Callon Petroleum Co (ticker: CPE) is engaged in the acquisition, development, exploration and operation of oil and gas properties in Texas, Louisiana and the offshore waters of the Gulf of Mexico. At the time of this writing, CPE had a market capitalization of approximately$184 million.
In 2009, Callon began a strategic initiative to diversify its operations from strictly offshore Gulf of Mexico by entering the Permian Basin of West Texas. Callon’s plan is twofold: reinvest cash flow generated from its offshore fields in the U.S. Gulf of Mexico into onshore oil plays, and divest non-core offshore Gulf of Mexico assets to provide increased liquidity and capital to grow onshore.
Stepping out of the Gulf of Mexico “Tub”
Callon’s most recent move to focus onshore was the company’s announcement on November 28, 2012. CPE sold its 11.25% working interest in the Habanero field (Garden Banks Block 341) to Shell Offshore Inc., a subsidiary of Royal Dutch Shell plc (ticker: RDS.B) for $42 million.
To put the company’s onshore transformation in perspective, at year-end 2009, 17% of CPE’s total proved reserves of 9.7 million Boe were onshore and the company’s onshore production was 350 BOEPD during Q4’09. Pro forma for the Habanero sale, CPE reported that its onshore assets represent 67% of total company proved reserves of approximately 14.6 MMBOE (primarily in the Permian Basin) and 51% of pro forma October 2012 production of 4,390 BOEPD (63% crude oil). In short, since year-end 2009, Callon has increased onshore and total proved reserves, pro forma for the Habanero transaction by 493% and 50.5%, respectively.
The company plans to use the cash to repay borrowings under its revolving credit facility. As of September 30, 2012, the company had borrowings of $40 million on the facility, which has an $80 million borrowing base. Pro forma for the transaction, total debt at the end of the third quarter 2012 would have been $111.5 million that included outstanding principal of $97 million and a non-cash deferred credit, net of amortization of $14.5 million. Although we expect Callon to rely on its credit facility to fund its 2013 capital budget, the improved liquidity will enable the company to continue growing onshore oil production, and equity value, without having to raise capital in a volatile market.
The effective date of this transaction will be October 1, 2012, and it is expected to close on or before December 28, 2012, subject to the exercise of preferential rights and customary closing conditions.
Callon’s net interest in the Habanero field produced approximately 336 BOEPD and 506 Mcf/d during the month of October 2012, or approximately 8.7% of Callon’s total production for this time period. As of December 31, 2011, Callon’s net proved reserves related to the Habanero field were 1.373 MMBOE, with approximately 84% classified as proved undeveloped.
Callon’s Oil Growth Engine in the Permian
As CPE’s critical mass in the Permian Basin increases, its growth potential in this multi-pay, multi-play oil-prone region becomes more clear. In the company’s existing leasehold, CPE’s visible growth potential includes:
- 100 vertical Wolfberry drilling locations on 40-acre spacing.
- 88 potential horizontal Wolfcamp drilling locations in its Southern/Central Midland County.
- 150 potential Cline and Mississippian drilling locations in its emerging northern acreage position in Borden County.
These opportunities provide Callon a multi-year drilling inventory for growing onshore oil production and reserves in its existing asset portfolio.
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We view the sale of Habanero as a strong positive for Callon, because it provides additional liquidity to fund the company’s 2013 capital program and further shifts focus from legacy offshore fields to onshore oil production.
Fred Callon, Chairman and CEO, made this point when he said in a news release announcing the sale, “Pro forma for this transaction, over 50% of our total production for the month of October 2012 would have been sourced from onshore properties.” It bears mentioning that Callon first entered the Permian Basin in 2009, as part of the company’s strategic shift to move onshore to reduce reinvestment risk and improve its visible growth potential.
An operational benefit from the sale is reducing the amount of production variability in 2013, which we view as a pivotal year for the company as growing oil production from the Permian Basin is expected to eclipse offshore production. Habanero was scheduled to be down through much of the first quarter of 2013, and selling the assets before year-end avoids the inevitable impact of lower production as well as the potential risk of unexpected shut-ins related to hurricanes.
We calculated that Callon sold its Habanero assets for a cash value of $30.59 per Boe, which compares favorably when compared to the average enterprise value to proved reserves of $21.18 per BOE for the 86 companies in EnerCom’s U.S. E&P database, as of November 23, 2012. When we consider that the sale takes Callon’s future capital expenditure obligations at Habanero off the table, which we estimate at $15 to $20 million, the deal looks even better. Assuming $15 million of capital expenditures were avoided, the effective value of the sale was $41.51 per BOE and the deal looks even better.
On a flowing barrel of production basis, the value of the sale is approximately $99,921 per flowing barrel per day, as equivalent production was 420 BOEPD. That metric compares to values sourced from EnerCom’s U.S. E&P database of $65,327 per BOEPD for the seven companies with offshore operations weighted to the Gulf of Mexico, and approximately $105,162 per BOEPD for the wider group of 86 companies, both as of November 23, 2012.
Liquidity and Capital
Although the company is still planning its 2013 drilling program, a few baseline assumptions are in order. First, CPE noted in its Q3’12 earnings conference call that the borrowing base on its credit facility has been increased to $80 million, up $20 million.
Also on the Q3’12 earnings call, CPE noted that its current estimate for full-year 2012 capital expenditures was $152.5 million, and the company’s 10-Q filing for the third quarter showed Callon had invested $115.4 million through the nine months ended September 30, 2012. That implies the company will spend another $37.1 million in Q4’12, assuming that no funds were earmarked to Habanero. CPE had $1.5 million of cash and cash equivalents on hand at the end of Q3’12.
If we assume that Callon draws down on its credit facility to fund projected capital expenditures of $37.1 million in Q4’12, then the company has sufficient liquidity to fund capital expenditures on par with 2012 through Q4’12 and Q1’13. Given the amount of drilling activity onshore in the Permian, the company’s year-end 2012 reserves report may show an increase in proved oil reserves more than what was sold with Habanero, which would bolster the credit facility and potentially increase it.
During 2012 and early 2013, Callon expect to reveal results from its first Cline well on its northern Midland Basin acreage. The company’s first Cline well is currently flowing back. Additionally, Callon anticipates its Mississippian Lime well should be completed by year-end 2012.
We do not expect to obtain any specific capital budget guidance before year-end, as the company has historically announced guidance, including capital plans, in February or March.
Oil & Gas 360® compiled a few paragraphs from research analysts who wrote on Callon following the announcement. OAG360 suggests that you contact the analyst and/or salesperson to receive a complete copy of the report. Please read the important disclosures at the end of this note.
Johnson Rice & Company, LLC
Callon’s sale of its interest in the deepwater Habanero field further increases its focus on its Permian properties and provides ample liquidity to fund its 2013 drilling program. Given its early success on its southern Midland Basin acreage and offsetting industry activity, Callon believes it has ~90 horizontal Wolfcamp locations in that area. In addition, Callon’s first Cline well on its northern Midland Basin acreage is flowing back and its MS Lime well should be completed by year-end, which could add 150+ potential horizontal locations.
Sale of Habanero – Callon has agreed to sell its 11.25% interest in the Habanero field (Garden Banks block 341) to Shell offshore (RDS) for $42 million. Net to Callon’s interest the field was producing approximately 420 boe/d (80% oil) and had proved reserves of 1.373 mmboe (16% developed). On a per barrel basis the sale garnered $100,000 per flowing barrel or $30.58/bbl for the reserves. The Company plans to use the proceeds of this transaction to pay down a portion of its revolver balance ($80 million borrowing base, $40 million drawn at the of 3Q). The sale is expected to close by year-end 2012.
Horizontal Permian being de-risked – Callon’s first two wells in its southern Midland Basin position came on-line at impressive rates and continue to perform above expectations. In the northern Midland Basin, Callon’s Cline shale well is beginning flow back while the completion of its MS Lime well is expected by year-end. The results of these initial wells are expected to be kept tight until early 2013, once 30-60 days of production is attained. With success, its Borden County acreage (15,000 net acres) could add approximately 120 net horizontal locations to an already deep inventory (~88 locations) on the southern portion of its 32,500 net acre position. Looking ahead to 2013, Callon intends to operate one rig on the southern portion of its acreage with the possible addition of a second horizontal rig on the northern portion of its acreage by mid-year (assuming success).
Habanero sale enhances financial flexibility – Callon will use the proceeds of the sale to pay down its revolver ($80 million borrowing base, $40 million drawn) and increase its financial flexibility heading into 2013, as it looks to potentially accelerate its horizontal activity in the Permian. While the Company is selling approximately 1.4 mmboe in reserves, we anticipate an increase in its Permian proved reserves to more than make up for the sold reserves, allowing for increases in its borrowing base next year.
Global Hunter Securities
Metrics. CPE’s 11.25% stake in Habanero represents 420 boepd of daily production (80% oil) and 1.375 MMboe of proved reserves (and only 220 Mboe PDP). On a $42MM sale price, CPE nets $100,000/flowing boe of production and $30.58/boe proved reserve (~$190/boe PDP). It’s worth noting that Habanero has near-term drilling opportunities that would have essentially doubled production in 2013; however, it would have required additional capex (~$15MM net to CPE) that we believe would be better off spent in the Permian.
Liquidity. We now estimate that CPE will have approximately $60MM of liquidity upon exiting 2012. On a $120MM capex program in 2013 (our estimate based on $75MM-$80MM for one horizontal Permian rig, $35MM of vertical work in the Permian, $10MM for leasing and GOM maintenance) and with estimated cash flow of $75MM, we see a CF/capex gap of $45MM. This is manageable and removes the liquidity overhang on the stock in our opinion.
Is Medusa next? CPE’s larger deepwater GOP asset, Murphy’s Medusa Field (15% WI to CPE), averaged 1,400 boepd (85% oil) net to CPE in October. We believe this asset also possesses near-term drilling opportunities not too dissimilar to Habanero. Thus, we think applying the same $100,000/boepd metric to current production to yield a potential sale price of $140MM is not an unreasonable expectation. However, we believe that before selling off Medusa (a sizeable asset at ~35% of CPE’s total production), management will need to be confident that its northern Midland acreage is ready to move into development mode, and we’re still a couple quarters away before that conclusion is reached. Nonetheless, if the acreage gets the green light, we think CPE will look to monetize Medusa, funneling the proceeds into the development of its 30,000 net acres in the play and reaching pure-play Permian status.
Cheap way to play the Permian. We forecast 53% of CPE production will come from the Permian in Q4 (big change from just a couple years back), and CPE is already the third most levered small-cap player to the Permian on an EV/acreage basis. From a valuation standpoint CPE stacks up well vs. its Permian peers at 4x 2013E EBITDAX vs. the average multiple of LPI, FANG, PXD, CXO, CWEI of 6.2x.
Estimates changes. We are reducing our 2013 production to 5,250 boepd from 5,800 boepd after accounting for the sale. CFPS and EBITDAX move to $1.89 and $83.11MM from $2.11 and $92MM, respectively. We reiterate our Accumulate rating and price target of $6 (NAV based).
Suntrust Robinston Humphrey
Solid deepwater divestiture. Callon announced the sale of its non-operated interest in the deepwater Habanero field for $42 million, or $100,000/Boepd. For comparison, the company trades at ~$70,000/Boepd, while recent deepwater transactions have been in the $50,000-60,000/Boepd range. Thus we believe Callon received great value for current output of ~420 Boepd (66% oil) and upside associated with a sidetrack that could have added ~900 Boepd.
Upcoming horizontal results could de-risk several years of inventory. On its 3Q call, Callon indicated it was completing a horizontal Cline well and drilling a horizontal Mississippian well in Borden County. Callon plans to release results from these northern Midland Basin wells in 1Q13, with each zone having the potential to add three to four years of drilling inventory. Also, the industry is testing the horizontal Wolfcamp in the central Midland Basin, where Callon could have another year or two of drilling inventory. In a best-case scenario, horizontal success could double inventory from nine to 19 years.
Undervalued on absolute and relative bases. We estimate CPE trades essentially in line with year-end 2011 PV-10 value pro-forma the Habanero sale. This implies 2012’s production and reserve additions and the upside associated with the northern Midland Basin are basically free. Furthermore, the stock trades at a ~20% discount to its Permian peers on 2013E CFPS.
Reiterate Buy rating. Callon is undergoing a transformation to an onshore business model that should result in a re-rating of cash flow and equity outperformance. We reiterate our Buy rating and $6 price target. Our target applies a discounted 3.0x multiple (3.5x peer median, 4.0x industry median) to our 2014 CFPS estimate owing to a relatively short inventory life. Northern Midland Basin results and continued acreage acquisition could lead to greater inventory depth and a higher valuation in our view.
Important disclosures: The information provided herein is believed to be reliable; however, EnerCom, Inc. makes no representation or warranty as to its completeness or accuracy. EnerCom’s conclusions are based upon information gathered from sources deemed to be reliable. This note is not intended as an offer or solicitation for the purchase or sale of any security or financial instrument of any company mentioned in this note. This note was prepared for general circulation and does not provide investment recommendations specific to individual investors. All readers of the note must make their own investment decisions based upon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Investors should consider a company’s entire financial and operational structure in making any investment decisions. Past performance of any company discussed in this note should not be taken as an indication or guarantee of future results. EnerCom is a multi-disciplined management consulting services firm that regularly intends to seek business, or currently may be undertaking business, with companies covered on Oil & Gas 360®, and thereby seeks to receive compensation from these companies for its services. In addition, EnerCom, or its principals or employees, may have an economic interest in any of these companies. As a result, readers of EnerCom’s Oil & Gas 360® should be aware that the firm may have a conflict of interest that could affect the objectivity of this note. The company or companies covered in this note did not review the note prior to publication. As of the report date, no employee of EnerCom holds an equity position in Callon Petroleum.