Ultra Petroleum (NYSE:UPL) is the last company to acquire some shale assets from Royal Dutch Shell (RDS.A) which is shedding non-conventional assets in Northern America.
Initially investors reacted negatively as the acquisition involved a partial divestment, resulting in a rather small addition to current production while the company spends nearly a billion to acquire the assets.
Yet after this initial reaction, shares recovered and edged higher as the deal will add significantly to proven reserves, bolstering the long term future outlook.
Pinedale Acquisition Highlights
Ultra Petroleum announced that it has reached an agreement to acquire the Pinedale properties which have previously been held by affiliates of Royal Dutch Shell.
The company will spend $925 million in cash and will exchange a portion of its Marcellus Shale properties as discussed below.
The deal which will be financed with new debt is expected to close in the current third quarter.
A Look At The Operations
The Pinedale field currently produces 189 million cubic feet equivalent, MMcfe on a daily basis in both natural gas and condensates. Note that the company only acquires the interest of Shell in the field which is about 68%, adding effective production of roughly 128 million cubic feet.
In exchange Shell will obviously receive the near billion cash component while it will also receive a 155,000 net acres in the Marcellus shale which currently produce about 100 MMcfe in natural gas.
As such the company will net increase production by just 28 million cubic feet per day, while spending a huge sum for this benefit. The main reason for this is the huge increase in reserves following the deal. Acquired activities contain 2.1 trillion cubic feet in proven reserves, while the divested assets contain just about 10% of that. As such the company-wide reserve base will jump from roughly 4.4 trillion cubic feet to 6.2 trillion cubic feet going forwards.
The net impact of the acquisition and divestiture increased the present value of the total energy reserves by $1.8 billion. This is as the company is spending an amount roughly half of that in closing the deal. If these estimates are correct, substantial accretion could materialize in the long term, benefits which executives are stressing when commenting on the deal.
Pure Play Pinedale Player
Following the deal some 95% of the proven reserves of the company will be located in the Pinedale area, up from an 88% before the transaction took place. As such the company is pleased to add to its core assets which allows the company to grow production without much of a cash flow impact. Already having operations in place, economies of scale are to be anticipated.
The remaining Marcellus acreage is of high quality, yet the overall contribution to the operations is becoming smaller as a result of the deal.
The present value of these reserves is anticipated to jump from $5.9 billion to $7.8 billion following the deal. As such CEO Michael Watford is very pleased given the increase in reserves, potential for better returns, higher operatorship stakes and better control on capital allocation going forwards.
Rosy Outlook Predicted..
Based on this deal and the already anticipated growth, Ultra sees much better days ahead. The company is very much a focused gas player. Of the 250 Bcfe in anticipated production per day for this year, some 231 Bcfe is being produced in natural gas.
This results in expected annual revenues of about $1.2 billion and anticipated EBITDA of $820 million. The company is very profitable indeed, posting net earnings of $208 million for the first six months of the year on sales of $622 million.
For the year of 2018, Ultra now forecasts total production to increase towards 414 Bcfe which combined with $4.55 anticipated realized prices could push revenues towards the $2.0-$2.5 billion region. EBITDA could improve towards $1.5 billion as non-gas production will increase slightly quicker. To support all of this growth, Ultra anticipates spending close to a billion in capital expenditures at that time.
.. But Beware Of The Leverage
Before the deal took place, the company's net debt position already stood around $2.5 billion which will increase towards $3.5 billion following the deal. EBITDA is anticipated to improve towards $1.01 billion, resulting in a rather steep debt multiple.
The net debt position is expected to improve to $3.0 billion by 2016 as EBITDA will improve to $1.2 billion, pushing the leverage ratio down to a much more acceptable 2.5 times. This ratio should fall further towards 2.0 times according to the company's estimates.
At $23 per share, Ultra's equity is now valued at round $3.5 billion which values the enterprise at $7 billion given the anticipated leverage position. This values operating at 8.5 times this year's anticipated EBITDA, a multiple which is expected to fall to 7 times by next year.
The company is currently posting earnings of about $400 million per year, which is quite appealing as it values equity at just around 10 times earnings. It should be noted that the company does not pay any real taxes at the moment, which could be a risk to the valuation at some point in time.
While the leverage position is rather high, the company anticipates production to increase at a compounded annual rate of 12% to 2018. Strong operational cash flows should allow for a rapid deleverage of this position over upcoming periods. It is worth mentioning that the company is not active in hedging the exposure to natural gas prices, which could create in additional risks if natural gas prices were to fall further.
Shares remain at historical low levels in their low twenties after trading as high as $100 back in 2008. Of course collapsing natural gas prices and leverage are to blame for the decline. While many of these players have adopted the pain of cutting capital expenditures and operational costs, the overall industry remains rather highly leveraged amidst relatively low natural gas prices.
In that light the latest deal is surprising, as it only adds to the short term risk profile which was already above average. In essence, the company bets on stable natural gas prices and its position as a low cost marginal producer. If things don't turn for the worst, the deal has the potential to be very accretive in the long run.
Being cautious on long term natural gas prices and avoiding excessive leverage in general, I will shun the shares. The long term prospects have improved if industry dynamics will become more favorable, making a bet on long term out of the money calls a better alternative instead.
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