Expand Energy Corporation (EXE) Earnings Call Transcript & Summary

Good morning, and welcome to the SilverBow Resources Acquisition Update. My name is Briana, and I will be your conference operator today. Please note that this call is being recorded. [Operator Instructions] I would now like to turn the call over to Jeff Magids, Vice President of Finance and Investor Relations. Please go ahead.

Thank you, Briana, and good morning, everyone. Thank you very much for joining us today to discuss SilverBow's acquisition of Chesapeake's South Texas position. During our call this morning, we will be making forward-looking statements, which may include statements which are subject to risks and uncertainties, many of which are beyond our control. These risks and uncertainties are described more fully in our press release today and our documents on file with the SEC, which are also available on our website. We may make reference to certain non-GAAP financial measures, reconciliations to certain non-GAAP metrics can be found in this morning's press release as well as our filings with the SEC. With me on the call today are Sean Woolverton, our CEO; Chris Abundis, our CFO; and Steve Adam, our COO. With that, I will now turn the call over to Sean to provide an overview of the transaction. After the completion of the prepared remarks, we will move on to the question-and-answer session.

Thank you, Jeff, and thank you, everyone, for joining our call this morning. We are pleased to announce that SilverBow has entered into an agreement to acquire Chesapeake's remaining South Texas assets. The strategic impact of this transaction is transformational for SilverBow as we expect to become the largest public pure-play Eagle Ford operator on a pro forma basis. This transaction marks to the eighth acquisition that we have made over the last 2 years and represents the largest to date. Our patience and persistence to acquire this asset comes after nearly a year of evaluation and discussions with the seller. The acquired asset checks all the boxes that we target in a deal and achieved key scale and financial goals in a single transaction. We are acquiring an asset with a well-established production base that has over a decade of high return inventory and that's expected to compete for capital immediately, all at a very attractive valuation. At the same time, we anticipate similar leverage to our current level shortly after close and to quickly delever to our stated 1x target by year-end 2024 with the strong free cash flow of the combined company, while also significantly expanding our liquidity. As Jeff mentioned, both Steve and Chris are joining me this morning. And before I turn the call over to take questions, I want to provide additional details on the deal. First, I will provide an overview of the assets and highlight the key attributes that enhance SilverBow's business going forward. Second, I will summarize how this acquisition aligns with our long-term strategic objectives and how it enhances our differentiated growth strategy, peer-leading cost structure, and ability to allocate capital across the balance commodity portfolio of assets. And finally, I will touch on how we are executing this highly accretive transaction with the financing construct that maintains our financial strength and conservative leverage profile. Starting with a summary of the assets. We are acquiring 42,000 net acres in the South Texas Austin Chalk and Eagle Ford liquids-rich window. The assets are 100% operated and are located within our core operating area. Client development of this resource should drive tangible value for all of our stakeholders. We expect the assets to produce approximately 31,000 to 33,000 BOE per day during the fourth quarter of 2023, including contribution from wells slated to be brought online by September 30. Importantly, the production base of the acquisition is comprised of approximately 60% oil and NGLs, which further broadens SilverBow's commodity diversification. We estimate the PDP PV-10 value of the assets to be approximately $850 million, assuming August 4 strip pricing. That PDP value more than covers the $700 million purchase price and does not factor in any value attributable to the current wells in progress that are expected to be producing prior to closing. Transaction also adds a material number of locations to our inventory that should immediately compete for capital within our balanced portfolio. SilverBow's long-standing technical and operating experience in the region -- in this region allowed us to rigorously assess the undrilled inventory potential. The acquisition adds approximately 300 gross drilling locations in the Eagle Ford and Austin Chalk. More than 200 of these acquired locations generate rates of return above 40% at $70 WTI and $3.50 Henry Hub and fortifies our decade-plus of premium inventory life. Turning to our long-term strategic objectives. The acquisition checks all the boxes. It delivers differentiated growth and enhanced scale, deepened SilverBow's balanced commodity portfolio of high return, drilling locations provides immediate accretion to SilverBow's per share metrics and corporate returns and provides SilverBow with a clear path to achieve its long-term leverage target. I will quickly walk through each of these key points. First, the properties add critical scale to our business, increasing our expected pro forma fourth quarter production to approximately 87,000 to 99,000 BOE per day and driving liquids production mix up to approximately 50%. The increased scale should enhance our operational efficiencies and optionality of capital allocation across commodities as well as our ability to secure competitive pricing with our oilfield service partners. Second, upon closing, we will have a material 60,000 net acre position in the core of South Texas, Austin Chalk play in Webb County and Dimmit Counties. The acquired 40,000 plus net acres directly offset SM Energy's chalk liquids development, while our existing 20,000 net acres reside within EOG's Dorado dry gas chalk play. Our pro forma Austin Chalk inventory across both the gas and liquids-rich windows of the chalk provides SilverBow with over 300 drilling locations and 2 of the most economic plays currently being developed in the U.S. We targeted this acquisition specifically to further enhance our balanced commodity strategy, and most importantly, the Chesapeake assets can immediately compete for capital in SilverBow's portfolio. Third, we are executing this deal at an attractive price that offers significant value creation for our shareholders. The cash consideration paid for the asset implies just 2.3x expected next 12 months EBITDA and over a 20% unlevered free cash flow yield. The deal is expected to be highly accretive to all of our key metrics, including cash flow per share and free cash flow per share. The increased scale from the acquired assets also positions SilverBow to deliver leading capital efficiencies compared to peers with our best-in-class cash margins and lower reinvestment rates. Moving from our strategic objectives to the financing approach. We expect the transaction to close by year-end 2023, with an effective date of February 1. The $650 million of upfront cash consideration is expected to be funded with cash on hand, borrowings under SilverBow's upsized credit facility, and the issuance of incremental second lien notes that will be prepayable beginning 1 year following issuance. This financing approach gives us the ability to quickly delever while maintaining optionality for future consolidation opportunities. We expect SilverBow's leverage to decrease through year-end 2023 and reach our onetime target by year-end 2024, given this strong free cash flow of the combined company. At the same time, SilverBow's cash flow per share and free cash flow per share is expected to increase over 50% and 80% in 2024, respectively. To protect the significant financial benefits of this transaction, SilverBow plans to increase the company's commodity hedges to cover at least 75% of pro forma PDP oil and gas volumes for the first 2 years and 60% for the third year. SilverBow also plans to hedge a significant portion of the NGL production stream over the specified period. The incremental hedge amounts are expected to utilize a combination of swaps and collars. To wrap up our prepared remarks, SilverBow is focused on advancing our multiyear strategy of delivering double-digit growth while simultaneously expanding our inventory and strengthening our balance sheet. The combined entity is expected to generate significant free cash flow and have one of the highest free cash flow yields amongst our peers. We believe there are a number of catalysts for SilverBow's shareholders to realize upside through a re-rating relative to other publicly traded mid-Cap and Eagle Ford operators. Since the end of 2020, we have consistently grown the company through our organic development plan and disciplined consolidation strategy. Closing 7 accretive acquisitions totaling approximately $680 million by year-end 2022. Chesapeake acquisition represents our eighth and largest acquisition to date. We believe the benefits of further consolidation are compelling and today's transaction should drive further value accretion for SilverBow's stakeholders. And with that, we can open up the line for Q&A.

[Operator Instructions] Your first question comes from Neal Dingmann with Truist Securities.

Congrats on the deal, Sean. Looks good. My first question is just on activity. Could you talk a little bit, I don't know, maybe premium sort of it or but maybe just in broad strokes, how much activity from a D&C the Rigs and Frac spreads Chesapeake might have been running there recently? And any early plans for you all in the area?

Yes. Thanks for the question, Neal. In terms of current year activity that Chesapeake has been enacting, their capital program utilized a couple of Rigs and a Frac spread over the second quarter into this early part of the third quarter. They're wrapping up their capital activity. What we like about the assets is we're acquiring into an uptick in production and as they're bringing on 16 wells here in the immediate future. So it's great that we are acquiring it as production is going to be increasing here soon. In terms of 2024s activity, we'll release our guidance once we get the asset closed, but we anticipate similar activity level on the asset as we move forward and potential to enhance that activity as we take control of the asset as well.

Great. And then that kind of what you said in the 60 wells leads me to my second. You mentioned in the release, you have 300 locations. So there's a 16 wells plus on top of the 300. I'm just wondering, is that the case? And then secondly, the 300, could you talk maybe about the split between Eagle Ford and Chalk and maybe even potential upside beyond that 300?

Yes. The 300 million is exclusive of the 16. So we believe that we have 300 locations beyond this year's program. Splitting it out between the Chalk and Eagle Ford: it's about 2/3 Chalk, 1/3 Eagle Ford. So plenty of runway within both assets, but weighted towards the chalk. In terms of additional upside, we do believe there's incremental benches within both the Eagle Ford and the Austin Chalk to target, that's not represented in the 300. So the area is seeing Upper Eagle Ford activity in the past. Right now, we're targeting the middle Austin Chalk in the inventory mix that we've provided. However, there's opportunities to explore other benches within the Chalk going forward. as well. So we like that there's a ton of inventory that's well delineated, well proven out by drilling on the asset as well by offset activity. And then as we always do, we think will unlock incremental inventory as we take control of the asset.

And Sean, that 300 just on sort of typical spacing, nothing, not like having that down space anything.

Good point. Correct. The Austin Chalk, we're modeling it at 1,200 foot spacing, which is, we think, probably on the conservative side. So long term, there may be some infill potential there. And then the Eagle Ford is more on 800 to 1,000-foot spacing, which has been very well delineated by development in the area.

Your next question comes from Tim Rezvan with KeyBanc Capital Markets.

Neal, took a couple of my questions. But the one I was curious on, you talked about 2.3x multiple. Can you just help walk me through that? Is that based on the $700 million? Does that include the $750 million with the contingency payment? How do you get to that 2.3x?

Yes. Yes, the 2.3x represents the $700 million does not include the potential for the contingency paper. So that could impact both the numerator and the denominator in that the 2.3x represents current strip, which would have not the full contingency payment triggering at this point and that we're between the $75 and $80 trigger points. So that's how we derive that number.

Okay. Okay. Great. And then you talked about the 300 locations, 2/3 really Austin Chalk. Based on that 200 locations that you think have the higher IRRs, is that the same breakdown? Sort of within that 200 2/3 Austin Chalk?

Yes. Definitely, we see the chalk as the premium zone to target and has the higher rate of returns the numbers that we quoted from a rate of return standpoint is kind of aggregate across the 300, but we definitely see the Austin Chalk as having the higher rate of returns.

Your next question comes from Noel Parks with Tuohy Brothers.

I was wondering, as you mentioned the process for Chesapeake sale of its Eagle Ford as it has been going on for a while. And just wondered if you could give some background on how much in terms of drilling resources has been going on there? And in particular, I'm interested how aggressive they had or hadn't been as far as continuing to pursue the sorts of technical and operational efficiencies you've been implementing across your acquisitions?

Yes. Yes. No, I appreciate the question. I think it's well known, Chesapeake's been looking to exit the properties for about a year now, having exited 2 other assets prior to this deal. So we really like it and that we've had a long time to evaluate the asset. This is the type of transaction that a buyer always is looking for. It's a core asset that is in a premium part of the play. It has well-established base production with a ton of inventory but just was -- wasn't high on the priority list for the seller as they've been have been and announced that they were going to focus their efforts elsewhere. So we like it and that as a buyer, we believe we're going to be able to come in and really put more attention to the base production as well as look to be more efficient around the capital program. This competes very favorably within our portfolio. So we think the a tremendous amount of upside as we will -- this asset will create a key focus area for us, whereas with the seller, it was something that wasn't as focused of an effort for them. So it's really an ideal type transaction that you always look for a large independent exiting an asset that isn't just higher in their strategic radar but something that is a premium asset to go after.

Great. And just wondering, and I can't recall if you commented on this or not. Is there infrastructure or gathering systems that accompany the transaction?

Yes. One thing that being a well-established asset, there's significant infrastructure in place. Some of it is via third party that we'll step into the arrangements with those third-party providers. But yes, the infrastructure is very well built out.

Your next question comes from Michael Furrow with Johnson Rice.

Congrats on the deal. It looks like it was made at a good price.

Thanks, Michael.

All right. So my first question is just sort of on the added scale that this deal is going to bring to the company. So one of the goals of SilverBow has always been growth through acquisitions. But one of the issues that you guys have been having has been accomplishing that goal through using equity as consideration just due to the relative valuation. So would you say that this deal is going to increase that scale in a meaningful way that maybe in the future, there's a wider variety of opportunities and potentially even higher deal sizes that could come with this added scale.

Yes. Appreciate the question. Definitely, there's efficiencies around scale from accessing capital markets. So we do see that this transaction puts us in a better position longer term. We've got a very good track record of transacting, closing deals and then integrating them in and unlocking value. So we believe the Eagle Ford has a tremendous amount of inventory in terms of additional deals to be done, and we feel like we'll continue to be in that stream of deals. In terms of the structure of this deal and what it does for our balance sheet, there's a significant amount of free cash flow that's going to be generated from it. We're going to quickly delever the asset. So there will be additional capacity within the balance sheet to do future deals as well. And then longer term, we see a lot of value from a shareholder perspective being unlocked as well. So equity, we'll use it judiciously, but could be a currency that we could use longer term on other transactions.

That's great. I know it's probably a little early to be asking about the next acquisitions, but that's what we do.

No, I appreciate it. And the A&D team here. They are very -- they're very focused on this deal, but already have other things that they have in their sites. So we have that mindset here.

Good. That's great to hear. My next question is sort of around the negotiations of the deal. I mean we know this package has been up for sale for about a year. And it sounds like in your prepared remarks that you all have been interested in it for about that same time. And so I was wondering if you could provide a little more detail around the negotiation process and sort of what came together recently that made this acquisition kind of cross the goal line.

Yes. Yes. It's definitely a little unique in that the deal has been out there for so long. It gave us an opportunity to continuously evaluate, have information around the transaction. We'd like the asset that was on our target list even prior to Chesapeake putting it on the market, but having the transaction out there for such a long period of time, we got to get regular updates on their activity levels, continue to watch how the base was performing, get updates around LOS statements to see what the costs look like. So from that standpoint, very comfortable in that we've just had a tremendous amount of opportunity to evaluate the property. In terms of it ultimately coming together, obviously, Chesapeake was exiting their entire position had a couple of other assets that they were closing on as well. So that impacted some of the timing as they look to essentially do 3 transactions here. During that time frame, commodity prices have been volatile, being patient like we were, commodity prices actually are significantly lower than when the asset first came to market. So it felt like just being patient and waiting for commodity prices to pull back, but then stabilize so that both us and the seller were comfortable with transacting really played into the timing of it as well.

Your next question comes from Donovan Schafer with Northland Capital Markets.

Congratulations on the acquisition. It does look like a good opportunity to get a big old chunk in the Eagle Ford. I want to first ask about -- I know SEC pricing last year for the reserve reports pretty high because of the Russian invasion of Ukraine. But I do remember a standardized measure came in at $4 billion, and the PV-10 is $5 billion at that time. And even though that pricing was pretty high in relative terms, we talked at that time about it being just sort of like an entrancing reference point. If there's a secular argument or a secular view for things like even -- suppose the energy transition forces folks to move away from oil and gas faster than already and so then that could lead to a period of sustained higher pricing or something like that. So as a reference point, did you take a look at that again? Or have you run this acquisition at that pricing to see what would your most recent reserve report look like? With these assets included? I'm just curious if you can provide any commentary there.

Yes, yes. Thanks for the question, Donovan. Now in terms of providing an updated valuation with the combined assets don't have that number available due to your point, we're bullish on both oil and gas, oil, even more near-term gas longer term. So I think there's -- we're acquiring it at the right time in the price commodity cycle. So I think there's upside. I think earlier in my prepared remarks referenced that we see the PDP, PV-10 here at current strip at $850 million, obviously at prices from last year. that's a significantly higher number. And that number doesn't reference the value of the undeveloped locations or the upside from other benches. So definitely see at current pricing that we got what we feel is a very good buy here. But to your point, I think that there's just tremendous upside if we see a reversion back to higher commodity prices in the future.

Okay. And then for hedging, I imagine a certain amount of the hedging is perhaps required with the incremental borrowing. But if -- and so if that's the case, I'm kind of looking at a time line here with hedging that pricing -- commodity prices can be volatile. The futures curve can move around a bit a good bet. So what kind of a time line is there for you to get these hedges in place where you've got 75% hedged for, I think, the next 2 years in 60%, 3 years out? Is that something that needs to happen in tandem with the securing the debt? Or if it's determined just on your own preferences, is that something you're trying to get done in some time frame?

Yes. Yes. No, you're correct in that there are some minimum hedging requirements within the debt -- the debt credit. So there is probably what I would describe an obligatory hedging requirement and then we have a discretionary hedging requirement. As we -- as we've talked about, we've been around this transaction for many months now. The benefit over the last probably 6 weeks as commodity prices have continued to increase and are actually above the level that we are underwriting the deal at. So we've actually already started hedging into some of that requirement just utilizing SilverBow's existing production. We had capacity within our existing production for both '24, '25 and even '26. So we've been taking advantage of the continued improvement in pricing and are actually nearing the obligatory portion of the hedging requirement associated with the debt. So we're going to continue to be proactive as we think about hedging the discretionary portion. We really like the deal at current commodity prices and locking in some of that upside is always good to do and to take some of the risk of the deal off the table and will allow us to focus just on operational. I guess summarizing that we're well on our way to meeting the obligatory hedging requirement and then we'll be patient and continue to look to add hedges proactively between signing and closing and then even if there's capacity beyond closing and prices are higher, we'll do that. The other thing that we'll do is leverage both swaps and collars. So we're seeing floors that are starting to approach our even some of the time frame and commodities were above the underwritten commodity price with the floor, so makes that even more attractive for us.

Okay. And then if I can get one more question in. Just this acreage, one of the appealing things about it is it's very contiguous. And so I'm wondering if given that it's not one of these fragmented situations where it really limits some of the development pattern. Do you see yourself taking advantage of that? Is this a case where there could be benefits to doing longer laterals or maybe other things that are escaping my creativity just utilizing -- also to the extent to which it's drilled up, it's not very drilled up. So that leaves a lot of these, not only is it contiguous, but what remains to be developed is also kind of nicely blocked up. So just are there any benefits with that, that are worth pointing out or highlighting?

Yes, definitely, to your point, this will become one of our most blocky assets in the company, and it is positioned such that long laterals are definitely part of the mix. We envision a number of opportunities within that 300 inventory location we quoted having lateral lengths greater than 10,000 foot. And so we really like it from that standpoint, just adds a lot of capital efficiency when you can drill longer laterals. On top of that, the assets have had development across the majority of it in the Eagle Ford, there remains some Eagle Ford, but we're essentially going to be layering the Austin Chalk on top of existing Eagle Ford infrastructure benefit from that is roads, surface locations, gathering systems are in place. So that's an advantage as well, less capital infrastructure costs on unlocking the Austin Chalk value since it's already in place.

[Operator Instructions] Next, we have a follow-up from Tim Rezvan with KeyBanc Capital Markets.

I just had a bigger picture question for you, Sean. Obviously, with the gas prices doing what they were doing over the winter, you sort of made the nimble move to lean into oil. seems to be another further tilt into having a liquids-focused production SKU. Is that the intent as you move forward? Or is this really sort of you like the returns on the assets? I'm just curious how you're thinking about it because once you consolidate it, it seems like you could potentially continue to grow. So what sort of management's view on gas versus oil and further scale?

Yes. We remain probably agnostic to the commodities. We're definitely returns driven and we'll allocate the capital to the best returns. But one of our long-term stated strategies that we put out several years ago was to become a balanced commodity company. We really love the Eagle Ford that you can do that within the same basin and take advantage moving from gas to oil very efficiently. So with this transaction, we get to that 50-50 type balance, maybe 60-40 towards gas. As we move forward, I think we'll put rigs where the returns are the best. That may push our split higher gas 1 year or vice versa, liquids 1 year. And we'll continue to look for both gas acquisitions and liquids-weighted acquisitions. But finally, after a number of years of working it, we're added production mix that's pretty close to 50-50 weighted our inventory now is really weighted more towards liquids. It's probably a 2/3 liquids, 1/3 gas inventory. So probably have more organic growth linking towards the liquid side. And then our revenue, it will fluctuate. Last year, it was 2/3 gas, 1/3 liquids. Just in the second quarter of this year, it was 3/4 liquids, 1/4 gas. So that kind of is a great example of, hey, we're flexible and will drive activity to where the commodity prices make sense. But yes, I think this is just further cementing of our strategy that we put in place many, many years ago, and we're great to finally be at this 50-50 mix.

Okay. That makes sense. And then just a final one for me. You talked about leverage down at 1x by the end of 2024. Is that based on that same strip pricing from early August that you're referencing in the deck? Just curious what sort of underwrites that free cash flow that you see.

Yes, that is based upon early August strip price. So actually, prices are up since then. So I would tell you that, that number is probably a little bit better. mentioned from Donovan's question, we have been hedging in some of those prices. So early August strip assumption with some hedge protection around that.

There are no further questions at this time. With that, I will now turn the call back over to your CEO, Sean Woolverton.

I want to thank everyone for joining us this morning. Hopefully, from my prepared remarks and answers to the questions we received. You're leaving with a better understanding of the transaction and really we're excited that we're finally able to get this deal done. It's very meaningful for the company, and we think it unlocks a lot of shareholder value, and we're excited to demonstrate that in the coming quarters. So thank you again for joining our call.

This will conclude today's conference call. You may now disconnect.