Permian Resources Corporation (PR) Earnings Call Transcript & Summary

Good morning, and welcome to the Permian Resources conference call to discuss its proposed acquisition of Earthstone Energy. Today's call is being recorded. A replay of the call will be accessible until September 4, 2023 by dialing (877) 674-7070 and entering the replay access code 042970 or by visiting the company's website at www.permianres.com. At this time, I will turn the call over to Hays Mabry, Permian Resources Senior Director of Investor Relations, for some opening remarks. Please go ahead.

Thank you, and thank you all for joining us on the call this morning to discuss Permian Resources recent transaction. On the call today are Will Hickey and James Walter, our Chief Executive Officers; and Guy Oliphint, our Chief Financial Officer. This morning, we posted a presentation to our website that we will reference during today's call. You can find the presentation on our website homepage or under the News and Events section at www.permianres.com. After the prepared remarks, we'll open it up for a question-and-answer session. Finally, I would like to remind everyone that today's call includes forward-looking statements. Any forward-looking statements that are made on today's call are based on reasonable assumptions as of this date and time, and we undertake no obligation to update these statements as a result of new information or future events. I would refer you to our SEC filings for a full review of these risks and/or additional disclosures. With that, I will turn the call over to James Walter, Co-CEO.

Thanks, Hays, and thank you to everyone for joining us this morning. We're incredibly excited to announce that Permian Resources has signed a definitive agreement to acquire Earthstone Energy in an all-stock transaction. We are extremely proud of our people, our organization and all that we have accomplished in the 12 months we've been a public company and we are highly confident that this acquisition is the right next step as we seek to maximize shareholder value going forward. But before I get into the merits of the transaction, I'd just like to say how impressed we are with the Earthstone team and the company they've built. Robert and his team have done a tremendous job over the past several years, transforming Earthstone from a production-weighted company with assets in the Midland Basin to the high-quality Delaware Basin focused horizontal business they have today. I speak for our entire leadership team when I say that we sincerely appreciate getting to know Robert and his executive team over the last few months and would say that day in and day out, we continue to be impressed with their singular focus on doing whatever it takes to maximize value for the shareholders and this transaction is a great example that does just that. I'm proud to welcome Earthstone's employees to the Permian Resources team, and we're excited to roll up our sleeves and get to work on building the best Permian business we can together. As you can see on Slide 2, we believe this transaction solidifies Permian Resources position as a leading Permian Basin independent. First and foremost, this deal enhances value for our shareholders, and it's highly accretive across all metrics including cash flow per share, free cash flow per share and NAV. Notably, the transaction is highly accretive in the near term, enhancing free cash flow per share by more than 30% per year in the first 2 years and long term, increasing free cash flow per share by over 25% per year over the next 10 years. All of that incremental free cash flow will increase our variable turn to shareholders and allow us to increase our base dividend by 20% all while maintaining a strong balance sheet with leverage less than 1x at closing. The combined business will also provide significant economies of scale with over 400,000 net Permian acres and 300,000 Boe/d of production making 1 of the largest producers in the Permian Basin with a pro forma enterprise value of $14 billion. We're excited about how this transaction significantly increases our scale in Northern Delaware and plan to harvest cash from the Midland Basin to reinvest back in the higher rate of return parts of our business. Now let me quickly go over the terms of the transaction, which can be found on Slide 4. The acquisition is structured as an all-stock transaction with each share of Earthstone common stock being exchanged for a fixed exchange ratio of 1.446 shares of Permian Resources, a common stock which represents an 8% premium to the 20-day volume weighted average exchange ratio. Upon closing of the transaction, which is expected by year-end, Permian Resources shareholders will own approximately 73% of the business and Earthstone's shareholders approximately 27%. Sponsor ownership will remain flat at approximately 45% up to this transaction, and we remain committed to ensuring a thoughtful and orderly path to liquidity for our sponsors over time. Turning to Slide 5. We would like to reiterate that we have maintained a very disciplined approach to M&A during our last 12 months as a public company as well as the preceding 7 years on the private side. We have a very long and successful track record of M&A that creates value for our shareholders and are highly confident that we will continue to build upon that with this Earthstone transaction. Given the high quality of our business today and specifically the depth of our high-quality inventory, the bar is very high when it comes to potential acquisitions but we are confident the Earthstone acquisition exceeds all of our rigorous investment criteria. First, we've acquired this business at an attractive valuation, where we are highly confident we can exceed our return thresholds. Our purchase price represents a slight discount to proved developed PV-10 while adding significant high-quality Delaware inventory at little or no cost. And the best of this inventory, which is found in the Northern Delaware, I'll set our legacy position and competes our capital within our portfolio immediately. We haven't seen very many opportunities in the past few years had inventory that can compete with what we already have, and that's one of the reasons we got so excited. Second, this transaction is accretive to all key financial metrics before synergies and extremely accretive with synergies. Third, we acquiring the business in a structure that allows us to maintain and ultimately improve our balance sheet and credit profile. But finally, and most importantly, we believe this transaction will continue our track record of enhancing shareholder value through increased free cash flow per share and returns to investors. There's just a few of the reasons I was so excited for this deal. As we flip to Slide 6, I'd like to take a step back and provide investors with a little more color on how we got here today. Going back shortly after we closed our merger, our team began the process of evaluating all of the larger businesses that we thought could become acquisition opportunities over the next year. Those private companies, we thought could be headed to market and public companies, we believe could be good merger candidates. As we went through that process, we became aware that Earthstone was a much more attractive acquisition candidate than we originally would have thought. And as we did more work on Earthstone at the start of this year, we came to the conclusion that it was likely the most attractive acquisition of any deal on our radar, both public or private. The recent series of Delaware acquisitions have really elevated the quality and duration of their inventory in the caliber of their business in a big way. We watched that they acquired Chisholm, Titus and ultimately, Novo and although our M&A focus was other places during those processes, we have done the work and really liked each of those deals. And ultimately, our evaluation made it clear that Earthstone's multiple did not reflect how good of a go-forward business they have built in Delaware. We went under exchange data with their team in late spring. And as we got under the hood and got our hands on private data, we came to like the acquisition more and more. And just as importantly, we grew comfortable that the Earthstone team as a group of like-minded people who we'd be excited to partner with in this next chapter. And as those on the call know, there have been quite a few other private Permian deals on the market over the past 9 months, with roughly 12 Permian deals totaling over $14 billion of value transacting. While none of those larger private deals met all of our acquisition right here, we have continued to find lots of smaller ground game opportunities, completing over 130 smaller transactions over the last 9 months. The larger deals we evaluated during the first 8 months of this year offered near-term accretion, but no other dealer scale is able to offer the combination of high-quality inventory in both near-term and long-term accretion that Earthstone offered. That's why we're so excited for this acquisition. It really was the first opportunity of scale we have evaluated since becoming public that checks all of our boxes. And most importantly, we believe that this transaction makes Permian Resources a better business. Ultimately, when evaluating potential transactions, our #1 goal has been and will continue to be to enhance value for shareholders, of which we are all big shareholders ourselves. With that, I'll turn the call over to Will to provide an overview of the Earthstone assets and discuss in more detail the synergies we expect to drive.

Thanks, James. On Slide 8, we show some details on the Earthstone Northern Delaware assets that got us so excited about this transaction. Our team has a lot of experience operating in the Delaware Basin, and that experience gives us conviction that Earthstone's Delaware assets brings Tier 1 inventory that competes for capital immediately. All of Earthstone's Delaware Basin assets are in areas where we are already operating, and they provide significant remaining undeveloped fairways in the same benches we are drilling today, but they also come a significant upside that we haven't seen in other recent opportunities. As James mentioned in his prepared remarks, this transaction is accretive to all financial metrics without synergies, but the large synergy opportunity is just another thing that made this deal so attractive. By leveraging our scale, efficient operational practices, organizational low-cost focus and balance sheet strength, we expect to achieve $175 million in annual operational and financial synergies. On the operational side, we are currently drilling and completing wells directly offset the Earthstone position with significantly faster cycle times and lower overall spread rates, which together lead to over $1 million per well in savings. For example, our high-spec rig contracts are at lower prices than Earthstone's lower-quality rigs, and we are averaging several days faster per well. Additionally, our operations team has identified significant opportunities to improve lease operating expenses on the Earthstone's assets and believe that we can lower their LOE per BOE to something closer to our current cost structure. For example, we plan on improving run times, reducing high-cost workovers, expanding power infrastructure and optimizing water gathering and disposal. Overall, between identified drilling completion and facilities, LOE and GP&T savings, we expect to achieve $150 million per year in annual operational savings by year-end 2024. As discussed in our Q2 earnings call that we've worked hard to reach a peer-leading cash G&A position, and we expect to continue our low-cost leadership on the G&A front for the combined company. We've already identified $30 million in cash G&A savings compared to Earthstone's current cost structure, which will further improve our industry-leading G&A metrics. From a financial synergy perspective, shown on Slide 11, we have identified an additional $30 million of annual savings that we expect to result from refinancing Earthstone's long-term debt. In addition, the all-stock transaction allows the combined company to maintain a strong pro forma balance sheet with leverage at closing less than 1x and pro forma liquidity of over $1 billion with the goal of eventually achieving investment-grade credit rating. In total, when combining the operational, G&A and financial savings, we expect to achieve $175 million in annual synergies. The Permian Resources team has a proven track record of executing on integration and synergy capture, as evidenced by the integration of the Colgate Centennial merger, where we successfully achieved the synergies and targets outlined at closing and more. We look forward to working with the Earthstone team to execute on these identified savings and make our combined business better to deliver more value to shareholders. As we think about the combined company on Slide 12, Permian Resources and Earthstone are running 11 rigs in the Permian, with 9 of those dedicated to the Delaware Basin. We plan on allocating roughly 90% of our capital towards the Delaware Basin next year with approximately 1 rig in the Midland Basin. The quality of Earthstone's Northern Delaware position allows us to maintain Permian Resources capital efficiency and well productivity year-over-year. Overall, our key priorities have remained unchanged. We will continue to focus on maximizing free cash flow in the near to midterm and creating shareholder value going forward. As a reminder, with this transaction, we're announcing a 20% increase to the base dividend effective in 2024 and will maintain our existing variable return framework. In closing, it's almost been 1 year to the day since we closed the Centennial Colgate merger to form Permian Resources. We're incredibly proud of all the work our team has done to put us in the position to execute on another strategic transaction to drive further value for our shareholders. Over the last year, we've been very active in evaluating potential transactions and are excited to have found the deal that we believe is the right one, making it even better Permian Resources. We are ready to get to work on integration and continue our goal of maximizing value for shareholders. Thanks for listening, and now we'll go to Q&A.

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

Guys, want to -- it looks like to be a great deal. James, will my first question. You all mentioned the 11 rigs, and I believe you'll have about 4 or 5 frac spread [indiscernible]. I know you don't have the '24 guide yet, but I'm just hoping could you give maybe a sense of how you are thinking about future production growth? I know you mentioned boosting the base dividend, but I'm just wondering how you're thinking about production growth and if you have any ideas on what acreage you might be targeting now in the pro forma first?

Yes, Neal, I mean, I think our view on kind of production growth really hasn't changed. The combined business has the same quality inventory and depth that gives us the flexibility to kind of turn that dial based on what we see from kind of service cost deflation and commodity prices. So really, I would think about it as kind of the same framework under which we were evaluating '24 kind of before this deal, which is -- we're going to continue to watch what service costs and commodity prices look like and kind of ultimately lay out a plan. But something kind of between 0% and 10% growth are probably the bookends and we just have to see kind of how the -- how it shakes out between now and then. And then as far as like -- specific allocation, it will be a Delaware-based in allocation and probably slightly weighted towards the New Mexico side over the Texas side.

That makes sense. And then probably [indiscernible] said about Will or I think James, I think you said about 45% pro forma overhang pro forma for the deal. I'm just wondering any idea of what the lockup would be for the large holders? And then secondly, would you all consider participating sooner than later on in a meaningful way if any of these large holders decide to sell in the coming quarters?

Neal, it's Guy. The short answer is yes, we have lockups from the Board member sponsors in [ Capital ] and Riverstone. We've had a coordinated process, as you know, for shareholder monetization, and we're going to continue to do that through the registration rights agreement as part of the transaction. What that really does is allows PR to continue to facilitate the coordinated and thoughtful monetization process that we've had post merger. We're really confident in our plan here. It's the same plan we've executed over the past 12 months, which has been successful for us and our sponsors. We're fortunate to have a really great and supported sponsor group that believes in what we're doing and our focus on long-term value creation.

And we'll be excited to and plan to use the buyback kind of as we have in the past.

Sorry. Operator, we can go to the next question please. Operator, this is Hays. Can you hear me?

Apologies, the operator speaking. I'll move on to the next question. The next question comes from Fernando Zavala from Pickering Energy Partners.

I was wondering to ask about the Midland or stepping out into the Midland asset for you guys. Can you talk about what you find attractive in those assets? And what the potential long-term plans would look like?

Yes. I mean I think I'd start by saying what really got us excited and the reason we did this deal was for Earthstone's Northern Delaware position. That's kind of the core of our investment thesis and the vast, vast majority of our go-forward plan. I mean the simple [indiscernible], we like that Midland Basin asset for the free cash flow that it fits off, that asset is a free cash flow machine. And our plan is to take that free cash flow and harvest it, come in harvest mode and we can reinvest those dollars in the Delaware Basin, and that actually is a really good system that works really well. I think longer term, we'll just have to wait and see. I think we like kind of having that on the shelf for now. while we harvest cash flow. But I think over time, if opportunities arose, I think we'd be -- we'd certainly be interested in what strategic alternatives could look like for that asset. I'd say that's not something we're doing at the present time or plan to do so immediately. But I think over time, would obviously explore if there's ways to kind of extract additional value from the Midland Basin. But this is a Delaware Basin company. That's how we think about the focus going forward.

The next question comes from Leo Mariani from ROTH MKM.

I wanted to follow up a little bit on the Midland here. So you talk about kind of the 1 rig there next year, is that going to basically lead to kind of production declines there in the Midland for the foreseeable future? You certainly talked about harvesting the free cash flow, reinvesting in the Delaware, that certainly makes sense, but just trying to get a little sense of the kind of profile there. And what's kind of the split of Earthstone's production between Midland and Delaware?

Yes. So I mean the plan is definitely to let that asset -- the Midland Basin asset decline. I think that 1 rig -- Earthstone does have some really good, high-quality inventory that competes for capital in kind of Midland County and, call it, the Northwestern most part of their position in Reagan, kind of Central Reagan. And that rig will be there at least for the next probably a year or 2, but the plan is to let that asset decline, and we like that. But as you know, our plan is always to allocate capital and rig activity to our highest rate of return projects. And for obvious reasons, the vast majority of those are in the Delaware.

Okay. And do you guys have an estimate of kind of the split on Earthstone's production between Midland and Delaware?

Pro forma the business is going to be kind of -- the majority of the production is going to be from the Delaware. I think it's something like 15% or less of oil production comes from the Midland?

Okay. And then with respect to the G&A that you guys talked about, you guys are targeting, I guess, $30 million in G&A synergies on the cash side. It looks like Earthstone probably as annual G&A of just over $50 million on the cash side here. So -- are you definitely planning on keeping some of the employees here as you kind of operate the much larger asset base. Can you just talk to that a little bit?

Yes. So I think Earthstone kind of post Novo run rate is closer to 60 and yes, I'd say the vast majority of those will be from kind of synergies at the executive level and other just kind of duplicative software programs, things like that. I think from an employee perspective, we are excited to keep and work with the Earthstone team.

Our next question comes from Nitin Kumar from Mizuho.

I want to start with just some of these drilling efficiencies. You were obviously as you show in your slides, a little bit ahead of Earthstone in terms of how efficient your operations were. Are there any challenges from a geology or a geography standpoint that you see with the expanded acreage?

No. This is -- we are -- we have run rigs kind of in all the same areas across the Northern Delaware Basin. So we know exactly what we're getting into. And I think we know how to achieve those synergies. We just got to go get them. It will take a -- it will take time to kind of incorporate our best practices, optimizing the rig fleet, but we're very confident that we can achieve those synergies.

Okay. And then maybe sticking on the synergies topic. There was a pretty wide gap between your lease operating expenses and where Earthstone was. Just -- have you -- you mentioned that you have some projects identified, et cetera. Would you -- can you maybe describe a little bit about the nature of the projects? And is it the low-hanging fruit? Or is it something that will require a bit more investment on your part to achieve those, I think, $30 million or so, you said of synergies?

I think it's a little bit of both. But I mean, as we sit here today, most of those synergies come from things that we were able to identify just from kind of, I'd say, evaluating the asset from kind of across the street. LOE, as you think about those synergies, you can only get so far from an evaluation. And I'm very confident kind of once our team gets our hands on these assets that we'll be able to achieve those and more. A lot of it is just things kind of from our scale, things like optimizing water disposal. We've got a long-standing relationship with WaterBridge, et cetera, to kind of continue to expand upon our water disposal footprint. And then a lot of it is just blocking and tackling. Think about it as artificial lift optimization, minimizing failures, increasing run time and just kind of doing the things on the ground that kind of over time picking up those pennies and quarters that adds up to dollars.

Got it. And if I can sneak one more in. You talk about how the pro forma company's oil mix is a little bit less than what your current oil mix is. I think it goes down to about 46% from 51%. As you refocus on the Delaware Basin, do you expect that oil mix to be in that 45% range? Or should we expect it to come back up over time?

Yes. I think of it as our development wedge that we're drilling every year should be consistent with the oil mix that kind of we got from legacy PR's development wedge, which should definitely kind of continue to bring that up over time.

The next question comes from Subhasish Chandra from Benchmark.

Congrats. A follow-up on the synergies again. So the synergies don't assume that you can drop a rig. But -- is it possible that once you get through it that you might be able to accomplish the same while reducing the rig count -- pro forma rig count?

Yes, definitely possible. But I think the way that we think about rig count, it really starts with kind of a capital allocation exercise for next year, which will be ongoing over the next 3 or 4 months based on kind of service costs and commodity prices, and we'll settle on a well count and then kind of back into the number of rigs to optimize kind of the execution of that well count. So I think everything is on the table. We could drop a rig, we could add a rig or we could keep rig count flat, it will really start from kind of the right amount of capital to spend, which is really dictated by what we see on the service costs and commodity price side.

Great. And I don't know if there's a perfectly clear response for this. But you [indiscernible] the inventory that Earthstone brings yet the transaction value, I think, according to the slide is slightly below PDP value. In the incongruent, how do you explain that sort of opportunity on valuation for the acquirer?

Yes. I mean I think the answer just goes back to how we got here. I mean I think that -- like I mentioned in my opening remarks, the Earthstone team has done a remarkable job transforming their business over the last 2 years. I can't emphasize enough that the acquisitions that they acquired are probably our 3 favorite Delaware Basin acquisitions that we didn't buy. We bought some other really good ones kind of around the same time. But I'd say for whatever reason, the market never adjusted and reflected the multiple that Earthstone trades at to reflect just how high quality that business was. And I can't answer the why because I think that's something that Robert and his team have been kind of working through for a long time. But the answer is their multiples kind of stayed the same and as it's been and their business has gone from one that was a production-weighted business with some development in the Midland Basin to an incredible high-quality Delaware Basin business and the market hasn't gotten there yet. And I think that's what created the opportunity for us.

The next question comes from Oliver Huang from TPH.

Congrats on the acquisition. It is still a bit early on getting details on the 2024 program, but somewhat of a follow-up to Neal's first question. But looking at the pro forma rig map that you all have, is that how we should be thinking about just the allocation split when thinking about lead versus Eddy County within New Mexico? Or is that something that can move around a bit more than the 1 rig on the Eddy assets?

I think you can definitely move around a bit. I think it's too early to kind of say exactly what the lead to Eddy split is. But we like the Eddy assets a lot. So just looking at that map, I would expect more rigs in Eddy than what you see on it. But again, I mean, it's -- this is stuff that we're going to be working through in real time, and I can't speak to the exact allocation between the counties yet.

Okay. That's helpful. And just with respect to, I guess, Northern Delaware infrastructure, how are you all feeling about that post deal? I know there's been some tightness and constraints in the area. I just wanted to see what plans for investment on that front might be?

I'd say both in terms of long-term takeaway out of the basin, we've both been fortunate to be partnered with the right crude transporters and gas processors, kind of some of the largest guys and the highest quality operators in the basin. So kind of to date, we haven't had any issues moving our hydrocarbons out of the basin. And don't expect any to arise going forward.

Thank you. There appears to be no further questions. I will turn the conference to James Walter for closing remarks.

Thank you. Since closing our merger almost a year ago, we've delivered leading returns for our sector and outperformed the S&P 500, and we believe that this acquisition positions us to continue creating value and delivering outsized returns to shareholders going forward. The transaction increases the overall quality of our business, enhancing our core Delaware Basin assets, potentially for organic growth, efficient operations and strong financial position. By continuing to enhance and cultivate these attributes, we believe that we can continue to create value for our shareholders while solidifying our position as the leader in the energy sector. Again, and finally, we're excited to welcome the Earthstone team to the Permian Resources family. Thank you, everyone, for your time today.

Thank you. This does conclude today's conference call. Thank you all for attending. You may now disconnect your lines.