Oasis Petroleum Inc. (OAS) is an independent exploration and production company focused on the acquisition and development of unconventional oil and natural gas resources, primarily operating in the Williston Basin.
On September 5, 2013, the company announced it increased its acreage footprint in the Williston Basin by nearly 50% with the acquisition of a combined 161,000 net acres (91,000 of those acres have rights to all depths) in three separate transactions. We will avoid repeating the details found in the Company's press release, and instead focus on what it could mean for investors.
On September 10, 2013, Oasis announced it completed a private placement of $1.0 billion in Senior Notes, up from the originally contemplated size of $600.0MM. The Senior Notes were sold at par value, priced at 6.875% and are due 2022.
Purely Williston Basin
Oasis founders Tommy Nusz and Taylor Reid both had promising careers at Burlington Resources, a company steeped in entrepreneurial moxy, an ethic they brought to fast-moving Oasis Petroleum.
Burlington Resources was acquired by ConocoPhillips (COP) in 2005 and once the golden handcuffs that chained talent to the combined company were unlocked, many Burlington executives left to chart new courses for their futures. Since starting Oasis Petroleum, Nusz and Reid have maintained a singular focus on the Williston Basin, making the company one of the few sizable pure plays for investors seeking exposure to the Bakken and Three Forks oil shale plays. In our view, the company's most recent acquisitions strengthen the Oasis brand and give the company the assets and visibility to continue to deliver on its brand promise: "Grow Oil Production and Reserves to Build Long-Term Per-Share Value."
With the three strokes of the pen, Oasis expanded its acreage position by 161,000 net acres and solidified its position as one of the larger operators in the Williston Basin with a total footprint of 492,000 net acres and 1,959 net operated drillable and economic locations.
The three deals have us reminiscing about Brigham Exploration Company, which was acquired by Statoil (STO) in 2007. That deal took one of the most dynamic Bakken operators off the market, burying the assets in large, global E&P with a market capitalization of $70 billion (as of September 5, 2013). Several companies are working to brand themselves in the footsteps of BEXP, but few have captured that company's brand strength. With this most recent acquisition, Oasis appears to be the heir apparent to the Brigham legacy.
From inception, Oasis has strategically and singularly focused on the Williston Basin and the Bakken and Three Forks plays specifically. Looking at OAS inclusive of the acquisitions, the company's acreage position is 68% larger than at its IPO on June 22, 2012, when it controlled 292,242 net acres in the heart of the Williston Basin. At the close of business on September 10, 2013, the OAS share price realized a 212% gain since its IPO.
With the addition of 161,000 net acres, Oasis extended its visible growth runway with another 119 operated drilling spacing units bringing the company's total up to 399, or an inventory of 1,959 net operated drilling locations in the heart of the Bakken play. That provides OAS with a 16-year drilling inventory, assuming the company maintains its current activity level at 13 rigs running and 172 wells drilled per year.
As the ranks of smaller independents building valuable franchises in the Bakken diminish, as the result of acquisitions or growth, it is increasingly difficult for investors to find a Williston Basin pure play. The chart below illustrates the publicly traded players primarily operating in the Williston Basin in which Bakken and Three Forks results might "move the needle" for shareholders.
After the deals close, Oasis will have solidified its status as the independent E&P with the third-largest acreage position and leverage to the Williston Basin. OAG360 notes that this deal positions OAS with more net acreage in the Bakken than Marathon Oil (MRO) and a longer reported Bakken drilling inventory than EOG Resources' (EOG) 12-year inventory.
Leveraging Resource Conversion, Driving Economies of Scale
Amassing a large acreage position in a resource play is nice, but being able to effectively and cost-efficiently develop the captured resource is an entirely different competency. Oasis describes its business strategy as "resource conversion," or the cost-efficient transformation of captured resource into proved reserves and production growth. This strategy is the foundation of Oasis' brand promise to grow long-term value per share. We evaluated the key elements of the deal within this context.
Two elements stand out. First, after the acquisitions close OAS will operate 91% of its total leasehold, the same proportion as before the deals. Second, the company reported that 86% of its total acreage will be held by production, essentially unchanged from the pre-acquisitions level of 87%. These two factors are encouraging, because with most of its acreage now HBP, the company in 2013 was able to move its development strategy to pad drilling. Pad drilling, a disruptive process technology in the oil patch, increases drilling efficiencies and economies of scale by reducing rig moves and keeping frac spreads on station for a longer duration. Management expects the shift will help it reduce total drilling and completion costs down to $8.0MM by year-end 2013, which is a big boost to well economics and getting more out of the same capital investment.
Maintaining high operational control and HBP percentage implies that the pad drilling strategy will likely remain a core element of Oasis' resource conversion strategy. In fact, management reported its target drilling and completion cost for year-end 2014 is $7.5MM, a reduction of 6.3% from the year-end 2013 target of $8.0MM and does not include the $200,000 per well reduction in cost from Oasis Well Services, the company's in-house pressure pumping and completion division.
Cash [Flow] is King
Prior to the announcement, Oasis was approaching financial "escape velocity" by achieving the enviable position of generating positive free cash flow (cash flow from operations less capital expenditures). The company outspent cash flow from operations for the past three years to grow production and proved reserves to a critical mass.
To get a read on how the acquisitions affect the company's path to free cash flow escape velocity, we used metrics sourced from EnerCom's E&P Database. First, we looked at cash inflows. For the TTM period ending June 30, 2013, Oasis generated $54.24 of EBITDA for every BOE produced (TTM EBITDA less TTM OpEx and G&A divided by TTM production volume).
Applying that metric to the 9,300 BOEPD of incremental production from the new assets, we estimate that the acquired assets could contribute estimated annual EBITDA of $184.0MM. Giving effect to the acquisitions, Oasis produces a pro forma 43,000 net BOEPD. Using the company's EBITDA margin of $54.24 as noted above, we forecast that on a company-wide pro forma basis Oasis generates an estimated $899.7MM in operating cash flow per calendar year. Additionally, we note that the company achieved an EBITDA margin of $66.17 per BOE for the single quarter of Q2'13, an increase that demonstrates the company's continued ability to increase efficiencies and drive cash flow.
In terms of capital outflows, we analyzed the company's existing drilling program and expected activity on the acquired properties. On a stand-alone basis, Oasis reported it is currently running 11 rigs on its existing operated acreage position. Based on data from the first six months of 2013 and per the company's Q2'13 filing, OAS spent approximately $78.0MM per rig per year. If we apply that metric to the 11 rigs, we estimate 2013 drilling and completion capital investment at $858.6MM, which is below the company's full-year 2013 guidance of $897.0MM for drilling and completion and $1,020MM for total capital spending.
To be conservative for the new assets, we applied $80.0MM per rig year for the two rigs the current operators of the acquired properties are running. Using the more conservative number for the acquired rigs implies an incremental $160.0MM per year or a total pro forma capital spend of $1,018.6MM, which is very close to the company's full-year 2013 guidance.
The chart below illustrates the company's progress towards reaching free cash flow status.
In the first six months of 2013, Oasis outspent cash flow by a modest $48.5MM, which was down 78% from the free cash flow deficit of $230.0MM the first six months of 2012. Based on our estimates of CFFO and capital expenditures outlined above, we estimate OAS's pro forma annualized outspend at $118.9MM, or 17% less than our estimated annualized outspend on a stand-alone basis. After the acquisitions, we estimate Oasis will have a cash flow deficit lower than it had before the deals, assuming no increase in the company's capital budget.
A Capital Idea
Concurrent with the acquisitions, Oasis announced an increase in its revolving credit facility to $1.50 billion, up from $1.25 billion as part of its semiannual borrowing base redetermination. The company noted that the new borrowing base was formulated on proved reserves as of June 30, 2013, on a stand-alone basis and prior to the acquisitions. As of September 4, 2013, there was $100.0MM outstanding on the credit facility. We note that the company's revolving credit line matures in 2018. In terms of longer term debt at the time the acquisitions were announced, Oasis had $1.2 billion in long-term bonds outstanding in three $400 MM bond tranches that mature in 2019, 2021 and 2023, respectively.
To improve liquidity, Oasis announced on September 10, 2013, that it priced a $1.0 billion private placement offering of Senior Notes at a coupon rate of 6.875%. The new notes were sold at par value and are due in 2022. The increased revolver size combined with the new bond financing provides Oasis with approximately $2.5 billion in liquidity to complete the acquisitions, fund its 2013 capital budget and head into 2014 with significant dry powder to accelerate development drilling.
Turning our attention to capital structure, at August 23, 2013, Oasis' debt to market capitalization stood at 32%. Assuming no increase in market capitalization, the company's debt to market capitalization would rise to 73%, or 42% of total capitalization.
The data shows that levering-up has its risks and can have a limiting effect on equity valuation, as measured by price to cash flow per share (P/CFPS). For example, in EnerCom's monthly Energy Industry Data and Trends report for August 2013, E&P companies with a debt to market capitalization exceeds 50%, P/CFPS multiples tend to be capped at 4.9x. The chart below illustrates this effect.
(click to enlarge)
Levering-up to fund the acquisitions does not appear to materially increase financial risk. The table below summarizes the increase in debt to market capitalization to 54% from 33%, using the pro forma share value estimated in the next section, which is above the average of 46% for the 85 companies in EnerCom's E&P database. Consequently, we believe that financial risk is slightly above average.
When considering the company's slight uptick in financial risk, however, we should consider the intended use of proceeds. Even though Oasis has increased debt, the use of proceeds is for the constructive purposes of expanding its core acreage position by nearly 50%, increasing its visible growth potential with another 199 operated drilling spacing units and accelerating value creation by adding two more rigs to the development drilling program.
Instead of increasing leverage to fund exploration ventures or acquire unproved acreage, OAS is adding debt capital to buy producing assets that generate cash flow possessing lower-risk development drilling upside. That is consistent with the old oilfield adage to match "E" with "E" and "D" with "D" or "Use equity to explore, and debt to develop."
We evaluated the potential impact of the acquisitions on valuation using two methods, including production and proved reserves.
At August 23, 2013, OAS was trading at an enterprise value [EV] of $170,328 per flowing BOEPD (based on TTM production at June 30, 2013) and $33.18 per proved BOE (using proved reserves as of year-end 2012). Using these metrics as benchmarks provides some insight into the near-term impact of the acquisitions on the value of Oasis.
In our analysis, we assumed that OAS will finance the acquisitions by utilizing its liquidity, net of cash and incremental cash flow generated from the acquired producing assets (previously estimated at $24.0MM). Scenario 2 in the table below outlines our estimate of the impact of the acquisitions on valuation.
Giving effect for the acquisitions, we estimated the average per-share value of OAS to be $50.53, using both production and proved reserves methodologies, which is 27% higher than the closing price of $39.60 on September 4, 2013, immediately prior to the announcement.
Additional upside could be realized from an accelerated drilling program in 2014, the upside from future downspacing (increasing the number of drilling spacing units) and/or increasing efficiencies in operations and drilling.
In summary, we view the most recent acquisitions made by Oasis as part of the company's long-term resource conversion game plan and strengthen its franchise in the Williston Basin. The new financing provides the liquidity the company needs to keep building long-term value for shareholders.