NOG & SM - Big Acquisition June 27

[dan_s]

DENVER, June 27, 2024 /PRNewswire/ -- SM Energy Company (the "Company" or "SM Energy") (NYSE: SM) today announces that it has entered into an agreement to acquire the Uinta Basin oil and gas assets owned by certain entities affiliated with XCL Resources, LLC ("XCL"), a private company backed by EnCap Investments L.P. ("EnCap") and Rice Investment Group ("Rice"), for an unadjusted purchase price of $2.55 billion. Concurrently, Northern Oil and Gas, Inc. (NYSE: NOG) ("Northern") will acquire an undivided twenty percent (20%) of the oil and gas assets of XCL for $510 million, resulting in a $2.04 billion purchase price net to the Company for an undivided 80% interest of the assets (the "XCL Acquisition"). SM Energy intends to serve as the operator of the assets currently operated by XCL. The Company plans to finance the acquisition through a combination of debt and cash on hand.

XCL ASSETS EXPAND SM ENERGY'S TOP-TIER PORTFOLIO ADDING (NET TO THE COMPANY):

~37,200 net acres (~99% operated), increasing the Company's core net acreage ~14%

43 MBoed/38 MBod (88% crude oil),(1) increasing the Company's 2025E net production to ~195 MBoed and oil mix to greater than 50%

~390(2) net locations with breakevens $43 – $57/Bbl,(4) increasing the Company's inventory life by 2 years to 12+ years(5)

$50.45/Boe 2025E cash production margin,(4) increasing the Company's 2025E cash production margin by ~11%; and

107 million Boe preliminary proved reserves,(7) increasing the Company's estimated net proved reserves by ~18%(8)

TRANSACTION BENEFITS

This value-driven acquisition meets SM Energy's strategic objectives:

Expected to be immediately accretive to key metrics: Acquired for 2.9x NTM Adjusted EBITDAX(6) ($78.00/Bbl and $3.25/MMBtu), the acquisition is expected to be immediately accretive to key financial metrics. Based on 2025E projections, 2025E Adjusted EBITDAX(6) is expected to increase ~35%, 2025E Adjusted free cash flow(6) is expected to increase ~45%, and 2025E cash production margin(6) is expected to increase ~11%.


Expands the Company's top-tier asset portfolio with accretive scale, significantly increases oil volumes, and extends low-breakeven inventory life: Pro forma 2025E net production is expected to increase to ~195 MBoed, oil production is expected to increase to 52% of commodity mix, reinvestment ratio is expected to decrease by 5%, and inventory is expected to increase by approximately 390(2) net quality locations competitive with current portfolio to add two years of inventory life(5).

Significant resource upside in Core Uinta driven by the Company's technical expertise: The Uinta Basin has stacked pay potential and high oil content that combine to result in top-tier well performance and inventory with upside. The Company's track record in full stack co-development offers the potential to drive differential value across as many as 17 benches.

Increasing return of capital while maintaining strong balance sheet: Highly accretive Adjusted free cash flow(6) metrics support a Board of Directors approved 11% increase in the Company's fixed quarterly dividend policy from $0.18 to $0.20 per share, expected to commence in the fourth quarter 2024 while projecting a reduction in post-acquisition leverage from ~1.3x net debt-to-Adjusted EBITDAX(6) to less than 1.0x by mid-2025 (assuming current commodity prices). The Board of Directors has also authorized a new $500 million share repurchase program through 2027, replacing the remaining existing program.

High margin barrels competitive with Midland Basin due to higher oil content, lower operating costs, and sufficient contracted transportation capacity: SM Energy's 2025E cash production margin(6) is projected to increase approximately 11% as the Uinta Basin cash production margin(6) slightly exceeds the Company's Midland Basin cash production margin(6) due to higher oil content and lower operating costs.

[dan_s]

I have updated my forecast/valuation model for SM. Slide 12 of this morning's presentation is why this acquisition should increase shareholder value.
> Immediately accretive to financial results.
> Adds high-quality Running Room.
> Improves SM's production mix.

Three energy sector analysts have updated their SM price targets this morning:
> Leo Mariani at Roth MKM rates SM a BUY with a price target of $58.00
> Neal Dingmann at Truist Financial rates SM a HOLD with a price target of $51.00
> Gabriele Sorbara at Siebert Williams Shank & Co rates SM a BUY with a price target of $76.00

At the time of this post SM was trading for $43.49

My valuation increases by $2 to $72 per share, despite lowering my valuation multiple from 4.5 to 4.25 X operating cash flow per share. I lowered the multiple due to increased debt and I need to see SM's production mix and updated hedge book for Q4 2024 and the year 2025. My model is now based on a production mix of 50% crude oil, 34% natural gas and 16% NGLs. < SM realized commodity prices did exceed my forecast for Q1 2024. Some of their oil sells at a premium to WTI.

When big acquisitions are announced the share price falls over 90% of the time; especially all-cash deals. This is when you have to trust the management team's ability to evaluate and close a deal of this size. SM and NOG both have good teams. NOG makes a lot of acquisitions. The fact that NOG is taking 20% of the deal is a PLUS for me.

[Petroleum economist]

I think the acquisition by SM energy of the XCL assets is not as bad as the market makes it out to be. I can see the short-term balance sheet concerns, but if you have a time span until 2027 or longer, then it is a good deal. The eps from 2027 onwards can increase by 15-18%. The price paid on first inspection looks OK.

Price paid
• SM Energy paid $ 2.05 B for 35 K BoE/d.
• This normalizes as 2,050/35 = $ 55M/K BoE/d.
• The 55 is towards the middle of the normal range of $ 40-70 K BoE/d.
• As many factors influence a price this is only a very rough assessment.

Financing
• The question whether to finance an acquisition with (1) 100% cash or (2) a combination of cash and a shares issue is influenced by the fact that the majority of the SM shareholder returns are done by means of share buy backs – why issue the shares first and then buy them back later over the next three years.
• I can understand the all-cash deal.
• SM decided to finance the acquisition with 100% cash (= more borrowing).
• Long-term debt will more than double, from $ 1,576 M to $ 3,626 M.

Balance sheet
• The solvency drops from a good 57.8% to a mediocre 43.8%.
• Debt/EBITDA ratio in 2024 climbs from <1.0 to a too high 1.73.
• The balance sheet is weakened considerable.

• Starting 2025, Solvency will improve again over time: 49.1% (late 2025), 54.4% (late 2026) and a good 59.8% (late 2027)
• Debt/EBITDA ratio can reduce to 1.12 (late 2025), 0.86 (late 2026) and a good 0.76 (late 2027).
• Above means that balance sheet is restored in mid-2027.

Shareholder returns
• Shareholder returns will be subdued till mid-2027.
• The new $ 0.20 quarterly dividend can be maintained, but it only equates to a return of 1.5%.
• Most of the free cash flow will need go towards debt reduction.
• Share buybacks thus will be reduced - my guess from 6.0-7.5 M shares /year to only 2.0 M shares/year. This will last till mid-2027.

Net effect on 2027
• With no deal, SM would have reduced its share count in 2027 from 116 M (2024) to = 95.5- 98 M shares (116 M minus 3*(6.0-7.5 M).
• With the deal, the share count in 2027 only reduces to 110 M shares (116 M - 3*2M).
• With the deal, SM energy will have in 2027 12-15% more shares then without the deal
• With the deal, 2027 net profit will increase 30% from $ 1.1 B to $ 1.4 B.
• Overall, the 2027 eps should be 15-18% higher than without the deal. (30% more profit and 12-15% more shares),
• The balance sheet in 2027 is comparable.

Conclusion
• Short term (2024) SM deteriorates its balance sheet (both solvency and debt/EBITDA).
• Long term (2027) SM boosts its eps and the balance sheet is restored.

[dan_s]

My opinion is that "Growth is Good".
Unless you want to own upstream companies that are just going to deplete out their assets, they must make acquisitions to grow or fund risky exploration programs.
I trust the management teams at SM and NOG. This joint venture with NOG is a good deal for SM.