Seven Generations Energy Ltd. (ARX) Earnings Call Transcript & Summary

Good evening, ladies and gentlemen, and welcome to the ARC Resources and Seven Generations Energy Strategic con -- a Combination Conference call. [Operator Instructions] This call is being recorded on Wednesday of February 10, 2021. I would now like to turn the conference over to Kris Bibby. Please go ahead.

Thank you, Colin. And thank you all for joining us on today's call to discuss the strategic combination of ARC Resources and Seven Generations and a strategic combination of the Montney. On the call today, we have Terry Anderson, President and CEO of ARC Resources, Marty Proctor, President and CEO of Seven Generations Energy; David Holt, Chief Operating Officer of Seven Generations Energy; Brian Newmarch, Vice President, Capital Markets and Stakeholder Relations; and myself, Kris Bibby, Senior Vice President and CFO of ARC Resources. In addition to the news release issued this evening, we have posted a transaction presentation on both companies' website at arcresources.com and 7genergy.com. As a reminder, all statements made by either company during this call are subject to either advisories included in the news release and in the presentation on the transaction. All dollar amounts discussed today are in Canadian dollars unless otherwise stated. I will pass the call over to Terry and Marty to provide some prepared remarks on the combination before opening the call to Q&A. And with that, Terry, over to you.

Thanks, Kris. And thank you, everyone, for joining us this evening. We are pleased to be announcing this transformational combination of 2 leading Montney companies to create the premier Montney company, a company that will lead in responsible energy development and drive incremental value for all shareholders and stakeholders for decades to come. The combined company will have size and scale that will generate significant free cash flow providing greater optionality in future capital allocation decisions and enhancing our ability to deliver strong returns to shareholders. The company will have financial strength and will have leading ESG characteristics. Also of importance, the company will have resiliency to better withstand volatile and uncertain market conditions. We're excited about the massive opportunity that lies ahead for ARC and Seven Generations. We recognize that the combined entity is better positioned to maximize long-term value together versus each company individually. There are a few key highlights of this transaction that I'd like to briefly touch upon. First, production from the 2 companies will be over 340,000 BOE per day in 2021, comprising approximately 140,000 barrels per day of liquids, of which over 50% is high-margin condensate and approximately 1.2 Bcf per day of low-cost natural gas. ARC will now be the largest pure-play Montney company, the largest condensate producer, the third largest natural gas producer and the sixth largest upstream energy company in Canada. The combination will allow us to considerably enhance our diversification amongst our product, geographic and marketing and sales mixes. We think this will give us greater optionality in allocating capital through all the price cycles and in diversifying risk. By combining these 2 efficient focused organizations, we'll be able to generate significant free cash flow, which will be immediately accretive for all shareholders. ARC's existing quarterly dividend of $0.06 per share will remain a key component of the combined company's returns-focused value proposition. The combination is expected to yield synergies that will deliver approximately $110 million in annual cost savings by 2022. Enhancing the company's free cash flow profile will increase the ability to fund the development of ARC's Attachie asset, further development of Seven Generations Nest asset and increased return of capital to shareholders through share buybacks or dividend increases. Also of great importance, combining with Seven Generations preserves our strong financial position which has been a key pillar of our company since we started 25 years ago. Our company will have a low-cost capital structure with ample liquidity. Initial leverage for the combined company will be slightly above our targeted range, but we have a strong deleveraging plan in place that will reduce the combined net debt to an expected 1.3x funds from operation by year-end 2021 based on forecasted commodity prices. We will continue to target to the between 1 and 1.5x debt to cash flow over the long term we have always admired Seven Generations for their enduring commitment to ESG leadership and strong stakeholder relations. We believe that the combination will elevate our collective position as an ESG leader in the energy sector both in Canada and globally. ARC's ESG strategies and practices are integrated with all that we do. This will be a large part of our corporate vision going forward as the world transitions to a lower carbon economy and the combined company further differentiates itself from its peers with its leading environmental, social and governance performance. The combined company will bring together the strengths and talents of both organizations to drive superior performance. From a governance and leadership perspective, Hal Kvisle will remain as the Chair of the Board. And we're excited that Marty Proctor will be joining me as Vice Chair. In addition to myself, 4 more directors from ARC will be selected to serve on the Board as well an additional 4 directors from Seven Generations. I will lead ARC as President and CEO with Kris Bibby as CFO, and we're excited that David Holt from Seven Generations will be joining the team as COO. Other senior leadership positions will be announced before the expected close of the transaction. By becoming the premier Montney company, we expect attractive free funds flow generation at all price levels and are well hedged to reduce the volatility in those cash flows. Our sustainable business model, which is founded on owning high-quality assets, including over 1.1 million net acres of Montney land with decades of top-tier inventory, demonstrating capital discipline, delivering operational excellence through managing a low-cost structure with owned and operated infrastructure and leading ESG performance will all continue to be key tenets for the organization. Maintaining financial strength and focusing on corporate profitability and maximizing shareholder value will also be of paramount importance. Ultimately, ARC believes that combining with Seven Generations will not only enhance but accelerate our investment thesis. The significant alignment that exists between the 2 companies makes this a logical transaction that will create significant value for shareholders for -- of both companies for many years to come. I want to personally thank Marty for leading such a great company in Seven Generations and for being open-minded to combining 2 great companies to further enhance shareholder value. I'll leave it to Kris to cover off some of the particulars of the transaction, but I want to pass it over to Marty to say a few words first.

Thank you for your perspective and the kind words, Terry. As an organization and as shareholders, we are excited about this combination and the opportunity it brings. ARC has always been a company we have held in the highest regard. We respect ARC's approach to responsible development, its commitment to operational excellence, disciplined capital allocation, consistent shareholder returns and governance practices. When discussions were first initiated, we saw that the combined entity would have the scale and high-quality asset base that is critical to remaining competitive in both the transitioning energy industry and the evolving capital market space. We see a combination with ARC as an opportunity to rapidly accelerate our strategic initiatives, reducing our corporate decline rate, lowering our debt levels and immediately opening the door to returning capital to our shareholders through ARC's dividend. In return, we are contributing our condensate rich Nest assets and helping enhance ARC's free cash flow profile. Together, we see the ability to improve our margins and create efficiencies through shared learnings across a much broader Montney asset portfolio that will benefit from economies of scale. This combination diversifies our production, geographic and operational risk profiles, and we see increasing relevancy and liquidity for our shareholders. We believe that a dividend-paying company has a broader appeal to investors who have the income or yield mandates. In the hundreds of investor meetings that I have participated in as a Seven Generations leader over the years, I have always been resolute in the fact that Seven Generations will not prioritize personal or management interest over those of our stakeholders or shareholders. This commitment to our stakeholders is what our company was founded upon, and it holds true to this day. This transaction is in the best interest of our stakeholders. I am proud of what we've accomplished at Seven Generations Energy in a relatively short amount of time, but also and equally important is how we have accomplished it, never compromising on our guiding principle and commitment to stakeholder service. At this time, both our management team and our Board of Directors feels that the right path forward for Seven Generations is to combine with an established, successful principal company like ARC. I am looking forward to working with Hal to oversee the combined company's strategy as Vice Chair of the Board, and ensuring that together, the combined company will thrive as a Canadian champion for responsible energy development. I will now pass the call over to Kris to walk through some of the transaction details and key financial aspects of the combination. Kris?

Thank you, Marty. As Terry mentioned earlier, ARC is excited to be beginning this new chapter of our company by combining with a well-regarded company like Seven Generations. I will quickly address the structure of the deal. ARC and Seven Generations have entered into a definitive agreement to combine an all-share transaction valued at approximately $8.1 billion, inclusive of net debt. Under the terms of the agreement, Seven Generations shareholders will receive 1.108 common shares of ARC for each common share of Seven Generations held. Transaction has been unanimously approved by voting directors of both companies' boards and is subject to the approval of ARC and Seven Generations shareholders, regulatory approvals and other customary closing conditions, which are expected to take place over the course of the next couple of months. Canada Pension Plan Investment Board, which has been a Seven Generations shareholder since 2012 and controls 16.8% of the issued and outstanding shares has entered into a support agreement, whereby will vote in favor of the transaction under the terms of the agreement. Closing is expected to take place early in the second quarter of 2021. As Terry and Marty have both said, we expect significant increase in free funds flow generation stemming from the combination. We expect to realize cost savings and synergies of approximately $110 million annually before tax, made up of corporate costs, operating efficiencies, marketing optimization opportunities and drilling and completion efficiencies. The transaction financing is fully committed and consistent [indiscernible] in level with cost, stable debt is expected to have an investment-grade credit rating. Ample liquidity will support a strong deleveraging profile through 2021 and 2022. At forecast commodity prices, we expect to reduce our net debt to 1.3x funds from operations by year-end 2021. In connection with the combination, ARC has entered into a binding agreement with RBC Capital Markets and CIBC Capital Markets, who are acting as joint book runners to provide the company with an underwritten aggregate credit facility commitments of up to $3.5 billion, which will ensure an ability to optimize the capital structure, including retirement of Seven Generations outstanding senior notes while maintaining adequate go forward liquidity. With that, I'll hand it back to Terry to provide some closing remarks.

Thanks, Kris. So if we add up all the things we just discussed, you'll understand why Kris, Hal, Marty and David and our respective boards support this strategic Montney combination. As individual companies, ARC and Seven Generations have both worked hard to become resilient, but especially during these uncertain and volatile times like today. Together, we will form a strong and sustainable business with scale, a premium suite of world-class Montney assets, operating expertise, financial strength and leading ESG performance. All key elements in our business that will truly differentiate us as a leader in responsible energy development.

And with that, I will turn it back to you, Colin, the operator for questions, please.

[Operator Instructions] Your first question comes from Michael Harvey from RBC Capital Markets.

Congratulations on the deal. So I guess a couple of questions, I guess, first on the synergies. You flagged that $110 million annually. The corporate cost, the $45 million, I think, are pretty straightforward. But maybe you can just fill in some of the specifics around the balance of that, just because it is a big part of the free cash flow contribution? So just any additional details you can provide in that regard. And then second part is just kind of on your capital allocation strategy and the portfolio ranking over the next couple of years. Obviously, the '21 outlook looks to be pretty much a summation of the 2 companies. But just wondering if you can let us in on your thinking of how that split will change in the coming years, i.e., which assets would you consider to be the ones that take more capital and which ones less? And just how the Attachie play in its significant price tag kind of fits into all this. That's it for me.

Well, thanks, Michael. It's Terry Anderson here. Appreciate the questions. So regarding the synergies and the by all means, Kris jump in on any more details here. On the synergies, we see a lot of opportunities on the operating expense side and in the capital cost. So we'll be able to gain more purchasing power through a whole bunch of different avenues like for chemicals, maintenance, fleet vehicles. We think there's consolidation in some of the gas plants. So there's probably at least 3% reduction in all of our operating expenses that we see that will add up to around $15 million annually on that. Same on the capital side. So obviously, we will be able to, I guess, command better pricing from the perspective of having more drilling rigs together, more frac crews. And just the design and execution of the plan, I think there's savings there from being able to consistently have rigs, the same rigs, hopefully going throughout the year. That's how ARC runs the business right now of having 2 rigs that go steady throughout the whole year, and we don't ramp up or ramp down if we can actually keep them steady through that time. There's some savings through that. So that's kind of some of the -- more of the operational side, but also on the transportation midstream Seven Generations has some unutilized transportation on alliance, which actually ARC could utilize so that will actually help out on that side, too. So that's kind of a few of the details on the synergies. When you talk about capital allocation, first step for us is reducing the debt. We need to bring that back into our comfort range. Obviously, when the deal closes, it will be above our top end of our range. And -- but based on the forward curve, we'll be bringing that back within the year. So that's pretty quick, and that makes us comfortable on that. Then from there, then we can actually look at -- you were talking about portfolio ranking. Well, we have way more optionality now, true optionality of focusing more on liquids or focusing on gas. And so depending on what the prevailing commodity prices are, we can look at doing that. The nice thing, Seven Generations has some unused capacity on facilities. So we don't have to spend capital. We can have half cycle economics to drive more of the liquids production. But eventually, we want to advance Attachie -- sanction Attachie down the road here and -- but first thing, we need to get our debt down to that low end of 1.0x before we start thinking about Attachie now that we've taken on this combination. So I think -- I don't know, Kris, if there's anything else on the capital allocation front. There's -- the nice thing about this opportunity is there's significant free cash flow and after that debt gets down to where we want it to be, I think we can actually pursue a number of different investing in our actual assets, but then also there's opportunity for share buybacks or dividend increases. But that's not within this year. That's for sure.

And Michael, I think I would just reiterate what Terry was talking about. So clearly, our short-term focus, just to bring that debt down a little out of the gate back into our 1 to 1.5x range. And then tying the -- our dividend increases going forward to the increase in corporate profitability, which can come from increased pricing or from incremental growth on, as Terry mentioned, either the Attachie asset or expanding the Nest asset. Both of them are great opportunities. And really, it is going to be a focus on shareholder returns going forward, both to -- similar to how both organizations have been driving here in the past as well.

Your next question comes from Arun Jayaram from JP Morgan.

I had a quick question on Slide 8, where you go through the pro forma in '21 and '22, the free cash flow yields. Just wondering if you could -- it looks like on a combined basis, low double digits in '21 and in the mid-double digits above that in '22. So could you talk a little bit about some of the priorities as you get out to 2022 in terms of returning cash to shareholders? And to get to that 1.3x target, how much gross debt reduction do you anticipate over the balance of the year?