Sanchez Energy - Investors React Cautiously Optimistic To The Latest Transformational Deal

May.24.14 | About: Sanchez Energy (SN)


Sanchez acquires Catarina assets from Royal Dutch for $639 million.

The deal is set to double proven reserves and implies an even greater increase in production.

Yet production of acquired assets is focused on NGLs and low-yielding natural gas.

Sanchez continues to expand rapidly, but I can not foresee all implications of this growth yet.

Investors in Sanchez Energy (NYSE:SN) were very enthusiastic about the company's purchase of the so-called Catarina assets of Royal Dutch Shell (NYSE:RDS.A) in the Eagle Ford.

During the trading session, enthusiasm regarding the deal kept fading as investors learned that while production results are impressive, actual revenues from those operations are much more limited with much production tailored to NGL and natural gas.

I remain on the sidelines not being able to see a clear picture about the new combination, its implications on earnings and cash flows in the medium term future.

The Deal Highlights

Sanchez Energy announced the purchase of Eagle Ford assets for $639 million in cash. For that amount, Sanchez will get a hold of 60 MMBOE of proven reserves while the assets produced an average of 24,000 barrels per day in the first quarter, of which 60% were liquids.

The assets are located on 106,000 net acres in Texas, boosting the presence of Sanchez in the Eagle Ford to 226,000 acres. The deal which is effective on January 1 of this year is expected to close as soon as June the 30th.

Implications Of The Deal

The deal which Sanchez made is transformational. The company will get access to another 3,000 potential drilling locations while pro-forma production is seen at 42,800 barrels of oil-equivalent in the first quarter. Note that the company's own production totaled just 18,800 barrels of oil equivalent over the past quarter.

Proved reserves will double toward 119 MMBOE while the acquired assets have supporting production and mainstream infrastructure in place. Catarina's proven reserves consist of 43% gas vs. 12% at Sanchez's properties. As a matter of fact only 21% of reserves are based in oil with the remainder being NGL.

According to CEO Tony Sanchez III, the acquired assets have the resource potential of up to 500 MMBOE, per the company's internal estimates.

Continued Growth Requires Investments

Based on the deal, Sanchez sees third quarter production of 37,000 to 41,000 barrels per day. Production is set to increase by another 8,000 barrels in the fourth quarter while production for 2015 is seen between 53,000 and 58,000 barrels of oil equivalent.

As a result of the acquisition, capital expenditures are set to rise further. Capex is anticipated at $770 to $830 million in 2014, set to rise towards $1.03-$1.12 billion by next year.


Sanchez believes that the deal will be significantly accretive to earnings and cash flows per share in both 2014 and 2015 as the company has secured financing commitments of $950 million to close the deal.

Following the deal, Sanchez will operate with roughly $111 million in cash. Total debt stands at $1.18 billion resulting in a roughly $1.07 billion net debt position. The company has access to nearly $500 million in liquidity needed to fund all the capital expenditure requirements.

Take notice, the company furthermore has $374 million in perpetual convertible preferred stock outstanding. Following completion of the deal, the combination's net debt/pro-forma EBITDA ratio is seen at 1.5 times.

Based on current production levels the combination could post revenues of roughly $900 million going forward. Sanchez's contribution to these revenues is roughly two-thirds of total revenues despite slightly lower production as its production is highly geared to high-yielding oil.

Sanchez Is Moving Quick

To be honest, I think it is quite easy to lose track of the real operational achievements at Sanchez following this deal. With a $1.7 billion valuation for its equity, the reported deal is very sizable, yet investors appear to be pleased by the headlines which call for doubled reserves and an even greater increase in production.

Yet the acquired assets are of inferior quality with just 21% of reserves being oil with the rest of production geared to much lower yielding NGL and natural gas. The deal adds to leverage, bringing it little over a billion, yet the real cash requirements are needed for the capex programs this year and next year.

Still investors are optimistic about the deal. At highs of $34.50 per share following the deal announcement shares jumped nearly 20%. This implied a $300 million boost to the market capitalization. Towards the close, shares have given up more than half of their gains as investors were digesting the news.

I still have a lot of news digesting to do myself, including figuring out the true cash flow picture, the earnings picture and quality of acquired assets. Until that time I have no rating/opinion about the deal and the prospects for Sanchez itself.

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.