Following the release of a major deal to purchase producing acreage in the Eagle Ford, Sanchez Energy Corp. (NYSE: SN ) surged to record highs. The stock had seen solid gains in the last year following mediocre returns after an IPO at the end of 2011. While the stock has surged nearly $10 following the deal in late May, to reach $38, there are several reasons the stock could head much higher.
Prior to the deal to buy Eagle Ford assets from Royal Dutch Shell Plc (NYSE: RDS-B ) , Sanchez Energy was producing significant growth from its own Eagle Ford assets. Besides the strong Eagle Ford position, the company has a solid position in the up-and-coming Tuscaloosa Marine Shale, which gives it a strong foothold for building production.
Extremely cheap deal
The main reason the stock shot up is that the deal for 106,000 acres in the Eagle Ford only cost the company $639 million. Even more incredibly, the deal adds production that hit 24,000 Boe/d in the first quarter and proved reserves of 60 MMboe. The news wasn't all great considering Shell had inexplicably stopped capital expenditures on the Eagle Ford properties, causing production to drop to roughly 20,000 boe/d at the time of the deal, on May 21.
An article from back in September suggested Shell would sell the assets because of the inability of the assets to meet internal targets. The company originally spent an incredible $10,000 per acre for the assets that at the time reached 200,000 acres in total. Back at the time of the article, the author estimated that Shell would hope to raise nearly $2 billion for the 106,000 acres plus the producing wells. Instead, Sanchez got the acreage for less than $6,500 per acre when excluding the significant production.
Quick ramp potential
Though the production is declining due to Shell cutting expenditures on the property, the deal included 22 wells that are drilled to total depth and cased but not yet completed and 27 wells that have been drilled with surface casing set. In basic terms, the project includes an incredible 49 wells that Sanchez can quickly get cash flowing and reverse the production trend.
With years of experience in the Eagle Ford, including another 120,000 acres that already produce by themselves some 20,000 boe/d, the company has the expertise and the experience in the shale to turn around the problems that Shell encountered.
In total, Sanchez Energy now has 226,000 Eagle Ford acres and production exceeding 40,000 boe/d making it a sizable force in the region. With 119 million boe of proved reserves, the company has a small valuation at only $1.9 billion providing plenty of upside especially considering the company projected that the acquired assets alone have resource potential of 500 million boe.
As an example, Gulfport Energy (NASDAQ: GPOR ) is now worth over $5.5 billion based on production that is expected to average 40,000 boe/d for the year. The Utica Shale driller does expect to exit the year around the mid-50,000 boe/d range, giving the company an advantage over the guidance of Sanchez Energy, which forecast reaching that target for 2015. The valuation difference is extreme considering similar production paths.
Every deal has two sides so investors can't just assume Sanchez Energy got a great deal from Royal Dutch Shell. Not to mention, other energy firms had the opportunity to purchase the assets and chose to pass, suggesting some doubt exists on whether the assets have the huge reserve potential projected by Sanchez. Still the propensity of the oil majors to struggle with the difficult shale plays that need ultimate focus suggests that Sanchez did make a deal that will provide years of solid returns. Combined with the other producing assets and the comparable valuations of a oil and exploration firm like Gulfport Energy, Sanchez Energy appears to be headed even higher.
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