Apache: Egypt Deal Sparks More Upside Potential

| About: Apache Corporation (APA)

Shares of Apache Corporation (NYSE:APA) jumped up on the final trading day of the week after the independent energy company announced the sale of a 33% stake in its Egypt activities.

The unanticipated deal is executed at a great price and underlines the successful strategy of Apache to rebalance its portfolio. After this excellent deal, I see more upside potential.

The Deal

Apache launched a strategic partnership with Sinopec International Petroleum Exploration and Product Company to jointly pursue upstream oil and gas projects. In reality Apache is selling a minority stake to the Chinese company at a great price.

Under terms of the deal, Apache will receive $3.1 billion in cash, in exchange for a 33 percent minority stake in Apache's Egypt oil and gas business. The company will remain the operator of the activities.

The deal is subject to normal closing conditions and governmental approval. The deal is expected to close in the fourth quarter of the year.

Egyptian Turmoil And Portfolio Rebalance Efforts

The deal is part of Apache's efforts to rebalance its portfolio towards assets with predictable growth rates and strong return on capital statistics. The Egyptian activities produced roughly 15% of total output for the second quarter.

The Egyptian deal results in a more balanced portfolio in order to focus on the potential of North American onshore resources.

Part of the proceeds will be used to pay down debt in order to maintain the current A credit rating, as well as to buy back shares under its current 30 million share authorization. If any, remaining proceeds will be used to fund future capital expenditures.

Net production from the Egyptian operations averaged 100,000 barrels of oil and 354 million cubic feet of natural gas, in 2012. Apache stresses that operations are located in unpopulated and remote areas, unaffected by the political events so far.


Apache ended its second quarter with $184 million in cash and equivalents. Total debt stood at $12.77 billion, for a large net debt position of $12.6 billion.

Revenues for the first six months of the year totaled $8.46 billion, down 0.6% on the year before. Net income attributable to shareholders rose by 53% to $1.71 billion.

A simple extrapolation of these results would result in annual revenues of $17 billion and earnings of $3.5 billion. In reality adjusted earnings should come closer to the $3.0 billion mark.

Trading around $85 per share, the market values Apache at $33 billion. The current valuation values the company at around 2.0 times annual revenues and 9-10 times annual earnings.

Apache corporation pays a quarterly dividend of $0.20 per share for an annual dividend yield of 0.9%.

Some Historical Perspective

Long-term investors in Apache have seen decent returns, although the leverage position and exposure to gas production has impacted returns in recent years. Shares rose from merely $40 in 2004 to highs of $150 in 2008.

Shares fell to lows of $50 during the crisis in 2009, to recover to levels around $125 in 2011. Shares have fallen to lows of $70 in spring of this year, but the news about the planned divestitures and solid second quarter earnings report pushed shares to current levels around $85 per share.

Between the calendar year of 2009 and 2012, Apache has doubled its annual revenues toward $17 billion. The company turned a $235 million loss into a $2 billion profit last year.

Investment Thesis

The deal pretty much has two surprises. For starters, no one has anticipated any deal at this point in time given the turmoil in the Middle East. Second, the deal value implies a valuation of Apache's Egyptian activities of around $9.3 billion, which came as a positive surprise.

The activities had 641 million barrels of oil and 3.79 trillion cubic feet of gas in probable reserves at the end of 2012. The price tag values the assets at some $33 per barrel.

Egypt accounts for about 20% of the current production of Apache, but investors are happy that the company managed to close the deal. The deal comes just a month after the sale of Gulf of Mexico assets for $3.75 billion to Fieldwood Energy LLC. Apache disclosed plans to sell at least $4 billion in assets back in May after engaging in large acquisitions in the years before.

While we can apply all kinds of multiples to the deal, Apache has only been the owner of the assets for merely three years. Following the Gulf of Mexico disaster for BP (NYSE:BP), Apache managed to acquire assets from the British oil company for $7 billion.

The company paid $3.1 billion for Permian basin assets which perform incredibly well after BP has been underinvesting in the business for years. Part of the deal was that Apache bought Egyptian assets for $650 million, while the current deal values the assets in that country at $9.3 billion.

Obviously operational excellence and investments have boosted production, but still the price tag looks surprisingly rich. Apache's technical capabilities are well recognized after the company acquired declining North Sea assets from BP already back in 2003. The company managed to produce more and at a quicker pace than many industry experts thought was possible.

Investors seemed to agree that Apache made a killer deal three years ago. Its shares rose from $80 to highs of $120 within six months of the announcement of the deal.

Investors are excited at the moment and they should be. The deal is executed at a great price and investors did not think such a deal could be done in the current geopolitical environment. The Egyptian activities alone could almost eliminate the entire net debt position or allow the firm to repurchase some 7% of its share base outstanding, under its current share repurchase program.

Focusing on much more stable geopolitical areas, by divesting Egypt warrants a premium valuation and is promising for the overall production growth profile driven by the solid growth in the US onshore Permian and Anadarko basin.

The rebalancing of the portfolio makes sense, and these deals are certainly no fire sales. The long-term prospects remain actually quite good. While energy investors traditionally expect higher dividend yields, which could depress Apache's valuation, I see potential for shares to breach the $100 level going forward.

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.