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.
In Callon Petroleum (NYSE:CPE): Let's Discuss Asset Value (Seeking Alpha PRO, April 8, 2016), I pointed out that the company's stock price implied a remarkably high valuation per undeveloped acre in its core operating area in the central Midland Basin. I also noted that the stock price effectively reflected investors' expectation of a strong recovery in oil prices. I concluded that investors should be prepared for additional equity issuances and acreage acquisitions:
Strategically, the small size of Callon's acreage position in the Central Midland Basin, which is the company's most valuable asset and valuation driver, is an issue. The company will be tempted to pursue additional acquisitions, possibly in other areas, including the Delaware Basin where acreage prices tend to be substantially lower than in the Midland Basin Core. The company will continue using the equity market for funding. This hypothesis is illustrated by the company's two equity offerings undertaken in the last several months. Given the competitive environment in the Permian, overpayment in acquisitions and operational focus dilution are obvious risks.
One did not have to wait long for the company to announce a significant acreage acquisition funded with new equity issuance.
(Source: Callon Petroleum Acquisition Presentation)
The Howard County Acquisition
Callon is acquiring 14,089 net acres operated by Big Star Oil & Gas, LLC for a total consideration of $220 million in cash and approximately 9.3 million shares of CPE's common stock, or $302 million in aggregate consideration (using the company's April 19, 2016, closing price of $8.79 per share).
The southern portion of the acquisition acreage is located in Howard County, Texas, offsetting the acreage that Encana (NYSE:ECA) acquired in the Athlon transaction. The northern portion of the acquisition acreage is located in Martin, Borden and Dawson counties and offsets the acreage that Diamondback Energy (NASDAQ:FANG) acquired in the recent Cobra transaction.
The Wolfcamp A, Lower Spraberry and Wolfcamp B zones are currently producing on the Big Star acreage and directly offsetting fields. Callon believes that the acreage also has potential in the Wolfcamp D (Cline) and Middle Spraberry which are known to be producing zones in the area.
According to the press release, the acreage represents largely contiguous positions allowing for average lateral lengths of over 8,300 feet. Over 80% of the acreage is operated. Working interest is ~81%, with 25% royalty burden.
The properties have five currently producing horizontal wells, including three Wolfcamp A and two Lower Spraberry wells with average 30-day peak production rates of 1,165 Boe/d. Estimated net daily production for Q1 2016 is 1,931 Boe/d (82% oil).
Callon estimates year-end 2015 PDP reserves associated with the properties at ~4.1 MMBoe, 71% oil (unaudited).
Based on these data points, I estimate the M&A value of the existing production at ~$50-55 million, which implies that ~$250 million is being paid for the undeveloped acreage or ~$17,750 per acre. Assuming, however, that only 75% of the acreage is "core" and attributing $10,000 per acre valuation to the remaining 25% of the acreage, the effective acquisition price per core acre would be in the $22,000 range.
The acquisition price is in line with many other recent transactions in the Midland Basin, but is below some of the acquisitions in Howard County. I should note that when comparing acquisition valuations, it is important to properly reflect the M&A value of the existing production and give consideration to such factors as existing delineation, HBP requirements, operatorship, access to infrastructure, etc.
As I discussed in my previous note, Callon's stock price implies a valuation for the company's existing core acreage (the central Midland Basin legacy acreage on the map at the top of this note) in excess of $80,000 per undeveloped acre. In this context, the announced acquisition is "accretive" to the intrinsic value, assuming the new acreage lives up to the high expectations.
Reagan County Acquisition and Joint Venture
In a separate transaction, Callon is also acquiring additional acreage in the southern Midland Basin. Total net cash consideration in this transaction is $33 million.
The transaction is interesting in that Callon is forming an area of mutual interest ("AMI") in western Reagan County with TRP Energy, LLC ("TRP"). Callon and TRP are jointly acquiring from a private party 4,745 net acres (with a 55% share to Callon) north of the Garrison Draw field operated by CPE. Callon simultaneously sells a 27.5% interest in the Garrison Draw field to TRP. As a result, Callon's acreage position in western Reagan County will increase by 1,759 net acres. Net daily production will increase by 953 Boe/d for the first quarter of 2016. The production comes primarily from existing horizontal wells completed in the Wolfcamp A and the upper and lower benches of the Wolfcamp B.
It is difficult to estimate the implied valuation per acre due to the complexity of the asset swaps.
New Production Guidance For Q1 2016
Pro forma for the transactions, net production for the first quarter of 2016 (assuming January 1, 2016, effective dates) would have been approximately 15,300 Boe/d, including production of approximately 12,400 Boe/d (79% oil) from Callon's existing operations.
The Equity Offering
The large equity raise is part and parcel of the proposed acquisition.
Callon just launched an overnight stock offering of 22 million shares. Assuming a 6% discount to the previous closing price, 20% upsizing and the green shoe exercised in full, the company would raise ~$250 million in proceeds. The proceeds would be sufficient to fund the acquisitions as well as provide additional funds for the company's drilling program.
Implications For The Stock
I anticipate that the transaction will be well received by the market as it adds scale to the company's operation and increases public float.
The market will likely like the fact that the Howard County acquisition is priced below several other similar transactions on a per-acre basis, even though the price paid is by no means low in absolute terms. The acquisitions also provide an opportunity for Callon to raise extra cash to shore up its balance sheet and, possibly, avoid a drawdown on the senior credit facility for capital spending.
I expect that this is not the last acquisition by Callon. The thesis that the premium stock valuation provides a strong incentive for the company to issue additional equity and acquire acreage remains intact.
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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.