Houston-based independent oil and gas producer Apache Corporation has emerged as the latest target in a wave of shareholder activism sweeping the energy industry. New York-based hedge fund Jana Partners wants the company to divest its foreign operations. But would it be the right move for Apache and its shareholders?
Progress in reducing expenses
On Monday, Jana revealed that is has accumulated a $1 billion stake in Apache and wants the company to sell off its international operations to focus on the U.S., The Wall Street Journal reported. Specifically, the hedge fund wants Apache to sell off its liquefied natural gas, or LNG, projects in Canada and Australia, among other demands that it argues will free up cash flow and improve shareholder value.
Listening to Jana's advice could provide a big boost to Apache's shares, which have lagged the S&P U.S. Energy index by more than 50 percentage points over the past three years. The weak performance is likely due to investor concerns about the company's exposure to geopolitical risk in Egypt and its relatively high levels of debt compared to cash flow.
To Apache's credit, it has significantly reduced its exposure to Egypt by selling one third of its interest in its operations there to China's Sinopec last year. It has also divested more than $10 billion worth of assets over the past year and a half, which has allowed it to significantly reduce its debt and return more cash to shareholders. But Jana contends it could do a lot more.
Potential assets up for sale
According to Apache's 2013 10-K filing, it maintained upstream interests in six countries last year: the U.S., Canada, Egypt, Australia, the UK North Sea, and Argentina. Earlier this year, it announced the sale of its entire Argentinian business to state-owned YPF for $800 million in cash. Now the company is considering monetizing all or part of its stakes in two LNG projects: Kitimat in Canada and Wheatstone in Australia, both operated by Chevron.
While selling its stakes in Wheatstone and Kitimat would mean foregoing a highly stable source of long-term cash flow, it could raise significant proceeds that would allow the company to reduce its capital spending commitments by about $2.5 billion this year and next. This would not only be enough to take care of its cash flow deficit, but would also dramatically improve its return on invested capital, which plunged to a disappointing 5% last year, given the long-term nature of returns from LNG projects.
A sale of its Australian upstream assets, which include roughly 7.9 million gross acres offshore Western Australia, is another option. While Apache sees major opportunities for further upstream development in Australia, given that nearly 90% of its acreage is undeveloped, its Australian assets ex-Wheatstone could be worth a whopping $3.2 billion, according to consultancy Wood Mackenzie.
However, I think Apache should most seriously consider selling its operations in Egypt, where it holds 9.8 million gross acres that contributed oil production of 90 Mb/d and gas production of 356 MMcf/d net to Apache's consolidated holdings in 2013. As I have argued before, while its Egyptian operations are a major source of cash flow and have been largely uninterrupted by recent unrest, the company may be taking unnecessary risk by continuing to operate in the country.
Benefits of asset sales
By getting rid of some of these assets, Apache would raise a ton of cash that would help it erase its cash flow deficit, reduce its debt, buy back more of its stock, and focus more fully on its core assets in Texas and Oklahoma, which feature more consistent and predictable growth and returns.
These assets, which are already the biggest drivers of the company's oil production growth, could drive double-digit oil production growth for many, many years to come. That's because Apache estimates it has some 35,000 remaining drilling locations left in Texas and roughly 32,500 locations left in Oklahoma. At the current pace of drilling, that inventory should last for well over a decade.
While I don't think Apache should sell off all of its international assets in a short period of time, I think a gradual divestment of certain assets may be in the company's best interest. The sale of its stakes in Wheatstone and Kitimat would easily erase its cash flow deficit, while providing a major uplift to its return on capital.
And a sale of its Egyptian assets would virtually eliminate its exposure to geopolitical risk. The end result would be a more financially secure company targeting low-risk, high-return North American oil plays -- a surefire strategy to boost its currently depressed valuation.