Riddle: How does a company with a market cap of $4.7 billion and debt of $3.9 billion purchase $6.1 billion in assets?
Answer: Gently stir robust oil prices, depressed interest rates and a semi-forced seller.
Yesterday Plains Exploration & Production (PXP) announced the acquisition of Gulf of Mexico oilfields from BP (BP) and Royal Dutch Shell (RDS.A). Most independent E&P's are turning from natural gas to oil as quickly as feasible. Plains dealmaking is company transformational.
The cornerstone asset of Plains has long been its California heavy oil production. This long lived, low cost, steady production asset generates excess free cash flow which is used to fund growth. Outstanding Eagle Ford success by Plains in the Eagle Ford was made possible by this capital. Unfortunately, Plains Eagle Ford position is only large enough to support growth until the middle of the decade, unlike Eagle Ford leader EOG Resources (EOG).
Four years ago the shale natural gas frenzy was publicly put into overdrive when Plains entered into a $3.3 billion Haynesville joint venture with Chesapeake Energy (CHK). Today Plains intends to sell its Haynesville stake to help fund the Gulf of Mexico asset purchase. With the long term natural gas outlook bleak, Plains can expect to receive only a fraction of its invested Haynesville capital back.
Prior to yesterday's acquisition announcement, Plains could have been viewed as an onshore oil and gas independent with offshore optionality. Going forward Plains will be predominately an oil producing Gulf of Mexico company. Ironically, after the 2010 Macondo oil spill Plains management worked tirelessly in an attempt to pare the company's Gulf of Mexico exposure. Plains already owns 32% of Gulf of Mexico oil and gas explorer McMoRan (MMR).
Deal highlights for Plains include:
- Doubling the company's oil production per share.
- Increased asset base with growth potential.
- Transformation to an oil company.
- Significant free cash flow.
Risks to Plains need to be addressed:
- Near term oil price risk with hedging required.
- Credit market exposure in the intermediate term.
- Gulf of Mexico valuation discount likely on shares.
Plains shares were already good value by the numbers and will be more so going forward. The financing of the assets shows the value. The purchase is being done exclusively with bank facilities. Repayment is expected over the next several years and to be driven by annual $1 billion Gulf of Mexico free cash flow and 2013 natural gas asset sales.
In a robust oil pricing environment shares of Plains would be deep value. After several years of debt repayment, the direction management takes with the prodigious free cash flow will be interesting. Join me as I follow the sector.