Callon Petroleum (CPE) Q2 Results - Aug 4

[dan_s]

Callon announced Q2 results that beat my forecast for production and operating cash flow. They also provided Q3 production guidance that was significantly higher than my forecast. My valuation increased $5 to $83/share, which was just 4X annualized operating cash flow for 2021-2022. Per my model, Callon is on-track to generate operating cash flow per share over $18 in 2021 and over $26 in 2022 based on realized commodity prices of $65/bbl for oil, $3.00/mcf for natural gas and $22/bbl for NGLs.

Then out of the blue they announce the Primexx Acquisition: The cash and stock transaction is valued at approximately $788 million, representing a headline purchase price multiple of approximately $43,800 per Boe/d, based on second quarter production.

The Wall Street Gang does not like surprises and this was a BIG ONE for a company of this size. Combine this news with "Delta Variant FEAR" and we get shareholders running for the exits. So, is this a buying opportunity??? On the surface it looks to me that CPE is now grossly oversold unless you believe that WTI is going back to $50/bbl. I don't, and I am still basing my 2022 forecast models on WTI averaging $70/bbl next year.
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Let's look at the press release details:

The acquisition represents a significant step forward in Callon's strategy to deliver long-term value to shareholders through the application of its scaled, life-of-field development model while also strengthening its financial position. Callon's proven ability to integrate and further optimize assets in its core operating areas represents untapped upside to the already attractive pro forma accretion to all key per share financial metrics.

Demonstrated strong well results and established infrastructure pave the way for the seamless addition of Primexx's current two-rig program into Callon's multi-year development plans. With approximately 300 identified core net locations, approximately two-thirds of which are two-mile laterals, the acquired assets will support Callon's continued shift to larger, more capital efficient development projects in the Delaware Basin. Additionally, the acquisition increases the oil cut of Callon's Delaware business and improves corporate-level cash margins.

This is a key to understand why Callon made this deal: Kimmeridge, a leading investor in both the public and private oil and gas space, has agreed to convert their remaining portion of the Callon second lien senior notes that were issued in 2020 into common shares after the close of the Primexx transaction. This equitization further advances the Company's deleveraging timetable and saves nearly $20 million per year in interest costs.

Joe Gatto is a sharp guy with a high quality team behind him. I trust the Callon Team more than the Wall Street Gang's knee jerk reaction. After the deal was announced Siebert Williams Shank & Co analyst Gabriele Sorbara maintained a Buy rating on Callon (NYSE:CPE) Petroleum Company on Wednesday, setting a price target of $64.

Callon President and Chief Executive Officer Joe Gatto commented: "The Primexx transaction checks every operational and financial box on the list of compelling attributes of consolidation. The asset base adds substantial current oil production and a top-tier inventory to our Delaware portfolio, and fits squarely into our model of scaled, co-development of a multi-zone resource base. Our integrated, future development plans will benefit greatly from the combined Delaware scale and we expect to generate approximately 30% more adjusted free cash flow from the third quarter of 2021 through year-end 2023 under our conservative planning price assumptions. The infusion of over $550 million of equity from the acquisition and Kimmeridge's exchange further heightens the overall benefits, immediately reducing leverage metrics and creating a visible path to net debt to adjusted EBITDA of below 2.0x next year."

TRANSACTIONS TO ADVANCE CALLON'S STRATEGIC AND FINANCIAL GOALS

The acquisition of Primexx, combined with the impact of the Kimmeridge exchange, is forecast to be accretive across all key financial metrics and will enable the Company to leverage its existing operating model and knowledge base in the southern Delaware Basin. With these transactions, Callon will:

Capture the benefits of a larger Delaware operation: The acquisition will increase Callon's Delaware Basin position to over 110,000 net acres. Primexx's assets will immediately compete for capital within the Callon portfolio and increase Callon's capital allocation to the Delaware Basin. In addition, numerous opportunities for cost and capital efficiency gains, which Callon has proven to achieve in past transactions, create upside to current forecasted performance.

Drive substantial FCF increases: The acquired asset base with substantial current production will immediately contribute to both near-term adjusted free cash flow and total cumulative adjusted free cash flow of almost $1.2 billion through 2023 at current strip prices. This forecasted free cash flow profile is the product of a reinvestment rate of less than 60% with an associated compounded annual production growth profile that remains under 5%. Importantly, the combined transactions are forecast to be accretive to adjusted free cash flow per share in 2022 and 2023 at both planning prices of $55 - $60/Bbl for oil and current NYMEX strip pricing for oil.

Accelerate deleveraging goals: The transactions will position Callon to accelerate its debt reduction goals, reducing leverage to less than 2.0x net debt to adjusted EBITDA by year-end 2022 at current strip prices. This rapid deleveraging opportunity accelerates the timetable for the Company's future transition from balance sheet strengthening to exploring return of capital opportunities.

Improve cash margins: The addition of Primexx is expected to further expand Callon's leading cash margins and increase the oil weighting of its Delaware Basin production profile. Given Callon's established operations, minimal incremental G&A will be needed to consolidate the Primexx assets into the newly combined footprint.

Support sustainability initiatives: Primexx has invested in a robust gathering and water management infrastructure that includes 80 MBbl/d of water recycling capacity and 60 miles of water transfer lines, more than doubling Callon's current water recycling capacity. This significantly enhances Callon's ability to manage its freshwater impact in the Delaware Basin while reducing overall development and operating costs.

PRIMEXX TRANSACTION DETAILS

The acquisition consideration includes $440 million in cash and 9.19 million shares of CPE stock issued to the seller, subject to closing adjustments. The cash portion of the purchase price can be financed using available capacity under the current credit facility with near-term repayment coming from forecasted free cash flow and proceeds from in-process divestiture initiatives. The Company will also look opportunistically to the debt capital markets to term out all or a portion of the cash payment in lieu of credit facility borrowings.

The transaction is expected to close early in the fourth quarter of 2021, subject to customary closing conditions and regulatory approvals.

KIMMERIDGE EXCHANGE DETAILS

The Company entered into an agreement with Chambers Investments, LLC, a private investment vehicle managed by Kimmeridge Energy, to exchange $197.0 million of its outstanding Second Lien Notes for a notional amount of approximately $223.1 million of Company common stock. The value of equity to be delivered is based on the construct of the optional redemption language in the indenture for the Second Lien Notes. The price of the Company common stock used to calculate the shares issued is based on the 10-day volume-weighted average price as of August 2, 2021 and equates to 5.5 million shares. This exchange is contingent upon the closing of the Primexx Acquisition described above as well as a shareholder vote as required under NYSE rules because Kimmeridge is deemed a related party due to its current ownership of over 5% of the Company's common stock. Callon has entered into voting agreements in support of the share issuance with shareholders representing approximately 16 million, or 30%, of the shares anticipated to be outstanding upon closing of the Primexx transaction.
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Conclusion: I am going to update my forecast/valuation model on Thursday morning with the assumption that the deal closes on 10-1-2021. My rough estimate is that it will only reduce my valuation of CPE to approximately $75/share because of the increase number of shares outstanding. IMO the increase share count is a good thing because CPE only had 46.3 million shares outstanding and not enough float to attract some fund managers.

[epg3601]

Good summary. Thanks.
Sounds like this could be a good time to hold on to Callon shares and ride back up

[Fraser921]

It's worth reviewing history.. CPE fell into the 20's, the market was shocked with the acquisition, sold off hard, Dan called it grossly oversold, 3 months later a double!

Well done

Dan's post on CPE 8/4...