Resolute Energy Corporation (NYSE: REN) announced a $250 million notes offering. The notes will be general unsecured obligations of the Company and guaranteed on a senior basis by the Company’s existing subsidiaries.
Resolute intends to use the net proceeds from the Senior Notes offering to repay indebtedness under its revolving credit facility, which matures in April 2017, to fund a portion of its capital expenditure budget and for general corporate purposes. The notes have not yet been priced, although we would expect a pricing announcement towards the end of this week.
Increasing Control — Strengthening the (Cash Flow) Foundation
Resolute’s notes offering follows recent moves to increase control of its foundation cash-generating asset, the Greater Aneth Field (GAF) in Utah, which consists of the Aneth Unit, Ratherford Unit and McElmo Creek Unit. On April 11, 2012, the company announced an acquisition with the Navajo Nation Oil and Gas Company (NNOG) to acquire all of Denbury Resources, Inc.’s (NYSE: DNR) interests in the GAF on a 50%-50% basis. NNOG also exercised its right to acquire 10% of Resolute’s interest in GAF (before the acquisition of the Denbury interests). NNOG has a second option to purchase an additional 10% of Resolute’s interest in GAF, prior to the Denbury transaction, on July 2017 at the then fair market value of the assets.
As a result of these transactions, Resolute’s working interests in the Aneth and Ratherford Units remain unchanged at 62% and 59%, respectively, and its working interest in the McElmo Creek Unit declined to 67.5% from 75%. The company reported that if the transactions had been closed on January 1, 2012, then Resolute’s proved reserves would have been approximately 1.9 MMBoe lower than previously reported, and would have had net cash proceeds of $62.5 million, implying a value of $32.89 per BOE of proved reserves. We note that as of April 13, 2012, REN was trading on an enterprise value to 2011 proved reserves of $12.12 per BOE, a 37% discount to the NNOG transaction. As of December 31, 2011, 86% of the company’s 65 MMBOE of proved reserves were attributed to the Aneth Unit.
We view Resolute’s move to increase operational control at GAF as a positive, in that it gives the company more certainty over cash flow from this asset that generates the majority of free cash flow for reinvestment into faster-growing assets.
Near-Term Growth Drivers
Speaking of growth, Resolute has taken initiatives to diversify its asset portfolio into oil-weighted, growth areas. In its fourth quarter and year-end 2011 earnings release, Resolute characterized 2011 as a “building year,” ostensibly for building visible growth potential for oil production from some of the areas the company has entered into over the past 12-18 months, including the Bakken oil shale and more recently the Permian Basin. Resolute participates in the Bakken largely as a non-operator in the play through its partner GeoResources, Inc. (NASDAQ: GEOI).
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Resolute entered the Permian Basin in 2011 with the acquisition of both producing developed assets and undeveloped acreage. The producing assets in Martin and Howard counties provide production, reserves and the potential for infill drilling. The near-term focus for growth from the Permian Basin comes from the company’s 9,000 net (24,000 gross) acres in the region, primarily in the Delaware portion of the Permian Basin in Reeves County. In Reeves County, Resolute is targeting the 3rd Bone Spring and Wolfcamp intervals with vertical wells. Other operators claim drilling and completion costs for vertical wells in this area ranging between $2.5 and $3.0 million. Assuming initial spacing of 80 acres, the company has a visible growth path of approximately 106 net (287 gross) unrisked wells. We note that other operators in the play have been drilling on 40-acre spacing providing additional visibility should the acreage prove commercially productive.
Comstock Resources, Inc. (NYSE: CRK) is another operator that recently entered the Permian Basin by way of Reeves County. Comstock entered the Delaware Basin portion of the Permian Basin in December 2011 through the acquisition of Eagle Oil & Gas Co. and other parties for $331.9 million. In a recent report, an industry analyst reported that Comstock’s fourth and fifth vertical wells targeting the Wolfbone in Reeves County came on with initial production rates of approximately 500 BOEPD. It may be early to say that these results are indicative of the typical Wolfbone well, they are encouraging for Resolute.
REN notes in their April 2012 investor presentation that they have more than 550 gross undrilled locations on 40-acre spacing in Reeves County alone. Assuming an end ultimate recovery (EUR) of 289 MBOE for a Wolfbone (3rd Bone Spring and Wolfcamp formations) well and 80-acre spacing, REN’s acreage is prospective for more than 81 MMBOE (21 MMBOE net to Resolute’s NRI) of reserves. We note that as of December 31, 2011, REN had only booked 3.5 MMBOE (75% liquid) of proved reserves related to the Permian Basin.
Resolute communicated to the market in their most recent earnings release that the company was accelerating its Permian Basin drilling program, going to two rigs from one. Other than four vertical Wolfberry wells to be drilled in the Midland portion of the Permian Basin, Resolute did not provide specific guidance with respect to how many wells it planned to drill in the Permian. If we assume the company is drilling vertical Wolfcamp wells and that it takes 40 days to drill one well and mobilize to the next location, then we estimate Resolute can drill as many as 18 wells during 2012. Dividing the company’s capital allocation to the Permian of $62 million, an 18-well program implies an all-in cost of $3.4 million per well, which although is on the high side of what other operators in the play have communicated, we recognize that the budget allocation most likely includes monies for seismic, acreage and other costs.
Though the company is initially targeting the Wolfbone formation, the acreage is prospective for Avalon, 1st and 2nd Bone Spring and the Delaware sand providing investors with additional longer term growth in the Permian. The company points out that their current drilling plan calls for two-thirds of the company’s Permian acreage expected to be held by production by 2014.
Emerging Plays — Long-Term Upside
A healthy exploration and production company has a mix of projects offering short, medium and long-term growth potential. In addition to growth in the near and intermediate terms from the Bakken and Permian Basin, Resolute’s asset portfolio includes some emerging opportunities providing longer-term prospects captured in its existing leasehold in Wyoming.
In the Powder River Basin (PRB), Resolute has a 45,000-acre leasehold that is held by production. In the PRB, the company’s existing Hilight Field produces mainly natural gas (approximately 60%, based on 2011 data) from the Muddy formation. The upside at Hilight really comes from the potential for the Mowry oil shale, which is considered the source rock for the oil produced from the Muddy. In 2010 and 2011, Resolute recompleted nine wells in the Mowry shale and established oil production from all of them, three of which were producing 30 barrels of oil per day per well. The company acknowledges that the recompletions were relatively small vertical well refrac jobs, the results were encouraging enough to commission a 3-D seismic survey covering much of the Hilight Field and surrounding areas to assess the potential for additional development of this captured resource.
The Turner sand formation is another oil-prone interval prospective in and around the Hilight Field. Based on log data and drilling activity adjacent to Resolute’s leasehold, the company said it believes that the Turner may be present within the company’s existing acreage position. Resolute has not given any indication on when it plans to test the Turner sand, so this play remains a long-term opportunity.
In the Big Horn Basin of Wyoming, Resolute is currently testing its first horizontal well targeting the Mowry oil shale formation. The Schuster Flats 14-27-47-94H well was drilled on the company’s Fourteen Mile prospect. The wildcat well was drilled to a depth of 14,000 feet, including a 2,800 foot lateral section in the Mowry oil shale formation. The company described the analysis of a 180-core cut from the Mowry as “encouraging.” Resolute had 73,000 net acres in the Big Horn Basin, and a commercial Mowry result would imply up to 406 net unrisked drilling locations on 180-acre spacing, providing additional long-term visible growth potential.
As a reminder, the Mowry oil shale and Turner sand are still early-stage plays, but they do provide opportunities to extend the company’s growth curve. Resolute indicated it is waiting to see the results from other operators who are drilling nearby the Hilight Field before allocating development capital to these plays. In our view, the Mowry and Turner could provide attractive, captured upside for Resolute, but more data and experience is needed to provide a valuation.
Liquidity and Capital for Growth
Drilling takes capital and assuming a successful notes offering, REN stands to have $402.5 million in liquidity pro forma for the offering, which includes $330 million in availability on the company’s revolving credit line (post pay down from the notes offering), $72.5 million in net proceeds from the notes offering (after estimated fees and net of revolver pay down) and an estimated $136.6 million in EBITDA (based on mid-point guidance). Also, our EBITDA estimate includes $11.7 million in cash interest expense (assuming a 7.0% coupon rate on the new notes for eight months during 2012) and we assume a flat $90.00 per barrel for crude oil prices and flat $2.00 per Mcf for natural gas.
Assuming our estimates are materially correct, the notes offering provides REN with the liquidity to fully fund its 2012 capital budget that ranges between $180-$190 million. Also, with an estimated $402.5 million in estimated pro forma cash and credit availability net of the $190 million capital expenditure budget, Resolute has the financial resources to pursue additional options for expanding in key growth areas and/or accelerating the pace of development in oil-prone plays like the Bakken and the Permian Basin.
Valuation
Post the notes offering, Resolute’s balance sheet should remain strong. At April 13, 2012, REN’s debt to market capitalization was a conservative 28%. Pro forma for the notes offering, we estimate the company’s debt to market capitalization will be 41%. From our perspective, that level of debt is at the top end of where we see the market begin to cap equity price to cash flow multiples around 5X (based on data as of April 13, 2012). However, with net debt to market capitalization at an estimated 29% pro forma for the notes offering, Resolute’s effective debt level will be essentially unchanged.
And, that’s a good thing because the company has the assets to put capital to work for growing production, cash flow and reserves. If Resolute comes out with a revised (read: higher) capital budget for 2012 subsequent to the notes offering, then we would expect a favorable market reaction as results are posted.
One important factor when assessing Resolute’s growth potential is the Asset Intensity metric, or the amount of free cash flow that a company must reinvest to hold production flat. Resolute enjoys a relatively low Asset Intensity of 41%, as compared to the average of 65% for EnerCom’s small-cap group. Meaning, Resolute can invest 59% of its free cash flow (mostly generated by GAF) into growth projects.
As of April 13, 2012, REN was trading at 6.4X estimated 2012 cash flow, as compared to the average of 5.7X for the 28 small-cap companies in EnerCom’s E&P database. Although on a price to cash flow per share basis, Resolute may look fairly valued, a quick look at intrinsic value provides a different perspective.
On a standardized measure (after-tax PV-10 of $816 million) valuation, assuming the pro forma debt ($250 million) and cash ($72.5 million) from the balance sheet, REN is a $10.48 stock. As of April 13, 2012, Resolute’s shares closed at $10.12, a 3.6% discount to the standardized measure. That compares to an average share price premium of 34% for the 81 companies in EnerCom’s E&P database.
More importantly, Resolute appears to be moving forward with plans to accelerate drilling in its oil-weighted plays, which we would expect to further drive increases in oil production and reserves. As drilling results demonstrate growth, we would anticipate the market to recognize the increased growth potential and provide an opportunity for the company’s equity multiple to increase.
