Diversified Energy Company (DEC) Earnings Call Transcript & Summary

Greetings, and welcome to Diversified Energy Company Acquisition Update. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host today, Mr. Rusty Hutson, Jr. Please proceed.

Thank you very much. Good afternoon for those attending in London. Good morning for those attending here in the U.S. Diversified announced -- had 2 RNSs in the market this morning. One was the conditional -- or announcement of a conditional signing of a PSA on some assets in the Cotton Valley/Haynesville area, which are complementary to our Indigo assets that we acquired back in May. The second RNS was the completion of the Blackbeard assets that we announced in May, and that was completed on Friday. You can read both of those RNSs to get caught up on that, but the Blackbeard transaction is now complete and the Tanos transaction PSA is signed. Today, what we'd like to do is just walk through a short presentation on the Tanos acquisition, really just to bring everybody up to speed on what it adds and the benefits that it brings to us in our new Regional Focus Area, the Central Regional Focus Area. It's also our inaugural investment with Oaktree, which is very, very important, and we'll talk a little bit about that as we go through the presentation. If you would, please -- if you have the presentation in front of you, Page 3 of that presentation, we'll start here. Talk a little bit about the scale that we are now starting to see develop in this new Central Regional Focus Area. Obviously, the Tanos assets are very complementary to the Cotton Valley assets we acquired from Indigo, starts to add some scale that we -- as you know, that we've had in our Appalachian region for some time now. But this is now starting to get us up to a point where we can start to create opportunities for cost and operational synergies that are so important to our business model. These assets -- and there's a map in here that you can look at, but these assets are very complementary, very close in proximity to the Indigo assets. And as we get on the ground and start to operate, we will obviously see opportunities there to reduce cost and, as I call it, rightsize the operation. The other thing really, really important and one thing that we really see as a huge upside for us is the -- these -- both this Indigo and the Tanos assets have a very large undeveloped resource. This is a very active natural gas play right now, the Haynesville, but the Cotton Valley shouldn't be underestimated. It has really, really good returns on new drills. So we will have the opportunity to take a look at the undeveloped acreage here and see if there's a way to realize additional upside either through JVs, selling some of the undeveloped acreage to drillers or participating with someone in the drilling of those assets. But there's a really good undeveloped resource here that we can tap into and find additional value. As I said earlier, this is Oaktree's inaugural participation. What that does for us is a lot of different things. But the biggest thing for us is they have up to $1 billion to invest alongside of us initially. It preserves our balance sheet, keeps liquidity there to continue to add and give us the ability to acquire additional assets in these areas. It was real important for us as we look at these transactions, Tanos, obviously, was the asset they first invested in. However, as we looked with the Indigo asset being so close in proximity and geography and the ability to -- really to execute on synergies with those 2 transactions, it just didn't make sense for them not to -- also not to come along in the Indigo asset, so we allow them to back invest into it, so that now we're fully aligned in that area and able to take advantage of those synergies together as we move forward. The other thing this tells -- should tell the investors out there is that Oaktree is all in on this investment strategy. And they're definitely all in on this Cotton Valley area, which we see as a major, major opportunity for us. So that's the -- it also affirms the quality of the business model. That's one of the things that I've been stressing over the last several years to all of our investors is that this business model -- we're not the only ones out there that would like to do it. And we are now -- but now we are the one that's really setting the precedent and are the ones that everybody is looking to as it comes to PDP acquisitions. And the Oaktree just kind of supports and affirms that strategy. On Page 4, strengthening strategic alignment. Really all the things I just said, but there's a lot of ample opportunity here for continuing to scale up now with us and Oaktree together. Lots of consolidation opportunities here that we see as we move forward and with a lot of undeveloped resource, which keep that -- as we move forward over the next several months, keep that in mind, I think that's going to be a big opportunity for us. Significant gas weighting, which plays into our ESG -- high concentration of natural gas in our ESG story. We know that natural gas is always going to be there as a bridge -- fuel of the future and the bridge to additional fuels going forward. So this is a big, big step for us, and this is a high concentration of natural gas and NGLs with access to those Gulf Coast markets, which is extremely important and has given us the ability to see extremely favorable pricing here compared to what we have in Appalachia. Basis differentials being very low, and in some cases, positive. And we've been able to lock some of those in. Extensive infrastructure, a lot of pipelines, a lot of markets. You have the LNG facilities for export here on the Gulf Coast. So takeaway capacity is not an issue, and it shows up in the basis diffs that we recognize there. Additional upside exposure. Our purchase price is only allocated to the PDP, as you all know. So all this undeveloped resource is additional value that we didn't have to pay for. So it's all these things very similar. I mean this story sounds just like Appalachia, which is what we told you from the beginning when we entered this area that we felt this was the best opportunity for us to replicate what we've done in Appalachia in this Regional Focus Area. So these are all key value drivers that we see as we move forward. The other thing that I think is very, very important is -- and we stress this with the Indigo and the Blackbeard transactions. It's a very constructive operating environment, accommodative political and regulatory environment, where the regulatory agencies are all about energy. And so it's very, very important when it comes to operating in this region. On Page 5, the acquisition highlights. Obviously, it looks a lot like the Indigo transaction. This area has been very, very active, especially the Haynesville. We've seen a lot of consolidation occur in the Haynesville. Over the last couple of months some big transactions. We'll continue to see that, but this is a very active area. Some of the players from other regions like Southwestern have stepped out and have bought assets here in Louisiana, especially the Haynesville. We love the Cotton Valley. We think that Cotton Valley is an overlooked asset from the ability to develop it and to produce it. It's a conventional asset, but it has a lot of potential. Big gas-weighted area, with significant dry gas production, not a lot of processing costs to have to deal with, which again plays into the margin story that we talk about all the time. Lots of infrastructure and a constructive regulatory environment. You can see down here in the left-hand corner the wells that we've just acquired or will be acquiring from Tanos. A significant amount of the well count is in that 6% to 8% decline rate bucket. And you can see that they did have some newer wells that were put on production in the last 4 or 5 years. And those will slowly migrate down into those 6% to 8% decline rates over time, which again fits right into our strategy of trying to maintain a corporate decline rate anywhere from 6% to 8%, in that range. Some of the other acquisition details. The gross purchase price, $308 million, plus some mark-to-market of some hedges that they were carrying. Again, we're sharing this with Oaktree. So 50% of that belongs to us, $154 million. When you take out an effective date for transaction back to January 1, and believe me, we've been working on this transaction for over 6 months now, from start to finish. But when you effective dated back to January 1, you can see out-of-pocket cash of about -- for us, is about $118 million plus the underwater hedges that we will assume. Expected closing date, mid-August, about 45 days from now. I don't see any problem with that at all. You can see here on the revenue side, the differentials on average over the last couple of years have been anywhere from negative $0.15 to negative $0.25. But I will tell you that they have firmed up here recently to where Henry -- or Houston Ship Channel is positive, anywhere from positive $0.02 to positive $0.06. So we will be taking advantage of that. Some of the expense and margin details. When you add the base LOE, it's about $0.46 per Mcf. Production taxes, gathering, transportation, you can see that the overall cost of about $1.16, of which 70% of that is variable. So as the production rolls off, about 70% of those costs roll off with the production. But very, very stable and large EBITDA margins here that we're dealing with, 65% EBITDA margins approximately because of the fact that you have a great Henry Hub price right now with very low differentials. And so that makes for a very, very positive and very strong cash margin. Some of the other asset overviews. You can see about 27,000 Boe per day gross, of which half of that will be ours. The well counts are relatively low, 855 wells. And you can see the mix of gas and NGLs. About 98%, 99% is gas, nat gas and NGL. So very strong gas component. You can see the average working interest and the average well age is around 9 years. The important thing for us is as we take our portfolio now, we combine it with all the assets that we've acquired or announced that we would be acquiring, we're still in that 8% to 8.5% decline rate year-over-year as a company. So that continues to stay pretty stable, even with some of these assets that are kind of newer that we're bringing in, in some of these portfolios that will continue to marginalize over the next couple of years. The acquired acreage 192,000 acres. Most of that is held by production, and there's a lot of undeveloped resource potential in there. And you can see the next 12 months EBITDA of around $100 million, of which you can see we're $51 million. So all in all, a very accretive transaction with a lot of potential here that we see adding with our Indigo transaction announced in May. On Page 6, talking about the participation, the funding and the allocations of the value. You can see Diversified has 50%. We have gross cash consideration of $154 million, of which only $118 million will be required at closing. The working interest allocation, 51.25%, which includes the promote from the Oaktree participation. Our EBITDA portion of $51 million, net production of 14,000 Boe per day. I believe as a company now that would put us somewhere up around 130,000, 135,000, with the other 2 transactions that we've announced, around 130,000 or thereabout Boe per day. And then these add about $201 million of PV10 value to us, and the transaction represented about a PV14/PV15-type transaction purchase price. The initial promote, you can see here of 2.5%. That's a little smaller than the initial promote that we announced in the Oaktree agreement. And a lot of reasons for that. But the biggest reason for us right now is, is that the amount of opportunity in the market is pretty substantial. And I know I said this on the last call, but in this case, probably more so than I've ever seen in my life. And so there is a tremendous amount of opportunity. We needed and wanted Oaktree to get into these deals, be involved from the beginning, and really they are extremely excited about the opportunity set out in front of us. And so together, we gave them a little discount on the upfront promote in this one and the Indigo deal so that they would get all in on the Cotton Valley, that as we move forward, we obviously will utilize the original promote. But we needed to get them in -- one of them in so that we could pursue the larger transactions together. There is a significant opportunity set out there. And so now, obviously, this will result in a quicker reversion of our interest with a higher reversion on the back end. But we wanted them in, and this was the best way to do it on the Tanos transaction to get them in. And really and truly the promote is meant to be more of a cover for us on G&A. These 2 deals alone just don't add a lot of G&A cost to us as a company. And so we gave them a little discount on the front end of these 2 transactions. I would expect that, that would go back to the normal amount. And we really have discretion. It was set up in the agreement to be the 5% promote. We have discretion on a case-by-case basis. But in this case, we wanted to get them in, see a lot of opportunity going forward and one of that alignment so that we could go after some of these bigger transactions that are out there in the market. Flipping to Page 7, again, more of the same, but just some of the economics of the acquisition as it relates to our share and adding the Indigo and the Blackbeard to the mix. You can see what we paid from a cash perspective, both gross and net. The metrics, as you look at the net production, is adding about 38,000 to our existing. So we're about 138,000 Boe per day. PDP reserves up 752 Boe -- MMBoe. So pretty significant increase there. PV10 value up to $2.4 billion, almost $2.5 billion from the end of 2020 of $1.9 billion and then the adjusted EBITDA up to $420 million from the end of the year $301 million that was reported. So all in all, very accretive across the board. You can see those increases. Net production is up 38%, EBITDA up 39%, PV10 is up 27% and reserves up 24%. So these -- even on a net basis, these transactions have pretty significant increases across all those categories. Page 8, again, goes to a lot of our opportunity set and what we're seeing out there. But you can also see here that there's a lot of near-term operational and administrative synergies that are being created as we continue to increase this area. And I can assure you, there's no absence of opportunity here. As we look forward over the next several months, we're going to see a lot of opportunities to -- as we increase the scale of the business. Brad will be -- our Chief Operating Officer will be looking for ways to rightsize the operation, to get those synergies started and recognized throughout the expense base. We're retaining the field personnel for all these transactions and -- which gives us a heads-up on being able to know where these opportunities exist, which wells can be put -- can be increased as it relates to production and doing the right things in the field to take advantage of all the opportunities that are out there. These folks all -- they already know. And so we're able to utilize those operating personnel to get the scoop on where to start. Future upside and monetization opportunities. I talked about it earlier, but I truly believe that this area is going to give us a lot of upside in value related to the undeveloped resource. And we're going to -- we've already started to work on some ways to try to recognize that. And so that -- anyway, this is a massive opportunity for us in this area. And we're looking forward to taking advantage of the existing synergies that are out there, but also to continue to add scale as time goes by. And we'll just sum it up with the -- on Page 9. Obviously, the partnership with Oaktree is big, and it's going to afford us the ability to do a lot of things as we move forward in a big way. The transactions that are out there continue to not only present themselves, but they are a big one. There's a lot of big ones. And so having Oaktree now all in, vested in the business, in the model, seeing the advantages of the model is a big component of what we want to do and where we're going from here. But it gives us the ability to do nondilutive. We don't want to -- we want to only use equity when we have to, and we have capacity now. With Oaktree's participation in these 2 transactions, we still have some capacity on the debt side to add additional assets here in the near term. Accretion, it's all about accretion, operating cash flow per share. And obviously, the dividends per share will be impacted by these transactions in a meaningful way. Scale. We continue to -- in this -- especially in this Cotton Valley area now be able to combine these assets, get the operations put together. Brad will have opportunities to look at rightsizing the operation and making sure that we're getting the most efficient operation that we can. And we have a strong balance sheet. We're about 1.9x levered on the back end of -- all of these transactions. So obviously, we have some additional capacity, and we will use that in the next transaction. And we have the ability to utilize Oaktree's participation to help with that and to assist with that on the next one, if it's upsized. So all of these things put us in a very good position as we look out over the next several months. We're not done. We have a lot of opportunity here. We have capacity on the balance sheet to do further transactions. And we have the ability now to go in and really look at what we've created already in this Regional Focus Area. Guys, we've -- between the 3 transactions that we have done on a gross basis, gross production anyway, we're up to 400 million a day, I believe, or thereabout of gross production, which is over half of what we were doing in Appalachia already. So we're building scale quickly in a commodity price environment that's looking very, very stable and very, very strong. And there's nothing but good things to come over the next several months. So with that, Eric, do you have anything that you'd like to add before we move on to questions?

Yes. No, I appreciate the overview. I think this really is -- we've talked about 2021 looking a lot more like 2018 than any other year, which was -- if those who have followed us, was the most transformative year as a public company we had. I think having 3 acquisitions now in this newly defined Regional Focus Area, as you said, with about half gross production and adding about 1/3 even to our net production is truly impactful. I think it's also telling that, typically, we've worked in more contrarian areas that aren't attracting new development capital. But to be able to acquire assets at these valuations in an area that is very active, specifically the Haynesville, I think, does give us some real excitement around the value of the undeveloped in different ways that we can look to tap that without having to ultimately initiate that on our part, but extract real value, I think, is very tangible. And then I do think that Oaktree's participation is both historic and very telling. I think it's further affirmation of the quality of the region and, candidly, the size of the opportunity set. And we've said over and over that one of the biggest advantages of having Oaktree alongside is that not only does it give us that much more credibility as a potential buyer of assets as we bid and sellers are looking for the likelihood of execution, but it's also a validation of, I think, the asset quality and creates an opportunity for us to acquire that working interest from them over time. Even though we did have a slightly smaller working interest upfront of the promote, the 60-40 split in the long term will continue to stay intact. And so that discount we offered in the inaugural opportunity will just put us on track to get to that back-end promote that much more quickly where we will still own 60% in the long run. So I think we're obviously really excited about what we had to do, and I think we've got tremendous momentum to, as you said, affect continued roll-up of these assets.

Yes, Eric. And real quick, Brad, our Chief Operating Officer, is on the phone also. I'd just like for him to give you guys a quick update as to how we're progressing on the 2 transactions that we've already closed and the progress we're already seeing there.

Sure, Rusty. Thank you, Eric, as well. Yes. We're real excited about the workforce that are part of both Blackbeard and the Indigo Minerals transaction. We've incorporated the Indigo team very well. We've done a lot of prework on Blackbeard, and we'll start tomorrow with them, incorporating them into our workflow. Indigo has been very successful. We've already been able to execute on numerous opportunities. We've also incorporated several of our Appalachia operational management team. We've moved them into the North Louisiana, East Texas market. They know how we operate. They know how we like to incorporate our assets. And so that's going to give us some additional speed to market with optimizing some opportunities in that area. So we're also working on the IT and technology aspects of the business and incorporating the back office. We've made great progress there. And those teams are working well together, and we think we'll be able to incorporate those here in the near term. So all very positive from the operational side and the integration perspective.

Yes. Thanks, Brad. And I think I echo what he's saying from the standpoint that I think that this has probably been a very quick turnaround in terms of being able to recognize some of the things that we can do and get the benefit of them pretty rapidly. So with that, I will turn it back over to the operator, and we'll open it up for any questions that people may have.

[Operator Instructions] Our first question comes from Chris Wheaton with Stifel.

Great. Happy 5th of July to you. A few questions from me, if I may. Firstly, is there any way you could put some potential size on the potential integration synergies here you've got from actually starting to be able to put the acquisitions together on top of each other? And secondly a question to Eric. Given the value of the assets acquired over the last 3 months, are you thinking about being able to expand your RBL capacity? Because clearly, you've got a lot more reserves against than you had at the beginning of the year.

Yes. I will -- Brad, if you don't mind, maybe just -- I don't know if you can really quantify all the stuff in the near term, but I know that there has been stuff. Brad, if you wanted to comment on that?

Sure. Sure. So for one, Chris, like we always like to do from an optimization standpoint is, we like to look for areas of production that we feel like can be improved. And that's -- and so we're definitely focused on that, and that includes bringing wells that had been shut in for various reasons back online to get that profitable production. We've already done some rationalization of some workforce opportunities in those areas on the pre-acquisition standpoint. And then we also believe that from a transportation and gathering and from a marketing perspective that these assets have opportunities to drive some additional margin. And so our operations team will be working with our commercial teams to realize some of those synergies as well. We'll do the traditional items by looking at vendor rationalization, any type of contractor -- third-party contractor spend, if there may be, that we would like to incorporate in-house, just like we've done in our Appalachia Basin. That's why it's important the fact that we put some of our Appalachia management team incorporated into these assets, so that they -- again, they know how we work and know how we like to operate and know how we like to realize those synergies. So that's -- those are the primary focus areas.

Yes. Thanks, Brad. And Chris, I'll jump in and answer the second part. I'll certainly follow Brad by saying it's a great place to start when you're north of 50% margins on the Indigo assets and north of 60% on here -- the Tanos assets. I think it put us in a tremendous spot, as we look for ways to continuously widen those margins. And you can tell that Brad's team has been hard at work identifying opportunities to do that. But we're really excited to be at a starting point that is as strong as it is. As it relates to the borrowing capacity, I appreciate the question because we're one of the few out there, I think, that really is in a position to play offense in what has been a tremendously challenging environment for so many having had low commodity prices for a historically long period of time and at historical lows. But we've built the company to be very efficient and operate at wide margins even at these low prices, which has given us not only a healthy syndicate of banks who you've seen have reaffirmed our borrowing base without any new collateral for the last 3 redeterminations, but stand ready to extend additional capacity as we drop down additional collateral. You may see some new names in the facility as well as we ultimately look to upsize and expand those relationships. You depreciate that there are some banks missing from the facility that are in, say, larger companies' portfolios that would love to do business with Diversified. So we've been hard at work on those relationships. And then we're looking, obviously, the best and most efficient way to tap the value given the opportunity set that we see in front of us. And so we'll look at the asset-backed securitizations that we've looked at before. We've all seen that the high-yield market has been very active lately and at rates that are quite compelling. And then the RBL market continues to be, at least for us, very strong. And so I think it's nice to have options. And so my team has been hard at work looking at the best way to tap the additional liquidity that's embedded in these assets, so that we can continue to, as Rusty said, leverage our ability to finance using borrowings as opposed to using equity on some additional transactions as we move forward to limit any additional dilution. So that's very much in focus.

At this time, I would like to turn the call back over to management for closing comments.

Yes. Thank you very much. So that's -- that was all of our comments for today. I would say that we're excited about the future here. We've got a much larger company than we had 2 years ago. We've got Oaktree's participation as we move forward to help us to continue to grow the company. We've got liquidity that we can tap into. As Eric was mentioning, we're at over $400 million of EBITDA now. We really look forward to growing that substantially in the next 12 to 18 months with the participation of Oaktree with us. The balance sheet is strong. The business is strong. We have a great team on the ground in both areas in which we operate. We will continue to evaluate opportunities in both of those areas, including midstream assets. So we have a lot of opportunity in front of us, and we look forward to closing the Tanos transaction in the next 45 days and proceeding with it and the synergies that come along with it. And with that, I'd like to thank you all for taking time today to listen to the call. Thank you.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and have a great day.