Dear CDEV,
It’s Technical Tuesday and you had to know it was coming. In the past 8 weeks, I have taken a lot of beatings on your behalf on Twitter for my equity ownership in you because, rightly or wrongly, I made you the poster child for my SMOG investment thesis. It is also relevant to this discussion that I own more shares personally than any of your non executive directors, so you know I care. Like really, really care.
Let’s start with the basis of my investment thesis. Your YE2018 SMOG value significantly exceeds your share price, even including 3 years of G&A/interest adjustment and factoring in your 2019 overspend. You have 2.5 SMOG/debt coverage and no maturities until 2026. Your peers trade at >150% of this value. You trade at 71%. Add your announced water infrastructure monetization plans, and tada, I made my investment.
We all know that there are too many small and mid cap companies and consolidation needs to happen. NEEDS TO. And with 100% certainty, you must be part of this. The cost efficiencies and scale that can be driven by selling to a larger (adjacent) company will unlock far more shareholder value than you can stand alone. Especially with capital markets closed, there is no other path forward.
In the game of consolidation, there are predators and there are prey. As a shareholder looking at your relative valuation, you simply can’t be the predator. Too many quarters of outspending cash flow has led to your trading at a discount to SMOG NAV and so it would be dilutive to shareholders to use equity to buy private E&P companies. So the question isn’t “should you sell” it’s “who should you sell to?”
Good news! Unlike many (many) of your small cap peers, your relative value, along with $80 million of annual savings in “synergies” make you an attractive mate and all-equity mergers are a relative value play.
The two companies that best fit the bill are Noble and Apache, both of whom have portfolio “opportunities” in the U.S. that need to be addressed (Colorado regulatory risk + Alpine High/ no longer operating in Suriname).
With thanks to ShaleProfile Analytics, let’s have a look at the Delaware footprint overlay and SMOG relative value play. On an annualized debt to cash flow basis, your balance sheet is better than both of theirs so you are accretive on a NAV, debt, cash flow, portfolio optimization, G&A basis.
The reason the market loved the WPX-Felix deal was because WPX used it’s equity to grow the footprint, streamline G&A per bbl and get bigger in the only basin that really matters. Their stock traded up 25% over a week because it made sense and investors loved it… and I’m not even asking for a board seat.
Love and hugs, #hottakeoftheday
Hi sir – can you explain how a cash burn is accretive you the equity? Shouldn’t your signs be reversed for the 9mo 2019 adjustment? Ie, +CFO and -CFO? That’s how cash accrues to the equity. Also, the correct measure of the equity value is SMOG – Debt. SMOG/Debt is not really saying anything. Companies have to repay debt, as do their acquirers.
Good questions. I’ll start with the last. The leading indicator of Chapter 11 in the cases of SN, AMR, EPE, HK and Jones and the takeunder of Lilis was when SMOG : Debt < 1. So that number is a “coverage number”. The math is done on SMOG-Debt but in cases where that number is 1.3 or so (Extraction comes to mind)- it suggests 2019 is extremely important.
On the cash burn CFO/CFI- the SMOG is a PV10 with a roll forward so all else (price, performance) being equal, you roll off a year of cash flow AND discounting. The math in the spreadsheet is that if you have positive free cash flow that is used to pay down debt during the year, my assumption is SMOG will decrease as you are shrinking (as your debt likely did). In an outspend case, my assumption is that the outspend accelerates the plan so increases It by the end of year. In CDEVs specific case, it factors in some monetization of the water system as well which as you know doesn’t show up explicitly in SMOG. Obviously, when we have the 2019 numbers, that plug away.
ok. I’m just hung up on the idea that, if the PV10 is a discounted cash flow, a negative cash flow period can not be additive to that. Appreciate the point about pull forward of cash flows, but there has to be some kind of adjustment to the CFI line. Particularly in the context of underperforming EURs and worse than expected declines in the outer years, it seems like the concept that the equity should accrue the entire CFI line with earned cash as the offset seems not right. Part of the problem is that investors no longer believe there will ever be FCF, so a year of cash burn isn’t going to be seen as adding value.
Btw sorry for not replying in the thread, seems like there’s some kind of issue with that function.
Nevermind! I see now, sunk cost approach. My bad. BUT, I think cash burn in 2019 was still deeper than what was embedded in the 2018 YE SMOG, so an adjustment is necessary. Also, the 2018 commodity deck needs to be written down, so there’s an adjustment coming there. Finally, there is risk the sec may redefine an economic location given the underperformance last year. Nevertheless, I do appreciate your methodology for its very efficient relative performance indication, even if it rewards the thing that investors react most negatively to in real life.
I wouldn’t say “rewards”. It adjusts as outspend gets added to debt. It’s just a way to keep current Q over Q. Yes. Prices will impact SMOG which is why I reiterate that this is a relative value measure. EVERYONE will come down, and as you know- “peers” trade at substantial premiums to their SMOG – that just means the premium will be even larger.
Bottom line, I am an oil bull and consolidation MUST happen. I own the companies I would buy if I was at an overvalued one…