After merging with CRZO what should CPE be worth?

[dan_s]

I just posted my "Post Merger" forecast/valuation model for CPE to the EPG website. I lowered the multiple used to value this mid-cap growth company (with FCF from operations) from 6X to 5X operating cash flow per share.
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Two of our Sweet 16 Growth Portfolio companies are merging in an all-stock deal. The merger is expected to close in the 4th quarter. Both boards have approved the deal, but they still need a majority of shareholders to approve it. It is a good bet that they've already gotten verbal approvals from some of their largest shareholders.

Callon Petroleum (CPE) will be giving Carrizo Oil & Gas (CRZO) shareholders 2.05 shares of CPE for each share of CRZO that they own. Callon will be the surviving company, even though Carrizo has more production today. Post-merger, there will be approximately 418 million shares of CPE outstanding.

I have followed both companies for over five years and I have a high level of confidence in my forecast models for each of them.

Based on my initial forecast/valuation model for Callon Petroleum (CPE) "post-merger" the valuation is $14.50. Three Wall Street firms have updated their valuations since the merger was announced to $10, $10 and $11 per share. CPE closed today at $5.13. You can find the oil, gas and NGL prices that I'm using to value it at the bottom of the model.

Here's what I like about a "merger of equals" like this:

> Size does matter in this business. There are significant D&C cost and G&A savings to be achieved by combining the two companies. CPE estimates over $100 million of savings can be harvested just in 2020.

> Both companies have solid production and lots of low-risk / highly economic horizontal drilling locations. Post-merger, CPE will have over 200,000 acres of leasehold (120,000 in the Permian Basin and 80,000 in the South Texas Eagle Ford). They have over 2,500 undrilled horizontal drilling locations.

> Today they are running 7 operated rigs in the Permian Basin and 2 in the Eagle Ford.

> Heading into 2020, production should be approximately 105,000 Boepd (70% crude oil, 10% NGLs and 20% natural gas). On a combined basis, annual production growth was 21.5% in 2018, should be over 8% in 2019 and over 20% in 2020.

> CPE should be generating over $200 million of free cash flow from operations in 2020 (assuming WTI averages $60/bbl) and they have double-digit annual production growth locked in for many years.

> Book value per share should be over $8.90 when the deal closes. An upstream oil & gas company with FCF and this much running room should NEVER trade below book value.

Here is your homework:

> Take about 20 minutes to review the spreadsheet. Note that I went back and combined the two companies since 2017. Focus on rows 47 and 48.
On a combined basis assuming 2.05 shares of CPE for each share of CRZO outstanding at year-end:
2017 Actual: 76,678 Boepd of production (68.3% crude oil), EPS of $0.56 and operating CFPS of $1.91
2018 Actual: 93,202 Boepd of production (69.5% crude oil), EPS of $1.70 and operating CFPS of $2.54
2019 Estimate: 101,075 Boepd of production (69.7% crude oil), EPS of $1.22 and operating CFPS of $2.81
2020 Estimate: 122,000 Boepd of production (68.0% crude oil < the company is targeting 70%), EPS of $1.45 and operating CFPS of $3.35.

> Read our recent profiles on both companies.

> Listen to the July 15th combined conference call on the CPE website (review the presentation slides first).

Keep in mind that a merger is much different than a sale. This merger is a 1+1 = 2.5 deal.