Rice Energy: Implications Of The Proposed Acquisition

| About: Rice Energy (RICE)

Summary

Rice may be able to add ~180 Marcellus locations at an attractive cost.

Given the company’s relatively small asset footprint, the expansion is a positive, particularly given the excellent operating fit.

The acquisition is a 'stalking horse bid' under Chapter 11 proceeding - Alpha Natural Resources is the seller.

The impact on the share value is minor, however, as the transaction represents a “scaling up” by using new equity.

Click to enlarge

Important Note: This article is not an investment recommendation and should not to be relied upon when making investment decisions - investors should conduct their own comprehensive research. Please read the disclaimer at the end of this article.

Marcellus Acquisition - Implications For The Stock

There are two components to the transaction announced today by Rice Energy (NYSE:RICE): a potential major acreage acquisition and a large equity offering. Both are important, in my view.

The acquisition acreage falls within the Marcellus and Deep Utica core fairways. While the opinion on the $200 million price being bid by Rice is a function of one's view on the trajectory of natural gas prices, I personally see the bid as attractively priced and opportunistic. The acquisition, if successful, would be an excellent fit with the company's existing acreage position in Greene County (acquired from Chesapeake few years ago). Please note that the announced acquisition agreement is a stalking horse bid and therefore there is no guarantee (although chances are high) that Rice will be the winner in the auction.

From a macro perspective, the timing for the acquisition appears highly opportune, given the severe downcycle in natural gas and the seller's Chapter 11 situation. In my opinion, the transaction's effective price of ~$6,600 per undeveloped acre, or ~$1 million per Marcellus drilling location, is not low but is quite reasonable, given the prime position in the fairway. It is important to note that after five years of acreage consolidation, core Marcellus properties are a scarce commodity and competition for them is intense. Therefore, one cannot expect that a high-quality asset can be won on a low-ball bid.

The arguably attractive price paid in the acquisition cannot be taken out of the context of the concurrent equity raise. Rice raised ~$327 million in gross proceeds in the offering. An additional up to $234 million of stock was sold by NGP Rice Holdings, an affiliate of Natural Gas Partners (the sell-down by the largest shareholder is, arguably, a negative signal). The offering priced at a modest ~2% discount to the previous close, which indicates strong investor demand.

The equity raise at the bottom of the cycle is a side effect that in significant part offsets the value benefits achieved in the acreage purchase. The size of the capital raise in excess of the acquisition price is in part explained by Rice's need to fund an expanded drilling program beginning in 2017 as only 44% of the acquired acreage is held by production or in fee. Rice obviously used the acquisition as an opportunity to shore up its balance sheet and fund a portion of its spending program. Assuming a strong cyclical recovery in natural gas, the increase in the share count will be a burden in the future, the factor that should not be overlooked.

In the immediate perspective, the market will likely perceive the highly successful equity financing as a guarantee of financial safety, and therefore, a strong positive. Using acreage acquisitions as a reason to raise significant new equity has been a common tactic adopted by many E&P operators with resilient stock valuations. I have highlighted the trend on multiple occasions (I, II, III). Rice's move is no exception in this regard.

Overall, I see the announcement as a positive for the stock. The price being paid in the acquisition represents approximately 6% of Rice's current enterprise value but increases the drilling inventory by a much larger percentage. Given Rice's compact existing acreage position, the market is likely to welcome the expansion in the footprint. Furthermore, given the equity financing, this is a transaction that Rice certainly can afford.

Assuming a successful equity offering, the initiative benefits existing shareholders the most, in part at the expense of the new investors buying into the equity offering.

The Stalking Horse Bid For ANR's Marcellus Acreage

Rice announced that it has entered into a stalking horse asset purchase agreement to acquire Marcellus and Utica assets in central Greene County, Pennsylvania for $200 million in cash from Alpha Natural Resources. ANR is a coal producer who has filed for reorganization under Chapter 11. The acquired acreage is immediately adjacent to Rice's existing acreage in Greene County (the CHK acquisition acreage) and is offset by EQT Corp.'s (NYSE:EQT) acreage to the north and Chevron (NYSE:CVX) acreage to the east.

(Source: Rice Energy, April 12, 2016)

As a reminder, the "stalking horse bid" approach is often used in the context of an asset auction by a bankrupt company. The bankrupt company's management and advisers choose, based on a preliminary marketing process, the "stalking horse" bidder to make the first bid. The idea is to avoid low-ball bids on the assets in the auction. Once the stalking horse has made its bid, other potential buyers may submit competing bids for the assets. There is no guarantee that the stalking horse bidder will ultimately emerge as the winner in the auction.

The bankruptcy court's approval is required for Rice to be named as stalking horse bidder for the assets. Given that Rice was selected based on a marketing process, the approval should not be a problem, in my opinion. Thereafter, a public auction process will follow. Consummation of the acquisition, if Rice is named the winner, would also be subject to bankruptcy court approval.

Given Rice's bid price and strategically advantaged position, Rice's statement that it is well positioned to win in the auction is valid, in my view (although some risk of an upsetting bid certainly remains).

Click to enlarge

(Source: Rice Energy, April 12, 2016)

The Assets

If successful, Rice will acquire leasehold interest in approximately 27,400 net undeveloped Marcellus acres, plus an additional 3,200 gross acres owned in fee that are leased to Rice Energy and currently generating royalty cash flow. In addition, the acreage includes rights to the deep Utica on 23,500 net acres. The acreage is directly adjacent to Rice's existing proved developed Marcellus position in Greene County and increases Rice's inventory of Marcellus locations by 37%.

In its presentation, Rice highlighted several important attributes of the properties being acquired. Unlike the Chesapeake acreage acquired by Rice two years ago, the acreage is not subject to any midstream dedications. As a result, Rice Midstream is ideally positioned to provide midstream services, with Rice capturing a significant portion of the upside via its limited partner interest, general partner ownership and incentive distribution rights. The integration of the newly acquired acreage increases the probability of the IDRs coming in the money.

In total, 6,200 acres of the acreage is owned in fee, contributing to strong estimated returns. Rice estimates that it will be able to generate a 40% drilling return on the acquired acreage at the 4/8/16 strip.

44% of the acreage is held by production/operation or in fee. However, Rice currently anticipates no changes to its 2016 budget.

Click to enlarge

(Source: Rice Energy, April 12, 2016)

The Impact On Rice Midstream Partners

Rice plans to dedicate the acreage to Rice Midstream Partners (NYSE:RMP), Rice's sponsored MLP. RMP would be able to extend its existing gathering system to the east and provide a link to long-haul transportation pipelines. As a reminder, Rice has 933 MMBtu/d of firm transportation on TETCO, TCO and DTI with firm paths to premium Midwest and Gulf Coast Markets.

Rice owns ~38% of the LP interests in the RMP and ~92% interest in the incentive distribution rights.

The Utica Upside

The acquisition acreage is prospective for deep Utica. However, I am not prepared to attribute much value to the deep Utica potential at this point given the significant cost and execution risk of deep Utica wells relative to the Marcellus and Ohio Utica inventory that Rice has in its portfolio. The resource has strategic value, however, as it can provide upside once Marcellus begins to mature.

Click to enlarge

(Source: Rice Energy, April 12, 2016)

In Conclusion…

The proposed Marcellus/Utica acquisition is a positive development for Rice Energy. The position as a stalking horse bidder provides hope that Rice will win the properties at the proposed $200 million price, which I view as favorable.

The large equity offering addresses the company's liquidity needs and strengthens the credit profile, which are positive factors given that the timing of the cyclical turnaround in natural gas remains uncertain.

For in-depth data and analysis of commodity fundamentals, please consider subscribing to Zeits OIL ANALYTICS that provides analysis of the crude oil market.

Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment, tax, legal or any other advisory capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. The author explicitly disclaims any liability that may arise from the use of this material.

Disclosure: I/we 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.