On August 23, 2012, QEP Resources, Inc. (QEP) announced it increased its operations in the Williston Basin to approximately 118,000 net acres with the acquisition of 27,600 net acres from multiple sellers in a new core area targeting the Bakken and Three Forks formations.
Details of the transaction:
- Total consideration of approximately $1.38 billion in cash, subject to customary pre-closing and post-closing adjustments.
- Effective date of July 1, 2012, with estimated closing date on or before September 27, 2012.
- Aggregate current net production approximately 10,500 barrels of oil equivalent per day [BOEPD].
- Aggregate net proved and probable reserves of approximately 125 million barrels of oil equivalent [MMBoe], comprised of approximately 81% crude oil, 9% NGL and 10% natural gas.
- Approximately 27,600 net acres of predominantly fee simple mineral leases with an average 80% net revenue interest [NRI].
- Approximately 90% of aggregate net acreage to be acquired will be operated by QEP after closing (presently operated by Helis Oil & Gas Company LLC of New Orleans, Louisiana):
- 24 operated spacing units with an average gross working interest of 82% with an average NRI of 66%.
- 27 non-operated spacing units with an average gross working interest of 10% with an average NRI of 8%.
- Above Williston Basin-average well estimated ultimate recovery [EUR] for both Bakken and Three Forks formations in the contiguous, operated acreage block. For long-lateral wells drilled after January 1, 2010:
- Average Bakken EUR of 1,160 thousand barrels of oil equivalent [MBoe].
- Average Three Forks EUR of 990 MBoe.
- The Bakken and Three Forks formations are both prospective across all of the acreage and will be developed by separate horizontal wells targeting each formation.
- Aggregate of 72 gross (29 net) developed locations and 301 gross (146 net) undeveloped locations.
- QEP estimates future net development capital for all acquired assets to be approximately $1.59 billion.
- Acquisition will increase QEP's net acreage in the Williston Basin to approximately 118,000 acres
- The company expects to fund the acquisition with proceeds from its revolving credit facility and cash on hand.
Click here to hear a replay of the conference call with investors and analysts.
As a result of the acquisition, the company modified its full-year 2012 guidance, as follows:
- Adjusted EBITDA increased to $1.40 billion to $1.45 billion, up from $1.35 billion to $1.40 billion.
- Production increased to 310 Bcfe to 315 Bcfe, up from 305 Bcfe to 310 Bcfe.
- Capital investment [CAPEX] increased to $1.50 billion to $1.55 billion, from $1.45 billion to $1.50 billion.
The market had been expecting QEP to make some sort of deal for the past several quarters, based on management comments earlier in the year to investors on conference calls and at other events. The company's announcement of expanding its operations in the oil-prone Williston Basin, targeting the Bakken and Three Forks formations, is consistent with the recent industry trend of gas-weighted companies moving into liquids-rich and crude oil plays. Since QEP will operate approximately 90% of the acquired acreage after closing, the assets provide QEP more operational control for increasing the proportion of oil in the company's production stream.
Management hosted a conference call to discuss the acquisition in more detail. Key elements, from our perspective, include:
- Reallocation of 2012 capital spending, allocating 32% of full-year CAPEX to the Bakken, up from 18%.
- Reduction of capital allocated to dry gas plays, with the Haynesville spend falling to 10% of revised 2012 capital spending, down from 32%, and Granite Wash/Tonkawa/Marmaton/Cana dropped to 22% of revised 2012 capital spending, down from an original 27%.
QEP explained the newly-acquired acreage fits it acquisition criteria:
- Oil-prone assets.
- Tight sand and carbonate conventional reservoirs with the ability to evaluate rock properties across a wide aerial expanse.
- Identify the best reservoirs in the targeted basins. Superior execution can't make up for inferior rock properties, and look to identify the "sweet spots" in resource plays which are typically over-pressured.
- Target stacked pay zones for multiple opportunities developed from pad drilling and better use of infrastructure.
- Focus on areas where the company already operates with the intent of leveraging existing relationships.
- Large, contiguous acreage positions to maximize efficiencies in both development drilling and operations; preferably, private fee ownership, as it better aligns owner and operator interests.
Management indicated this acquisition fits its criteria "perfectly" and represents a new core area for oil reserves and production growth. The acquired acreage falls outside the Fort Berthold Indian Reservation, primarily on private fee leases.
See below additional news releases or presentations:
- Unit Corporation news release dated August 23, 2012
- Black Hills Exploration & Production news release dated August 23, 2012
- Sundance Energy South Antelope presentation
Balance Sheet Impact
The acquisition will be financed with existing cash and drawing down on the company's $1.5 billion revolving credit facility. Management was forthcoming with metrics providing insight into how the additional debt will impact key credit and leverage statistics using the balance sheet as of June 30, 2012:
- Net debt increases to a pro forma $3.16 billion from $1.72 billion.
- Debt to EBITDA increases pro forma to 2.0x, up from 1.2x.
- Debt to total capital increases to a pro forma 48%, up from 34%.
Those metrics appear manageable, and we dug deeper into the balance sheet to see what kind of impact the financing will have in absolute terms. At June 30, 2012, QEP had $1.867 billion in long-term debt [LTD]. If we use the pro forma net debt of $3.16 billion as provided by management and add back cash at June 30, 2012 of $146.4 million, the implication is that total debt pro forma for the transaction is approximately $3.3 billion and the company drew down $1.44 billion on its $1.5 billion revolving credit facility. That puts total pro forma debt at an estimated $3.3 billion, or 69% of market capitalization, as of August 17, 2012. That compares to a 38% average for the 25 companies in EnerCom's mid-cap E&P group.
Management seemed to recognize that the increase in leverage has the potential to stress the balance sheet, and remarked that the company would be seeking to de-leverage in the future. The company said on its conference call that an equity raise was described as a "last resort" leading us to believe that potential midstream or non-core assets sales are likely. In addition, as the company ramps up drilling activity in the new Bakken acreage and drives up oil production and reserves, we anticipate an increase in market capitalization and a reduction in debt on a relative basis. Increasing oil production combined with efforts to reduce absolute debt give us comfort that the increase in leverage should be viewed as a bridge to an oily future, not as a permanent change in debt policy.
In the mid-cap group mentioned above, there are other companies with similar debt to market capitalization percentages (using debt at Q1'12 and market capitalization as of August 17, 2012), including Berry Petroleum (BRY) at 70%, Linn Energy LLC (LINE) at 63%, Newfield Exploration (NFX) at 67%, Plains Exploration and Production (PXP) at 71%, SandRidge Energy (SD) at 89%, Ultra Petroleum (UPL) at 58% and WPX Energy (WPX) at 52%. These companies are generally oil-weighted with an average cash margin of $27.86 per BOE. At $22.38 per BOE (as of Q1'12), QEP's cash margin was already competitive and rising oil production selling at a higher energy-equivalent value than the company's natural gas production should have a disproportionately beneficial impact on cash margins.
Management mentioned on the conference call that Standard & Poor's published a note specifying that the pro forma debt levels will not impact the company's credit rating.
With respect to future acquisitions, the company said on the call that it was "never done" in reviewing and evaluating future opportunities to make additional deals that strengthen its competitive position in its key operating areas.
Management did not specify if any of the acquired production was hedged, deferring to QEP's next board meeting, but did indicate that the company would take steps to reduce commodity price risk.
We estimate that QEP paid $50,000 per net acre, $131,429 per flowing BOEPD and $11.04 per 3P reserves. The company did not disclose proved reserves for the acquisition, deferring that disclosure for its year-end 2012 reserves report.
Although the per-acre cost seems expensive, we note that on the basis of production, the acquisition is more reasonable. The average enterprise value to flowing BOEPD for oil-weighted, Bakken-levered names like Northern Oil & Gas (NOG) and Oasis Petroleum (OAS) is $231,129 per flowing BOEPD. We know these smaller, oil-weighted names are not perfect comps to the gassier QEP (trading at $50,652 per flowing BOEPD as of August 17, 2012), but they do indicate the premium investors are willing to pay for repeatable crude oil growth in what is arguably the nation's most attractive oil play.
Of the ten property acquisitions made year-to-date this year, QEP's was by far the largest. Data is spotty, but we note that two property deals made this year, including Legacy Reserves purchase of Paramount Resources' acreage in Montana and North Dakota (April 30, 2012) and Magnum Hunter's purchase of Baytex Energy's properties in North Dakota (April 18, 2012), averaged $19.73 per BOE. We do note that on a 3P basis, the $11.04 per BOE compares favorably to QEP's three-year average finding and development cost of $10.38 per BOE, which is primarily gas-weighted (year-end 2011 proved reserves were 76% natural gas).
Extending the Runway
QEP didn't make the acquisition for its producing properties, but rather for the development drilling from the 301 gross (146 net) drilling locations. If we assume a five-rig drilling program with each rig drilling 12 wells per year, the newly-acquired acreage provides QEP with a drilling inventory of approximately five years, further increasing its long-term visible growth potential for increasing crude oil production and reserves.
QEP is currently running two rigs on the acquired properties and will simultaneously be running three rigs on existing assets for a total of five rigs. The company said it would keep five rigs running through 2012.
In summary, we view this acquisition as an important strategic move to increase QEP's visible growth potential, crude oil growth potential and should have a disproportionately positive impact on cash flow per share as higher-profit oil production increases as a percentage of the company's total production stream. In addition, the contiguous acreage position will provide QEP the ability to apply its expertise in large-scale development of resource plays for driving efficiencies in drilling and operations, creating value per-share.