Back in November, Devon Energy (NYSE: DVN ) announced a deal to acquire Eagle Ford assets from privately held GeoSouthern Energy. The company heralded in the new Devon concept along with the deal that included several positive financial metrics. Considering every deal involves a seller, one has to wonder whether the presented facts will materialize or what encouraged GeoSouthern to cash out of such valuable assets especially considering Blackstone Group (NYSE: BX ) will exit its stake with this transaction.
Off the top, the biggest concern is the limited acreage of only 82,000 net acres acquired and the likelihood that GeoSouthern has already maxed out the potential reserves. Did Devon just buy these acres at peak prices?
Devon is paying $6 billion for the assets that produce 53,000 barrels of oil equivalent per day, boe/d. In total, the acreage has roughly 400 million boe with the majority of which is proved reserves. The deal value amounts to roughly $15 per proved boe. The 82,000 acres reportedly have at least 1,200 drilling locations, though the amount of reserves is vastly more important.
The shocking stat is that the deal price amounts to roughly 2.5x expected 2015 EBITDA numbers. Typical oil companies trade at multiples of this EBITDA level. The assets are expected to grow production at a compounded annual growth rate of 25% over the next few years, reaching a peak production rate of 140,000 boe/d, up from the 53,000 boe/d currently reached. Even more interesting, is the expectation of reaching free cash flow levels of $800 million starting in 2015 and growing in the following years.
If these numbers sound too good, than one should be skeptical of those milestones based on Blackstone exiting their position. The major concern has to be that oil prices will recede by 2015, severely damaging the free cash flow and EBITDA targets. Remember that Devon expects to add nearly 100,000 boe/d to the markets from these Eagle Ford assets alone. The added production from this deal combined with other projects in shale oil could add significantly to the oil production in the U.S. and potentially impact the price of oil.
PetroHawk bought at the top
The Devon deal probably doesn't sit out as an absolutely transformational deal that signals a top in the market, but the inclusion of Blackstone does add some firepower to the theory. Another deal in the Eagle Ford signaled the top of the natural gas market back in 2011.
BHP Billiton (NYSE: BHP ) made the unfortunate mistake of buying out PetroHawk for $12 billion right as the natural gas market peaked. Again this deal appeared transformational by bringing a major resource company into the shale gas market, yet the sellers were the smartest people in the room.
The pricey deal does bring up some questions. BHP paid the $12 billion for access to 1 million net acres in the Eagle Ford and Haynesville shales, and the Permian Basin. The net production for those assets in 2011 was 158,000 boe/day. In essence, BHP paid double the money for three times the production.
PetroHawk was a lot more focused on natural gas, and BHP was an outsider jumping into the shale gas areas. Devon is an industry insider adding to existing shale oil assets with the industry outsider leaving, making for a considerable difference in the structure of the deals.
By all accounts, Devon made a transformational deal at a very attractive price. Like all similar large-scale deals, with PetroHawk as a prime example, the deals tend to signal a top in the market. In the GeoSouthern case, the smart financial guys at Blackstone want out while the smart oil guys at Devon want the Eagle Ford assets. The biggest concern with the deal is that oil prices need to remain high to support the $9 million it costs to drill wells in the shale. Blackstone clearly thinks the price of oil is going to drop in the next year to sell out at the forecasted EBITDA levels.
At this point, investors can invest alongside Devon, but the suggestion is to keep an eye on whether this deal signals the top in the oil shale boom, especially in the Eagle Ford.
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