Encore Boosts Volume on Timely Deals

Value-enhancing transactions justify an increase in estimated Net Present Value (NPV) to $48 a share from $44 for buy-recommended Encore Acquisition Company (EAC) and to $18 a unit from $17 for 52% publicly-held Encore Energy Partners (ENP), in our opinion.

Announced June 29, EAC entered a deal to acquire $375 million of oil properties in Oklahoma and natural gas properties in East Texas. Also announced on June 29 and earlier in May, EAC transferred $244 million of oil and gas properties to ENP. On June 29 and earlier in June, ENP sold in two public offerings a total of about 11 million units for about $160 million. Earlier in March, EAC cashed in oil hedges for almost $200 million and essentially redeployed the proceeds in the latest acquisition.

A buyer’s market for deals in 2009 makes acquisition terms favorable. Moreover, properties appear to be valued higher by investors in ENP (McDep Ratio, 0.85) than in EAC (McDep Ratio, 0.76). Monetizing hedges in March when oil prices and stock prices were low has proved to be well timed. Now natural gas price is low thereby giving Chief Executive Jon S. Brumley the confidence to include natural gas properties in the latest acquisition. Commenting on the analyst call on July 1, Mr. Brumley, the younger, declares, “You never really know what part of the [natural gas] cycle you are buying in, but it feels like this is definitely in the lower half.”

Deals Boost Volume Trend
At a time when industry volumes are in price-induced decline as a result of reduced drilling, EAC and ENP may report increases with the latest deals. As well as enhancing NPV, the new deals are likely to increase debt-adjusted volume per share (unit). At the same time, our estimate of NPV for EAC may be conservative relative to an approximation by cash flow multiple depending on reserve life. NPV for ENP appears in line. To avoid double counting, we classify the publicly-held units of ENP as debt for EAC, which also may overstate EAC’s fixed obligations from a credit point of view.

Represented 74% and 77% respectively in oil, EAC and ENP are among the most concentrated stocks on liquid energy. Willingness to use debt is part of management’s call on the business outlook. ENP’s distribution yield at a high 15% a year, reinforced with currently favorable hedging, contributes to a higher unlevered market cash flow multiple (EV/Ebitda) compared to EAC. In a difficult environment, EAC and ENP appear to be making positive progress toward delivering favorable investment returns, subject to the usual risks.

Originally published on July 3, 2009.