Recently, I gave the management of ConocoPhillips (NYSE:COP) a big compliment following the divestiture of most of its Canadian assets at a great price. Just weeks after this huge $13 billion deal has been announced, ConocoPhillips announces the next multibillion divestiture. This $3 billion deal marks another sizable sale for ConocoPhillips, but unlike the Canadian deal, I am not impressed by the price being fetched for the assets. This is certainly the case as Conoco had the time to wait for a good price.
Following this most recent deal, I remain cautious. While ConocoPhillips is reducing its costs, it remains less competitive than shale players, continues to operate with quite some debt and environmental liabilities, and has large commitments to investors, which shale players do not have.
Selling San Juan
Conoco has agreed to sell its stake in the San Juan Basin to Hilcorp Energy in a $2.7 billion cash deal. This price tag excludes contingency payments, which are capped at $300 million, depending on the price of gas in the coming years.
The assets produced 124,000 barrels of oil-equivalent per day in 2016, of which 80% was in the form of natural gas, 18% in the form of NGL, and merely 2% in oil. That suggests that at a $3 billion valuation, each barrel being produced each day is valued at merely $24,000. Despite the fact that most of the production is in the form of gas, the valuation looks on the softer side.
Proven reserves totaled 600 million barrels of oil-equivalent, as these reserves are valued at just $5 per barrel. These multiples are not very high and this is re-confirmed by the fact that the book value of the assets amounts to $5.9 billion, while the company received just half that amount. This is highly disappointing as the company actually obtained a 1.2 times book value multiple for the assets, which were recently sold in Canada.
The Pro-Forma Implications
This deal comes on top of the divestiture in Canada last month. ConocoPhillips sold most of its assets in Canada for a total consideration of $13.3 billion, which includes a $2.7 billion equity investment in Cenovus, which the company is looking to divest over time. All in all, ConocoPhillips is hoping to receive roughly $16 billion in value for these two divestitures. That excludes contingency payments related to the Canadian assets, which could potentially run into a few additional billion if oil prices see a meaningful recovery.
The Canadian assets being sold produced 265,000 barrels of oil-equivalent per day (of which 2/3 are liquids), as this latest deal will bring the total production being divested to 389,000 barrels of oil-equivalent per day. This is substantial but serves a goal of reducing the break-even costs of all of ConocoPhillips, while cash flow estimates are largely held intact. ConocoPhillips itself claims that these two deals will reduce the break-even costs across the portfolio from $40 to $35 per barrel of oil equivalent.
Following this latest deal, pro-forma production comes in at 1.16 million barrels of oil-equivalent per day, a quarter less than the 2016 run rate. Total reserves will drop by 30% to just 4.5 billion barrels of oil equivalent. The good news is that oil production itself is not that much impacted. Oil production, expressed as a percentage of total production, is expected to jump by 10 points towards 45% of total production.
The 1.25 billion shares outstanding of ConocoPhillips trade around the $50 mark, for a $62 billion valuation. Net debt stood at $25 billion at the end of 2016, which valued daily production at $53,000 per barrel and reserves at $13. The $16 billion in proceeds from divestitures will therefore meaningfully reduce net debt towards $9 billion although taxes and transaction costs might result in some leakage.
ConocoPhillips has already indicated at the time of the divestment in Canada that it aims to spend some of the proceeds on buybacks, targeting a $20 billion net debt load. That level might be lowered a bit, as the latest deal impairs the production profile of the business again. I would urge some caution for ConocoPhillips as it aims to boost leverage again, as the size of the company has come down a lot. Additionally, the company reported another $10 billion in environmental-related liabilities on its balance sheet at the end of 2016.
I was upbeat on the sale of the Canadian assets in March as it avoided any remaining debt overhang concern. That deal furthermore took place at very reasonable prices in terms of production, reserves and the book value. That deal provided a big boost for the shares, while I am not so convinced about the sale of the San Juan assets and the price being received.
While most of the production is in the form of natural gas, the valuation is not very steep. This is confirmed by the huge book value loss (50%) as the deal will furthermore impact short-term cash flow a bit.
The company claims that the two recent deals reduce break-even costs by $5 towards $35 per barrel, but this does not correspond to the actual financial numbers reported by ConocoPhillips in recent times. The company posted an adjusted loss of $3.3 billion, equivalent to $6 per barrel in 2016 at a time when WTI averaged $43 per barrel.
In the fourth quarter of 2016, in which oil averaged $49 per barrel, adjusted losses narrowed. Losses were still substantial at $318 million, equivalent to roughly $2 per barrel being produced. With oil having recently recovered to levels in the low fifties, and taking into account that ConocoPhillips has divested some of its higher cost assets, it seems fair to assume that adjusted losses have been halted for the moment. Perhaps Conoco can squeeze out a small profit on an adjusted basis at these levels.
Conoco has taken the right steps in terms of de-risking its balance sheet, simplifying the business and reducing break-even costs, while increasing the focus on oil production. This has come at a long-term cost if energy prices recover in a big way, which is something that ConocoPhillips does not anticipate given that it is selling its higher cost of production assets. This confirms the view that US shale producers act as an efficient ¨cap¨ on oil prices at this point in time.
That being said, Conoco has taken a beating with production and reserves being down between 25 and 30%, while the company is not yet profitable. I applauded the Canadian divestiture, which served debt reduction and lower cost of production at a fair price. This latest deal does the same, but the price received for the assets looks a bit soft, as there was no pressure to engage in a deal.
It is furthermore a dangerous strategy to sell to many assets at a time when the prices for these assets are generally soft. This comes years after the company spent huge amounts on capital spending when projects were expensive, and share buybacks at elevated price levels.
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.