Apache (NR): GOM acquisition highlights disciplined, returns focused management - Goldman Sachs - April 19, 2006
We view favorably Apache's pending $1.3 billion acquisition of properties from BP in the Gulf of Mexico, given our view that the company is likely to generate very attractive rates of return on the deal even if commodity prices unexpectedly decline. We believe Apache is pursuing a strategy that will serve its shareholders well over the long run by sticking to its knitting of building a diversified E&P asset base and not succumbing to short-term Street pressure to divest Gulf of Mexico production. Most importantly, we think Apache is investing its capital in an asset in which it is capable of generating a very attractive rate of return. We think this returns focus will ultimately overwhelm the short-term Street disenchantment with even well-run Gulf of Mexico-exposed companies. We also view favorably the implementation of a 15 million share stock buyback program. Apache is Not Rated. (Goldman Sachs & Co., and or one of its affiliates, is acting as financial advisor to Apache Corp in the proposed acquisition of BP's producing properties on the Outer Continental Shelf of the Gulf of Mexico. Goldman Sachs & Co., and or one of its affiliates will receive a fee for its financial advisor role.)
APACHE BUCKING THE STREET CONSENSUS BY ADDING TO GULF OF MEXICO POSITION, A GOOD MOVE IN OUR VIEW
Over the past 12-24 months investors have been most attracted to the so-called "resource" companies focused on unconventional gas onshore North America, with Gulf of Mexico-exposed companies particularly out of favor. Like others on the Street, we have a very favorable view of many of the onshore resource companies. We have also have supported the divestiture of Gulf of Mexico assets by companies like Forest Oil, which is one of our favorite small-cap E&Ps.
However, we do not view unfavorably all Gulf of Mexico-exposed companies. Long-term successful players like Apache and Newfield Exploration we do not think should necessarily divest Gulf assets simply because it is currently out of favor with most of the Street. The ability to generate attractive rates of return and significant free cash flow we think is a major positive of the Gulf of Mexico. The key is to take what the Gulf gives and not over-invest in an attempt to maintain production volumes if the asset base no longer yields economically attractive opportunities. It is the Street's obsession with volume growth over return metrics and free cash flow that at times creates the excessive valuation discount seen in well-run Gulf of Mexico-exposed companies as we think is the case today.
BP ACQUISITION EXPECTED TO GENERATE FAVORABLE RETURNS AND TO BE ACCRETIVE TO EPS
We estimate Apache will generate an internal rate of return of 19% on the BP acquisition assuming commodity futures strip pricing. If starting in year three we instead reverted WTI spot oil and Henry Hub spot natural gas prices to $45/bbl and $6.50/MMBtu, respectively, we estimate the acquisition IRR would be a still healthy 12% or so (inclusive of hedges Apache has taken out for the transaction).
Using our base-case commodity price deck of $66/$8 and $68/$9 for oil/gas in 2006/2007 and assuming the deal closes in the second quarter of 2006, the transaction has caused us to raise our 2006 EPS estimate by $0.45 to $10.12 ($9.67 before) and our 2007 EPS forecast by $0.83 to $11.28 ($10.45 before). Note, we have modeled in 100% of the purchase price at this time, though it is possible that the exercise of preferential rights by other owners of the fields could reduce the amount Apache ultimately ends up purchasing.
The apparent accretiveness of the transaction is indicative of what we believe may become two increasingly intersecting trends: a large number of companies with unlevered balance sheets (and therefore the ability to do cash-only acquisitions at money market-type marginal costs-of-capital) combined with a persistent disparity between equity and asset valuations and their intrinsic values implied by the commodities futures markets. We believe if these trends continue, as appears likely, increased M&A activity is likely.
APACHE SHARES HAVE LAGGED E&P SECTOR AND TRADE AT A VERY INEXPENSIVE VALUATION
Apache shares have badly lagged its large-cap E&P peers year-to-date and in 2005. We attribute the lagging performance to the Street's preference for onshore-focused "resource" companies and concern over hurricane-impacted, Gulf of Mexico-exposed E&Ps. The fact that the shares reacted positively on April 19 rising 5% (peers up around 1.5%) following the announcement of the deal we think is an interesting reaction and could signal investor pessimism was overdone and could be reversing. Apache currently trades at 3.9X 2007 EV/DACF, which is at a 27% discount to the 5.4X large-cap E&P average. Historically, Apache has shown an ability to trade at parity with its peers. We are currently Not Rated on its shares.
UPDATING ESTIMATES
We are updating our quarterly 2006 and full-year 2006-2010 EPS estimates to reflect the impact of the BP acquisition. For 2QE, 3QE, and 4QE 2006, we now estimate EPS of $2.25, $2.65, and $2.88 respectively versus $2.19, $2.43, and $2.69 before. Our full-year 2006 EPS estimate is now $10.12 ($9.67 before) and our 2007 EPS estimate is now $11.28 ($10.45 before). Our 2008-2010 (normalized) EPS estimates are now respectively $5.14, $5.37, and $5.65, up from our previous estimates of $5.00 for 2008, $5.35 for 2009, and $5.61 for 2010.
I, Arjun Murti, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
