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EP Energy (EPE) made its public debut on Friday, January 17. Shares of the independent exploration and production company ended their first day with losses of 9.6%.

While shares have sold off significantly since the public offering, and especially from the preliminary offering range, this does not translate into an automatic buying opportunity.

I will await the release of the fourth quarter results before making up my opinion on the company, after being able to make a better informed opinion about sustainable cash flows of the company.

The Public Offering

EP Energy is an independent exploration and production company focused on the acquisition and development of unconventional onshore oil and natural gas properties in the US.

The company operates in the Eagle Ford Shale, the Wolfcamp Shale, the Altamont field and the Haynesville Shale. Within these areas the business identified 5,200 drilling locations, including 916 locations with proved undeveloped reserves, of which 96% produces oil.

EP Energy sold 35.2 million shares for $20 apiece, thereby raising $704 million in gross proceeds. All shares were being sold by the company with no shares being offered by selling shareholders.

Initially, bankers and the firm set an initial price range of $23-$27 per share, aiming to sell 40 million shares. Shares were eventually sold far below the low end of the preliminary initial public price range as the consortium and the company cut the size of the offering as well.

Some 14% of the total shares outstanding were offered in the public offering. At Friday's closing price of $18.08 per share, the firm is valued at $4.5 billion.

The major banks that brought the company public were Credit Suisse, JPMorgan (JPM), Citigroup (C), Goldman Sachs (GS), Morgan Stanley (MS), Deutsche Bank and Wells Fargo (WFC), among many others.

Valuation

EP Energy has proven reserves of 513 MMBoe as of September of last year, representing 24 years of current drilling inventory. Average production for the quarter ending in September of past year totaled little over 88,000 barrels of oil equivalents per day. Some 45% of production represents oil, with the remainder in liquids.

For the first nine months of 2013 the firm generated revenues of $1.13 billion. This compares to revenues of $727 million a year earlier, marking growth of 56.1%. Note that revenues in the comparable period last year were generated between half of February and September of 2012.

As a result of income of $496 million from discontinued operations, EP Energy reported earnings of $397 million which compares to a loss of $256 million a year ago. Note that during the third quarter, EP energy sold natural gas properties in Raton, the Black Warrior and Arkoma basin for $1.3 billion.

The company operates with $75 million in cash and equivalents while total debt stands at $4.12 billion. The gross proceeds of $704 million are disappointing, with the firm aiming to raise a billion in proceeds originally. These proceeds are used to retire debt outstanding with interest rates of over 8% per annum, resulting in pre-tax cost savings of roughly $50 million per annum.

Note that the reported headline results are based on the successor company. So far in 2013, EP Energy posted similar revenues of $1.13 billion while posting a modest $14 million profit. Assuming annual revenues of $1.5 billion are attainable, the equity in the business is valued around 3 times annual revenues.

Investment Thesis

As noted above, the offering of EP Energy has been a major disaster. The company priced the offering at $20 per share, some 20% below the midpoint of the preliminary offering range. Ever since, shares have fallen even more, trading some 27.7% below the midpoint of the preliminary offering range.

Investors have not been happy with the public offering, possibly on the back of concerns for oil prices, the debt position, high capital expenditure requirements and general uncertainty about the business. Reading from the public offering, it might be hard to judge the true sustainable revenue run rate and normalized earnings.

There are a lot of red flags. While competition is normal, uncertainty about normalized results, the lack of information and higher revenue multiples, this sell-off does not automatically translate into an automatic buying opportunity.

As such I will await the upcoming fourth quarter results to learn more about the business, the "normalized" revenues and cash flows before making up my mind on this offering. While the company has nicely growing assets and focused on oil production, its leverage position and current uncertainty are a drag for me.

I remain on the sidelines.

Source: EP Energy - Failed Energy Offering With Many Uncertainties Left