VAALCO Energy, Inc. (EGY) Earnings Call Transcript & Summary

Good day, and welcome to the VAALCO Energy Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Al Petrie, Investor Relations coordinator. Please go ahead.

Thank you, Elisa. Good morning, everyone, and welcome to VAALCO Energy's Conference Call to review the transformational and strategic acquisition of Sasol's Gabon assets. After I cover the forward-looking statements, Cary Bounds, our Chief Executive Officer, will review key highlights, rationale and terms of the transaction before we take your questions. Liz Prochnow, our Chief Financial Officer, is also on the call and will be available to answer financial-related questions on the transaction. During our question-and-answer session, we ask you to limit your questions to 1 and a follow-up. You can always reenter the queue with additional questions. I would like to point out that we posted an investor deck regarding the transaction on our website yesterday that has additional information and analyses that should be helpful. With that, let me proceed with our forward-looking statements. During the course of this conference call, the company will be making forward-looking statements. Investors are cautioned that forward-looking statements are not guarantees of future performance and those actual results or developments may differ materially from those projected in the forward-looking statements. VAALCO disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Accordingly, you should not place undue reliance on forward-looking statements. These and other risks are described in yesterday's press release and presentation posted on our website and in the reports we file with the SEC, including our most recent Form 10-Q that we filed back on November 5. Please note that this conference call is being recorded. Let me now turn the call over to Cary.

Thank you, Al. Good morning, everyone, and welcome to our call. Today, I plan to provide a high-level overview of a truly transformational and strategic transaction. Over the past several years, we have worked diligently to build a solid foundation for the future and the Etame asset has been the cornerstone of our success. We have taken actions to strengthen VAALCO operationally and financially, including eliminating all debt, growing our production base and reducing our costs at both the group and asset level. Our recent success at Etame has enabled us to focus on generating positive free cash flow and prepare for future drilling campaigns to unlock additional resources and value. All of these actions have allowed us to build cash even in a difficult environment like this year. As a result, we are able to fund this transformational acquisition using the cash we have on hand, thus remaining debt-free and preserving our financial flexibility. The acquisition of Sasol's interest at Etame was a competitive sales process and our deep knowledge of the field, having been the operator since 1995, was highly beneficial. We have spoken about our Vision 2025 strategy for some time now, and this transaction is an important step in implementing that strategy. It expands our position in West Africa, provides us with additional scale and offers both near-term and long-term catalysts for profitable growth. We previously stated that our acquisition criteria is for an asset with a very similar profile to Etame in terms of adding low-risk cash flow with significant upside potential. So this value-accretive transaction is wholly consistent with our stated growth strategy. The acquisition is expected to deliver a step change in both our net production and our reserves, almost doubling both of these key metrics. If you look at Slide 6 of the presentation that Al referenced earlier, you will see that our production for the 9 months ended September 2020 would have been 9,300 barrels of oil per day net when you include the impact of the transaction. Including the impact of the transaction on reserves, we would have seen a significant increase to 2019 year-end proved SEC reserves from 5 million barrels of oil to 9.4 million barrels of oil net. For our 2019 year-end 2P CPR reserves, we would have seen an increase from 9.2 million barrels of oil to 17.5 million barrels of oil net. We expect there to be minimal additions to our overhead costs post closing. As a result, this transaction should lower our unit G&A cost per barrel by approximately 40%. Coupled with the increased production, we expect that the acquisition will significantly boost our cash flow profile. If you look at Slide 7, you will see that the transaction reduces our free cash flow breakeven price to under $31. It also provides a significant 23% increase in free cash flow per barrel at $45 realized oil prices, which is about what Brent is trading for today. This slide also shows the significant upside in free cash flow potential associated with increases in oil prices. Because approximately 90% of our costs at Etame are fixed, we add production -- are fixed as we add production or when prices increase, we see significant growth in our ability to generate free cash flow. Without this transaction, each $5 per barrel increase in the price of Brent crude oil drives up our free cash flow by approximately $8 million. However, with the transaction, our free cash flow grows by approximately $15 million with each $5 per barrel increase in the price of Brent crude oil. This is especially important as we look to the future and build on a highly successful drilling campaign that we completed in April of this year, a drilling program that demonstrated the upside potential that resides in this field. In late September, we announced that we are acquiring and processing a continuous 3-D seismic survey that will cover the entire Etame license and will allow for a more robust subsurface interpretation than ever before. This full field 3-D seismic will optimize our future drilling locations, provide better imaging of existing satellite and infill locations as well as identify additional upside opportunities. And with the greater working interest in Etame, the seismic is even more critical to our future drilling success. If you take a look at Slide 8 of the presentation, you can see the upside potential of the future opportunities at Etame and how this acquisition will meaningfully increase VAALCO's net reserves and resources in some very good prospects and extensions. With the acquisition, our net revenue interest reserves and resource potential at Etame would have increased from about 31 million barrels of oil to about 59 million barrels of oil at year-end 2019. Having operated Etame ever since its discovery over 20 years ago and having produced 118 million gross barrels of oil since then, it is safe to say that we know this high-quality asset extremely well, and we see significant value to be exploited going forward. The acquisition includes Sasol's 27.8% working interest in the Etame license which, combined with our prior working interest, provides us a significant majority interest in the Etame field at 58.8%. The transaction also includes a 40% nonoperated participating interest in Block DE-8 that has an existing discovery and a potential appraisal well next year that I will discuss shortly. In total, the purchase price is $44 million, subject to customary post-effective date adjustments and future contingent payments of up to $6 million. The effective date of the transaction is July 1, 2020, and we hope to close within 90 days. Cash paid at closing is expected to be less than $44 million as the amounts paid at the time will be reduced to account for the net cash flows attributable to the period from 1 July through the date of closing. As a point of reference, interim cash flows from July 1 to September 30, adjusted for Sasol's ownership interest, were about $5.5 million. Keep in mind that VAALCO's reserves, production and financial results will not include the benefit of the transaction until after the date of closing. Our other joint owners at Etame have a 30-day period to exercise their preemptive rights to acquire their proportional share of Sasol's 27.8% working interest. Lastly, the deal terms include 2 contingent payments. The first is a $5 million payment to Sasol if Brent averages more than $60 per barrel for 90 consecutive days between July 1, 2020, and June 30, 2022. There is also a $1 million payment at the DE-8 appraisal well if successful. The other exciting component of this transaction is the acquisition of the 40% nonoperated, participating interest in Block DE-8 offshore Gabon that can add meaningful optionality to our portfolio. This block straddles the Gabon shoreline in is 180 miles northwest of Etame. Perenco is the operator of the block and holds the other 60% participating interest in the exploration license. It has had some successful discoveries in the past, but those producing fields are carved out of what we are acquiring. Nonetheless, those producing fields do indicate prospectivity across the block. The near-term catalyst for DE-8 is the Akoum-B discovery and the potential appraisal well in 2021. We are looking forward to getting a better look at the data and leads on the block, but the primary focus for now is the Akoum-B appraisal well that we estimate will cost between $7 million and $9 million net to VAALCO. If the well is successful, it could be tied back to an existing production platform operated by Perenco. Similar to the Etame piece of the acquisition, Perenco could preempt the purchase of Sasol's participating interest in Block DE-8 if they so choose. This is a great addition for VAALCO as it diversifies our portfolio and adds potential near-term catalyst for us next year. In summary, we are very excited about the future for VAALCO. This acquisition is immediately accretive and nearly doubles our production and reserves while providing material additional working interest for future exploitation. We are completing the acquisition with cash on hand and cash from operations, meaning we are not diluting shareholders nor stretching the company beyond its financial means. We have consistently demonstrated our ability to grow reserves and resources at Etame and the seismic program we are undertaking will help to identify prospects for the next several drilling programs and refine relatively low-risk development opportunities that we already see on the block. We are increasing our optionality with an interest in Block DE-8 and the potential appraisal well in 2021 on the Akoum-B discovery, and we also still have future potential at Equatorial Guinea with multiple discoveries and strong leads. We are well on our way to delivering profitable growth through both acquisitions and operational execution in line with our Vision 2025 strategy. We're excited for the future and believe that we are even better positioned now to capture value and continue to profitably grow VAALCO into a leading West African E&P company. Thank you. And with that, operator, we are ready to take questions.

[Operator Instructions] The first question today comes from Garrett King of Truffle Hound.

Congratulations on the deal. I have a couple of questions. My first one is regarding the liquidity, assuming this transaction goes through, as you have illustrated. It looks like the company has the $44 million payment for the acquisition, the $5 million seismic, these are both due in the next 90 days and that they'll obviously be reduced by the cash generated by VAALCO's interest and Sasol's interest. But just working through the numbers on my end, it looks like the liquidity gets fairly tight, maybe not if crude stays at these levels or goes up, but if Brent did decline significantly, it seemed like it was tight. So can you kind of just talk through the way you think about that, if you're considering hedging any of the near-term production or if you're in any talks regarding the credit facility despite the [indiscernible] liquidity position.

We are not -- right, right. We do not have any hedges in place at the moment. So let me answer that question first. And so we're continuously evaluating the market and our cash needs. And we will hedge when we see -- when we believe the time is right. And -- but for now, we are not hedged. And so I mean, you're right, this purchase will -- or this transaction will utilize a good portion of our cash when it closes. But we are still debt-free following the closing, and we still maintain our financial flexibility. Now once the transaction closes, we expect to be generating significantly more positive free cash flow post-closing due to higher production and lower unit cost per barrel. So at current pricing of around -- oil pricing of around $45 a barrel and cash flow breakeven of less than $31 a barrel, we expect to grow our net cash position significantly.

Yes. And Garrett, let me just add to that. So for the 3-month period from July through September, we had $5.5 million worth of cash flow related to this interest. So thinking about it in terms of the closing, it's probably going to be -- we're expecting that to be around 90 days. So you've got 6 months to 8 or 9 months of cash flow that's going to come in before you have to make the payment. So that $44 million will get reduced by the cash flows during that time period, if that makes sense.

And the $5.5 million, that's just related to Sasol's interest, not VAALCO's.

Right. That's correct. And that's only for that 3-month time period. We -- like we could share with you some information based on historically what's happened because we've already released our September results. And so that -- we wanted to give you that as a frame of reference. I mean we've done our own forecasting, obviously, carefully to make sure we had plenty of cash to complete the transaction, and we feel comfortable that we can do that with cash and cash on hand.

Got it. And the company does not have a credit facility in place at the present time, correct?

We do not.

Okay. And so just in, I would say, the very unlikely sort of doomsday scenario that we have these lockdowns and Brent goes to like $20 for a month or 2. What -- I mean how do you kind of think about that? What happens in that scenario?

Well, let me -- I think both of us need to answer your question, but I'll talk about from the operational side. We will react very quickly and suspend all nonessential activities and make sure our costs are as low as possible, which is what we did earlier this year. And so that will take us through part of the way.

Yes. And I mean, as Cary mentioned, we do look at hedging periodically, and we're evaluating that in the context of our cash requirements. Because this one is so close in the near term, we're a little bit less concerned if it was something that we had to make an obligation payment, say, the middle of next year, we'd be a little more concerned about something happening and not having the cash on hand between now and then. So -- but that -- because we expect this to close so quickly, we may put some hedges in place for other things, but this one probably not.

Got it. Got it. And then just the 30-day -- this is my last question. The 30-day opportunity for the partners to acquire their pro rata share, that's just at the same price as the -- as you guys are paying now? And that potentially, if they did take up their full share -- I'm just running the numbers now, but it could be -- I could be wrong, like would that reduce your combined interest from 58% to 47% in Etame, if they did exercise that right in full?

Something -- yes, you're close. Yes. I was doing the math in my head. Yes, you're very close at 47%.

Got it. And then the Block D would -- if the partner there exercised this right in full, would they be able to buy the whole thing or only a piece?

They would take the entire 40% interest. Now -- or they have the opportunity to -- I would doubt that they would take just a part of it. But I can't speculate on what Perenco would do.

Got it. Okay. All right. And again, congratulations. I mean I think this is -- you guys have kind of laid out the plan in the presentations for a while. And so I think this is certainly in line with that.

Next question today comes from Bill Dezellem of Tieton Capital.

So congratulations. It looks like an outstanding transaction. So what additional overhead costs are going to be required if the transaction stands as is and none of your partners make any changes? You made reference to minimal overhead costs, additional overhead costs required. What are those minimal costs?

Yes. It's -- this is Liz. And it's not a whole lot. Essentially, we have a little bit of overhead that is charged to all the joint owners in connection with the transaction. And so -- I mean not the transaction, but just normal operations. And so our G&A will go up just a little bit for that, but it's not significant.

Great. And then the Block DE-8 appraisal well, I think the presentation implied that it needs to be drilled by the middle of next year. Why would that well not be drilled?

Well, it relates back to the COVID-19 issues and moving equipment and people in and out of Gabon. And so all of the operators in Gabon are considering whether -- if they had drilling plans for this year, late this year or early next year, are going back and reconsidering their plans because it is still difficult to get equipment and people in and out of Gabon.

And if as a result of COVID that well was not drilled, what are the -- what implications are there from that? And to what degree is the Gabonese government inclined to provide some grace to that situation?

To the -- so do you mean provide grace to the COVID-19 and the ability for operators to change or extend their drilling programs?

that's exactly right. If there was a, I guess, I'll call it a penalty or some negative for not drilling, is there some indication that the government would kind of give a pass and say, "Nope, we understand that you had good intentions, but couldn't actually get things done because of the pandemic, therefore, we'll extend the period." Or just trying to understand that full picture if you can lay that out, please?