Our Take On The Crescent Point Energy Acquisition Of Hammerhead
Our Take On The Crescent Point Energy Acquisition Of Hammerhead
Summary
CPG is becoming gassier and is delaying the return of captial to shareholders, but intrinsic value per share is little changed.
We believe the current selloff is overdone.
We maintain our Buy rating on CPG shares, which offer more than 40% upside below $10 per share.
On Monday, Crescent Point Energy (CPG) announced that it plans to acquire Hammerhead Energy (HHRS). The market panned the deal, sending CPG’s shares down 10% the day after it was announced. We could only find one shareholder who offered their public support.
The deal’s timing was terrible, as it came amid a violent oil market selloff. We’d note that CPG shares would have fallen by 3%-to-4% during the broader market selloff that day, so the reaction to the deal likely accounted for 6%-to-7% of the 10% decline, but, of course, that’s small consolation for CPG shareholders.
We aren’t crazy about this deal, but we believe the pros and cons are fairly balanced. We therefore view the selloff as overdone. We see little change in CPG’s intrinsic value, and while netbacks deteriorate, we like the fact that its extended drilling inventory gives investors more time to realize that value. We view the selloff as an attractive opportunity for long-term investors to buy shares worth considerably more than their current market value.
The deal metrics aren’t great, particularly for a relatively gas-weighted operator like HHRS. CPG will pay $2.55 billion of consideration, for which it will acquire 105,000 acres with 308.7 million proved and probable reserves forecasted to produce 56,000 boe/d in 2024. CPG will assume HHRS’s $455 million of debt, increase borrowings on its credit facility, issue $750 million of new debt, and issue 101,750 new shares. Its share count will increase by 19%,
In connection with its increased cash flow after the deal, CPG plans to increase its quarterly base dividend by 15% to $0.115 per share, or $0.46 per on an annualized basis. On today’s $9.70 share price, the new dividend equates to a 4.7% yield. Note, however, that CPG has paid considerable variable dividends in recent quarters, which have increased its total dividend payout to more than $0.115. In light of the debt reduction required after this deal, variable dividends are likely a thing of the past for shareholders until debt has been reduced.
Management intends to return 60% of free cash flow to shareholders and use the remaining 40% to pay down debt. Once debt reaches management’s stated target of $2.2 billion, we expect more capital to be delivered to shareholders.
On a per-flowing boe basis, the deal is priced at $45,535, on par with CPG’s previous acquisition, in which it acquired Montney assets from Spartan Delta (OTCPK:DALXF). Still, the deal is expensive compared to other recent Canadian E&P acquisitions, many of which were made at half the price on a per-flowing-barrel basis. On a positive note, it comes with $1.3 billion of tax pools, which will shield roughly $300 million of CPG profits from taxes and extend the multi-year period during which it will not pay taxes.
In terms of reserve value, HHRS’s reserve auditors estimate the net present value of proved and probable reserves to be $2.1 billion. They based this estimate on the company’s net 252 booked locations. Management believes HHRS acreage holds 800 drilling locations, which would conservatively put its reserve value at more than double the figure in the reserve auditor report.
Hammerhead Acreage: Gassy Growth
Private equity firm Riverstone Holdings owns 86% of HHRS equity and has pursued rapid growth in the lead-up to selling the company to a strategic buyer. In recent years, HHRS has invested nearly all its operating cash flow in capex to grow production. Over the past year, production increased by 31%, from 32,111 boe/d in Q3 2022 to 46,046 boe/d in Q3 2023. CPG expects to increase production on the acreage to 56,000 boe/d in 2024 and to 80,000 boe/d over the next five years.
HHRS had also boosted the liquids component of its production, which increased from 42% in 2022 to 48% in the most recent quarter. The high production growth rate and higher liquids content helped the company fetch an attractive sale price for its shareholders.
HHRS’s main attraction for CPG is its acreage contiguity, as shown in the following slide that touts the deal’s benefits. Contiguous acreage allows for more efficient and economical development.
Source: CPG Hammerhead acquisition presentation, Nov. 6, 2023.
The addition of HHRS acreage would extend CPG management’s estimate of the company’s existing drilling inventory depth by 25%. After the deal, it expects to have 20 years of “premium” drilling locations.
As an added benefit, HHRS also owns approximately $500 million of midstream infrastructure and associated egress contracts. Gassy infrastructure is more valuable than oil infrastructure, and infrastructure in place will save CPG considerable sums to accommodate HHRS acreage production growth.
The acquired infrastructure assets are expected to support HHRS acreage growth 80,000 boe/d, CPG’s long-term growth target. CPG will therefore require minimal midstream growth capex for at least the next five years. HHRS management will be valuable to CPG. CPG will exit the deal with half its production coming from the Montney, and HHRS management has much more experience operating in the basin.
On the Hammerhead side, the transaction makes it easier for Riverstone to sell its equity stake. Riverstone will hold onto its equity after the transaction closes, at which point it will own 7% of CPG shares. It has agreed on a 3-month lockup for 50% of its holdings and a 6-month lockup for the remaining 50% in order to minimize the selling pressure on CPG shares in the wake of the deal.