On August 24, QEP Resources (QEP) hosted an analyst call to review its $1.38 billion acquisition in the Williston Basin. In addition to transaction details, the discussion yielded valuable insights into the Bakken/Three Forks M&A dynamics.
Management confirmed that the South Antelope area assets had been won in a highly competitive auction. The quick 6-8 week data room process indicates a high level of buyer interest (Tudor, Pickering, Holt was the advisor to the selling group). The very high level of competition for assets in this strategic "black oil" play explains the full price that QEP had to bid in order to win the auction. QEP Chairman and CEO Chuck Stanley commented with regard to the acquisition price:
"We have not changed our criteria. We still focus on returns. We still believe that we can generate our targeted returns, including the acquisition cost on this property, or we would not have bought it."
Management did not specify their minimum return threshold or risking criteria, however my analysis indicates that the acquisition should pass (with a slim margin) a 20% pre-tax, pre-overhead rate of return test, assuming the provided EUR estimates have been risked appropriately.
During the call, management emphasized the exceptional quality of the property from both geologic and operating perspectives. According to Chuck Stanley, the company's geologic model identifies the area as one of distinct "sweet spots and a clear anomaly" in the Williston Basin. The assessment is confirmed by results from the 32 high-EUR long-laterals in both the Three Forks and Bakken intervals as well as additional strong wells drilled by others around the property. Similar to QEP's existing operation on the nearby Fort Berthold acreage, the acquisition block lies within an over-pressured cell. However, the expected 1.0 million Boe average EUR per well is two times greater than what QEP estimates for its Dunn County leasehold.
QEP targets accelerated development and operating synergies across a larger scale business within the combined compact and largely contiguous area. The company plans to ramp up its drilling program on the newly acquired block from two rigs currently to five rigs during 2013 (the five rigs may include the two units that the exiting operator Helis Oil & Gas is currently running and some of the three rigs that QEP operates on its Fort Berthold leasehold; QEP's retention drilling requirements for its existing acreage appear to be minimal). In the future, the drilling program may expand to as many as eight rigs across the combined acreage. Chuck Stanley commented:
"I think ramping up to five rigs throughout the life of this property will get us to that [target] return, if not better. And of course it's a lever that we can pull to juice the return. Of course the faster we can drill this up in the front end, the higher the PV."
On the financing side, QEP affirmed that no equity issuance by QEP is currently planned. QEP has sufficient liquidity to fund the transaction (in combination of the $146 million cash on hand and availability under its undrawn $1.5 billion revolver). However, QEP will need to divest, in my estimate, over $700 million worth of assets within a year to meet its target credit metrics and fund its accelerated drilling program in the Williston Basin (an eight-rig program may translate in $300+ million incremental capex). S&P's affirmation of QEP's credit ratings on the night of the announcement is without doubt premised on the company's commitment to bring leverage within target levels in the near term.
On a pro forma basis, Debt/LTM EBITDA ratio is expected to increase from approximately 1.2x currently to just over 2.0x; Net Debt will grow from $1.72 billion to $3.16 billion; and Net Debt/Total Capital ratio will step up from 34% to 48%. QEP indicated its preference for a 1.5x EBITDA coverage ratio in six months (a tall order). While no specific divestitures were identified, it appears that QEP may follow its many E&P peers in creating an MLP vehicle for its strong midstream business (which may be valued at over $2.5 billion and could generate in excess of $400 million in an IPO). In addition, QEP is likely to divest select assets within its diverse E&P portfolio. In any event, the monetization strategy is likely to be announced during the forth quarter.
Management did not rule out additional acquisitions in the Williston ("we look at everything in the basin," including publicly traded companies), as well as in QEP's other operating areas. Chuck Stanley emphasized that QEP will be looking for the same type of geologic and operating attributes as in the South Antelope transaction. While oil and liquids acquisitions seem to be the focus, "contrarian" acquisitions on the natural gas side are not being ruled out either.
Management's comments during the call illustrate the highly competitive M&A environment within the maturing Bakken/TFS play. QEP is one of many highly sophisticated acquirers with an appetite to increase their footprint in the basin. As the play is getting increasingly delineated, both in the Bakken and Three Forks intervals, its sweet spots as well as sub-economic fringe areas become thoroughly mapped and analyzed financially by a broad number of interested parties. QEP's M&A screening process is highly illustrative:
"We've looked at everything in the basin that has been for sale. And as a result of that we've mapped the whole basin, forecasted all the wells in the basin, and from that work, we saw certain parts of the basin that attracted our attention. I guess you can say we've done a lot of that preliminary legwork here... We do a DCF drill-out analysis on every acquisition that we look at. That requires… a lot of detail about ownership and understanding, that you will not get from the public data, about the exact NRIs and working interests on the target acreage. As far as learnings from acquisitions, we have been able to value every one of the deals that we've looked at and get to the number that people have successfully transacted at."
In addition to the underlying geology and demonstrated well performance histories, other factors carry significant weight in setting property prices. Those factors include operatorship, anticipated development plans for non-operated interests, HBP requirements, sufficiency of existing infrastructure, permitting/surface issues, "blocked up" geometry of acreage parcels, and other considerations.
"In many instances we were not willing to go there [i.e., bid aggressively] because of our perceptions of risk... In many of the previous transaction there have been significant components of non-op[erated interests] that drove value dramatically, depending on your perception of how fast other operators would develop acreage that you are acquiring. And it's a really tough thing to do because, as you can imagine, you really have no way of knowing whether the operator is going to jump on the acreage that you have an interest in and drill it up early in the life of your acquisition or late in the life of your acquisition. And if it makes up a substantial component of the potential value, risking, and the perception of risk, differentiates the winners and runners up in a bidding transaction."
The acquisition announcement by QEP has sparkled a renewed wave of M&A speculation around smaller Williston Basin-focused stocks. Among the smaller cap names often mentioned as potential targets are Kodiak Oil & Gas (KOG), Triangle Petroleum (TPLM), Magnum Hunter Resources (MHR), and Northern Oil & Gas (NOG), while among larger cap stocks the frequently mentioned are Oasis Petroleum (OAS), Whiting Petroleum (WLL), and even Continental Resources (CLR) and Newfield Exploration (NFX). Three observations are in order.
- First, many resource play companies see the same attractive value in their portfolios as potential buyers and may prefer to capture it all than split it with the buyer. Some rumored "targets" may simply not be for sale early in their growth trajectory.
- Second, the QEP transaction does seem to confirm that there is appetite in the market for quality properties and the implied returns to the acquiror are low in the extremely competitive environment. However, in some instances, the public market valuation already reflects a relatively low expected return leaving little room for a take-over premium.
- Third, while there may be a temptation to use the QEP transaction metrics to value other Bakken-focused companies, the comparable multiples approach does not work for broad property portfolios. The discussion during the conference call once again reminds that per acre valuations in resource plays are highly idiosyncratic and very strongly depend on the specifics of each property.
QEP commented on the call:
"One of the things that is absolutely important here,.. acreage math alone does not drive the value of the transaction or the scope and scale of the operation. Because... these resource plays have vast quantities of acreage that are on the fringes of the play that yield marginal wells. Even with good operators drilling low cost wells it is tough to overcome marginal rock. So having a nice chunky core acreage positions in one of the highest EUR parts of the basin allows us to have kind of scale we are looking for, which is profitable scale, not just having thousands and thousands of acres in the marginal part of the basin."
It is difficult not to agree.
Disclaimer: This article is not an investment recommendation and does not provide a view on the value or price direction of any security.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.