Halcon milk from these assets? Can the proceeds help Halcon reduce its huge debt overhang significantly, making its current whopping valuation more attractive? To find this, I need to make some calculations first.
I decided to take the time and gather all the information about the major oil-weighted deals at the oil-rich Basins of Texas during the last 15 months. My database showed the following results:
1) Penn Virginia (NYSE:PVA) acquired Magnum Hunter's (NYSE:MHR) Eagle Ford assets a few days ago, paying $400 million for 19,000 net acres in Gonzales and Lavaca Counties. These assets were producing 3,200 boepd (~93% oil and liquids) and had 12 MMboe proved reserves (96% oil and liquids). The acquired acreage is adjacent to Penn Virginia's current position in both counties.
As a result, Penn Virginia will hold a dominant position in the area because it will have approximately 83,000 gross (54,000 net) contiguous acres in the volatile oil window of the Eagle Ford Shale, and it will increase its drilling inventory by 345 (169 net) locations from 295 (251 net) drilling locations to 640 (420 net) drilling locations. The transaction metrics were $125,000/boepd and $33.33/boe of proved reserves.
Although the production from these assets was heavily oil-weighted, Penn Virginia obviously paid richly for this deal because these metrics were significantly higher than the ones for the other deals of the area as mentioned below.
2) In March 2013, Sanchez Energy (NYSE:SN) purchased approximately 43,000 net acres in the Eagle Ford shale play in South Texas from Hess Corporation (NYSE:HES) for $265 million in cash. The acquisition adds about 13.4 MMboe (70% oil) to Sanchez's proved reserves and about 4,500 boepd (72% oil) daily production.
The acreage is located in Dimmit, Frio, LaSalle and Zavala Counties of Texas. The transaction metrics were $59,000/boepd and $19.7/boe of proved reserves.
The acquisition will materially increase the company's reserves, production, and net acres. The company's current production will increase by 115% over the company's 3,800 boepd average rate for first two months of 2013. Additionally, Sanchez's 2012 year-end total proved reserves will increase by 63%. The company's producing well count will also increase by 150% to 84 gross producing wells, and its Eagle Ford net acres will increase by ~50% to 138,000 net acres.
In connection with the acquisition, Sanchez has secured commitments for US $325 million in debt financing and expects to access the capital markets in the near term. Closing of the acquisition and availability of the debt financing are expected to occur concurrently in the second quarter of this year and will be subject to the satisfaction of various customary closing conditions.
3) In early 2013, SandRidge Energy (NYSE:SD) struck a deal to sell its Permian Basin properties to privately-held oil and gas company Sheridan Production Partners for $2.6 billion. With the proceeds, SandRidge will reduce its huge debt load that exceeded $4 billion in December 2012, and fund development of its core Mississippian play. The company's Mississippian encompasses parts of northern Oklahoma and western Kansas, where SandRidge has 1.85 million net acres and 11,000 possible future drilling locations.
SandRidge was producing 24,500 boepd in Q3 2012 and 22,900 boepd in Q4 2012 from these oil-weighted assets (82% oil and liquids) that were also holding 199 MMboe proved reserves. After all, these assets were purchased at $113,540/boepd and $13.07/boe of proved reserves.
However, these relatively rich transaction metrics were not enough to calm SandRidge's shareholders, who have been calling for a restructuring of the company's board and for the CEO, Tom Ward, to resign. It remains to be seen whether Tom Ward will follow the way of his old friend Aubrey McClendon, the disgraced ex-Cheasapeake (NYSE:CHK) CEO. As a reminder, Cheasapeake was founded by McCLendon and Ward in 1989.
4) In March 2013, Aurora Oil & Gas (AAGLF.PK) acquired 2,700 acres in the Eagle Ford shale from Cinco, including 11 producing wells and associated interests in field infrastructure and related assets for US$117.5 million in cash. The acquired assets are located in two consolidated blocks either adjacent or very approximate to Aurora's other Sugarkane Field interests, in the liquids-rich area of the Eagle Ford shale trend in South Texas.
The acquisition increased Aurora's net acreage in the Eagle Ford to 21,800 net acres and adds to the company's future net well inventory. The acreage had proved reserves of 13.5 MMboe and was producing 1,750 boepd (76% oil and liquids). The transaction metrics were $67,100/boepd and $8.7/boe of proved reserves.
5) In late 2012, the Australian Sundance Energy (SDCJF.PK) agreed to take over fellow ASX-listed junior Texon Petroleum in a $100 million transaction to gain access to the Eagle Ford shale in Texas. The assets were producing 1,242 boepd and had 7.1 MMboe proved reserves. The transaction metrics were $80,500/boepd and $14.08/boe of proved reserves.
6) In May 2012, Marathon Oil (NYSE:MRO) bought privately held Paloma Partners II LLC for $750 million. At the time, Paloma owned about 17,000 acres mostly in Karnes and Live Oak Counties of Texas, and production of about 7,000 boepd. The transaction metric was $107,100/boepd.
7) Moreover, Marathon Oil closed the acquisition in the Eagle Ford of 4,300 net acres for $232 million in November 2012. This acreage included 2,900 boepd of production, and added at least 40 net drilling locations to Marathon Oil's inventory in the Eagle Ford. The transaction metric was $80,000/boepd.
8) In late 2012, it was Marathon Oil again that sold about 97,000 acres in Wilson, Karnes and Bee Counties for $227 million. The transaction metric was ~78,300/boepd.
Marathon Oil sold almost one-third of its Eagle Ford acreage in South Texas because it did not consider it to be essential to its exploration plans and production growth targets. Marathon Oil had approximately 325,000 net acres in the Eagle Ford, and wanted to focus future development on a core area of 200,000 net acres. According to the company, it plans to spend $1.6 billion per year over the next five years on its Eagle Ford acreage.
9) The privately-held NFR Energy spent $81 million for Eagle Ford assets in December 2012. NFR acquired 2,300 acres in DeWitt County with proved reserves of 20 MMboe. The transaction metric was $4.05/boe of proved reserves.
The following table helps us visualize things better:
1) Using the average metrics of the oil-weighted deals above, we get the followings:
Per production: 2,000 boepd X $88,818/boepd = ~178 M
Per Proved Reserves: 3.6 MMboe X $15.49/boe = ~56 M
Obviously, there is a significant valuation gap depending on the metric we use. This is why, we had better use the average price tag which is ~$117M.
2) The most optimistic scenario gives:
Per production: $125,000/boepd X 2,000 boepd= ~$250M
Per Proved Reserves: $33.33/boe X 3.6 MMboe= ~$120M
In this case, the average price tag is $185M.
3) The most pessimistic scenario gives:
Per production: $59,000/boepd X 2,000 boepd = $118M
Per Proved Reserves: $4.05/boe X 3.6 MMboe = ~$15M
In this case, the average price tag is ~$67M.
Assuming the most optimistic scenario takes place tomorrow and Halcon sells this acreage for $185M, the long term debt will drop down to ~2.250 billion.
However, the sold production will also impact the cash flow that will drop down to ~$360M (annualized) based on Q4 2012 production. This gives a whopping D/CF ratio (annualized) at 6.25x which is actually worse than the current sky high D/CF ratio that stands at 6x.
Although this asset sale obviously carries a significant price tag on an absolute basis, it is a drop in the ocean for Halcon's ocean of debt. In fact, this asset sale, if materialized, will not improve Halcon's fundamentals but its debt ratios will most likely deteriorate. This is a pity and obviously nothing changes on my bearish call for this stock.