The Board of Directors also includes ex-Morgan Stanley superstar Robert Niehaus and Pickens' longtime oil & gas attorney, Robert Stillwell. Miller has assembled a top-notch management team that averages 26 years of industry experience. Pickens is the largest shareholder with over 12% of the shares outstanding. Management owns over 12% and Niehaus, through Greenhill Capital Partners, owns about 3%. Private equity group Ares Capital owns 6%.
These are arguably some of the most savvy and aggressive dealmakers in the energy business. The Investment Banking and finance relationships of this group are second to none. With the backing of Pickens, Niehaus and Ares, private equity capital is readily available to do deals. Miller’s business plan is to aggressively grow EXCO through acquisitions, through the drill bit and through creative financings to maximize asset values.
EXCO Resources issued 53 million shares in an IPO in February 2006. Miller and other managers contributed their EXCO Holding shares obtained in an equity buyout in October 2005. Pickens contributed his recently purchased properties from the Oneok Energy acquisition. Proceeds from the offering paid off existing debt (from the equity buyout) and preferred stock/debt to Pickens. Needless to say, insiders all made out well on the IPO. Total shares outstanding after the offering is 104 million. EXCO thus created sizeable positions in Appalachia and East Texas as well as positions in the Permian Basin, the Rocky Mountains and Mid-Continent. Production is approximately 90% gas. Pro forma market cap was $1.35B and long-term debt totaled $570MM, or 42%.
At the time of the offering, proved reserves totaled 66 Bcfe. Daily production was 113 Mmcfe, with a reserve life of 16 years. These assets will provide EXCO with a large inventory of long life, low-risk drilling locations that should support high single digit organic growth for many years.. The company sells at about an average valuation based on reserves, cash flow and earnings. But, because of its large inventory of low risk step-out drilling locations, EXCO sells at a substantial discount to its 3P (proven, probable and possible) reserves. They are 60% hedged for 2007/2008 production at about $8.00. Analyst coverage includes Goldman, Bear Stearns, Deutsche Bank, Key Bank, Morningstar, Execution and JP Morgan.
EXCO started the year with an aggressive drilling budget of $190MM. They had 15 contracted rigs working on 418 (334 net) approved locations spread amongst its properties. During the first half of 2006, 171 wells were drilled at a 100% success rate. Production volume grew to 124Mmcfe per day. Drilling continued through Q3 as EXCO drilled an additional 124 (94 net) wells at a 99% success rate. Production increased to 129 Mmcfe/d through drilling and acquisitions.
The company has a three-year average finding cost of $1.27/Mcfe versus the $1.92/Mcfe peer average, and has outperformed its small-cap peers on reserve replacement in recent years. EXCO now has 21 rigs turning in their key development properties.
The leverage behind EXCO’s growth story is in acquisitions. In Q2, EXCO made three deals totaling over $252MM, adding to key acreage in West Texas, East Texas and Appalachia. These properties increased proven reserves by 223Bcfe at an “all in” cost of $2.52 Mcfe and were purchased with cash and revolving debt. They added 133 (87.9 net) wells to the 2006 drilling program and added over 2200 drilling locations.
In Q3, EXCO made two smaller acquisitions totaling $76MM in Appalachia and the Rockies. These properties added 30 Bcfe to reserves and 4 Mmcfe/d to production. In July, EXCO announced the purchase of Winchester Energy from Progress Energy for $1.1B in cash. These East Texas properties increased proven reserves by another 385 Bcfe, included 75Mmcfe/d of production and 734 (558 net) drilling locations. The acquisition also included a pipeline system with throughput of 115Mmcf per day. The production includes considerable hedges through 2009 at about $9. These high quality long life reserves include acreage with an additional 280 Bcfe of probable and possible reserves. The Winchester deal closed on October 2.
While acquiring assets at attractive prices is clearly EXCO’s game plan, these dealmakers will also sell assets that become overpriced. In 2005 they sold their Canadian subsidiary, Addison Energy for $443MM. Canadian trusts hungry to add assets made it unattractive for EXCO to add new properties in Alberta. EXCO recorded a gain of $174MM on the Addison sale. More sales can be expected from non-core areas this year.
Since the IPO, EXCO has increased proven reserves by 637 Bcfe, about 95%. They increased net acreage and now control over 1,164,000 net acres. They added over 2500 drilling locations and now control over 4400 locations, 2500 of which are proved. They increased production by 80% to the current 204.4 Mmcfe/d. Miller’s current acquisition strategy is also focusing heavily on 3-P reserves.
The market is just beginning to realize the true value of probable and possible reserves in the long life, low risk fields where EXCO is growing their key properties. Total 3-P reserves now stands at 1960 Bcfe. Miller indicates that they are seeing very good deal flow of well over $25B in properties and some significant JV opportunities in their upstream assets.
Maximizing Asset Values
Concurrent with the Winchester acquisition, EXCO announced its intention to form a master limited partnership [MLP] to include the newly acquired properties and some additional East Texas acreage in the EXCO portfolio. The Winchester purchase was completely financed “off balance sheet” in a new entity, EXCO Partners LP. Following a three-year audit of Winchester, EXCO plans to sell some 50% of EXCO Partners in an IPO this spring. In speaking with CEO Miller he indicated he had been working on a unique structure that he feels will negate the problems with existing MLPs.
With natural gas prices appearing to have bottomed and interest rates appeared to have peaked, the early 2007 offering may be very well timed for yield hungry investors looking for the tax advantaged distributions of the MLP. The market is somewhat skeptical of the MLP because of the size of the offering and the relatively unknown US market for E&P assets. But EXCO is willing to put their money where their mouth is and is preparing a “rights offering” to existing shareholders.
Miller tells me that most, if not all, of management and insiders will participate. They are also planning a promotion to existing shareholders. I would expect that current directors, Pickens and Neihaus, will be a part of this promotion and will be exercising their rights to buy MLP units. This should be a strong endorsement for institutions and individuals. Pickens has never been shy about appearing in public and in the media to promote his ideas.
What does all this mean to EXCO Resources shareholders? One, individuals will be able to purchase MLP shares through the rights offering that may otherwise be hard to get from their own brokers. More importantly, the MLP will add significant book value to XCO. If successful, the retained MLP units will be worth about $11.50 per XCO share while book value of the retained assets will still be over $8. Also, Miller is already crafting the larger Appalachia assets into a second MLP using the same structure.
Like the bull market for energy in the 1980’s, there appears to be substantial profits ahead for those that can buy undervalued energy assets and find ways to sell them at a premium. Doug Miller and Boone Pickens have proven track records to “buy low, sell high” in the energy business. Since I believe in the strategy of “investing in management”, my money is riding with them in EXCO Resources.
Disclosure: Author is long XCO
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