Energy XXI: The Problems With Major Corporate Events

| About: Energy XXI (EXXIQ)

Summary

Oil production trading at multi-year lows.

History of successful reserve growth suggests the EPL acquisition will eventually work out.

Energy XXI trades at an attractive multiple once it regains the confidence of the market.

The Q214 results from Energy XXI (EXXI) highlight the short-term pains that investors can encounter with major corporate events including acquisitions. For those new to the story, Energy XXI has a history of buying Gulf of Mexico assets including smaller corporations and improving the results and increasing the associated reserves. Recently the company closed on the deal to purchase EPL Oil & Gas for total consideration of $2.3 billion.

With Brent Crude still trading above $100 a barrel, investors are left scratching their heads with Energy XXI trading at multi-year lows. The oil exploration firm has struggled to grow production recently having just finished FY14 with total production only up 4%. On top of that, the stock crashed after some relatively disappointing guidance following the numbers presented in merger news leading investors to think results would be significantly higher.

History Of Increasing Reserves

A prime reason for being bullish on the deal for EPL is the history of growing reserves of previous deals. The CEO famously states that big oil fields get bigger and the results previously backed up those statements.

Click to enlarge

Source: EXXI EnerCom presentation

Disappointing Production Guidance

The most perplexing part of the Q414 earnings release was the guidance for Q115 that ends in September. At the time of the merger announcement with EPL, Energy XXI released that the company would be the largest independent producer in the GOM shelf with current production of approximately 65,000 boe/d. The company had production of 46,100 boe/d in the quarter ending in June and guided to numbers far below the stated pro-forma numbers.

Energy XXI issued a mid-point guidance for the current quarter of 58,500 boe/d. See the full guidance numbers below for both production and EBITDA:

Source: EXXI Q414 earnings report

Even more disturbing to investors is the suggestion that full-year production for the year that began after the merger close will fall significantly below the suggested production numbers at the time of the merger announcement back in March.

For those reading the earnings transcript, one of the big frustrations was the lack of reconciliation between the proposed numbers and the actual guidance. The company provided some clues to the declining volumes when mentioning a previous deal with Exxon Mobil (NYSE:XOM) where the production numbers were lower by the time the deal closed. See CEO comment below when answering a question from Sarah Hunt of Alpine Fund:

John Schiller

Yeah, I hear you. So look, I've done a lot of mergers in my life. I will tell you that the integration on this deal has gone as seamless and smoothly as any deal we've done. In the field it takes longer. We still operate fields out there as EPL and as Energy XXI, different spill plans, different everything until the government gives approval and we become the operator of record and all that. And so there are certain things you can impact, certain things you can't. West gave a great analogy last night when talking about this. When we bought Exxon, we were six months before we took over those fields and they all continued in decline before we got in there and started turning everything around. And we announced that we bought 20,000 barrels and by the time we took it over we were operating about 16,500. The same thing we have to go through here, we are making a lot of improvements very quickly on the cost side.

One wouldn't have expected that a full acquisition would allow production to decline so this seems bizarre. It is more understandable for neglect when selling off a non-core asset. Either way, the company did a horrible job of disclosing the fact that 65,000 boe/d wasn't the expected production at the time of the merger close.

Conclusion

While Energy XXI continues to tout a PV-10 of $7.6 billion that far exceeds the current enterprise value, investors aren't interested in a oil production firm that can't grow numbers organically. Not to mention, the confusing nature of the guidance numbers will likely leave investors on the sidelines for a few quarters. The stock is relatively cheap and probably has significant upside if operations improve. Regardless, this situation provides a prime example of how corporate events such as mergers, IPOs, and spin-offs tend to lead to misunderstood financials.

With an EV of roughly 5x forecasted adjusted EBITDA of around $1 billion for the current fiscal year, Energy XXI is undeniably cheap for investors certain that it can hit targets going forward.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.