Civitas Resources, Inc. (NYSE:CIVI) announced an acquisition and a note offering to help finance that acquisition. That acquisition is actually more than one transaction that management labels “Hibernia” and “Tap Rock.” The company intends to use some stock as part of the payment to help keep the debt ratio low. For Civitas, which has a fair amount of acreage near or in Colorado urban areas, the diversification into perceived industry-supportive Texas is a needed diversification that will probably help value the stock higher.
Colorado has not yet come to terms with the industry when urban areas expand into former or existing oil and gas industry operations. Other states like California do have a successful operating model in this area. But the fast growth of Colorado has only recently brought this issue to the forefront for discussion. So, it is likely to take some time for everyone to settle down so that cool heads can prevail long enough to provide a permanent solution.
Mr. Market does not like uncertainty. Therefore, it is likely that the urban exposure will cause a discounted valuation. The proposed acquisition will likely nearly double the size of the company. Therefore, the materiality of the urban area situation in Colorado will decline because Texas really has no such issues for the properties involved.
Permian Basin Diversification
The diversification into the Permian Basin makes issues in Colorado less significant and can, therefore, over time result in a better enterprise valuation. The risk, of course, is the lack of company history in the Permian. So, management will have to show that they can run the Permian properties as well as any neighboring operator (or better).
The other thing is that this diversification is relatively large compared to the company size and, in fact, relatively large period. Larger acquisitions tend to be riskier than smaller acquisitions, as whatever happens next is more material.
Oil and gas companies themselves trade for historically low valuations. So, a lot of these purchases are likewise for low valuations in order for management to claim that a combination of stock and debt results in an accretive transaction.
A lot of the selling funds got into these positions during better times. Though some of them did snap up bargains during 2020 when prices were highly distressed. Nonetheless, it is interesting to see sellers are “at” roughly 3 times EBITDA (with an assumption of $70 WTI). This is something that before fiscal year 2020 (with the coronavirus challenges) probably would not have even occurred to sellers.
To me, it seems that a lot of speculative money (that thought it would be easy to make a killing) is now leaving the industry. The industry itself is, of course, happy to purchase accretive bargains.
Another risk here is that the New Mexico acreage is likely to have a presence on government land. When positions in the federal government were going vacant, then permit applications (processing) was delayed or even stopped. That is often enough in any industry to cause people to leave fast.
That problem has since been resolved in the current administration. Several companies I follow that need federal permits like Earthstone Energy (ESTE) now state (time and again) that they have years of permits in hand. So, the permitting issue is now in the past. Nonetheless, the issue needs to fade from the market evaluation and that will take time. Until it does, it may affect property and possibly enterprise values.
But then again, the time to buy prime acreage (and this is some of the best Permian acreage) is when it is out of favor. So, like Earthstone Energy management, this management sees darn good acreage “with a cloud over it” that provides a chance to get the acreage cheaper than one would expect and now needs a government that is fully staffed to do the normal processing things for this to work out. On paper, this looks like a no-brainer. However, with politics nothing ever goes the way it should (it seems). Therefore, time will tell how this works out.
The company management made a proposal to keep leverage around 1.0. Now, of course, the market will want that leverage to decline so that the 1.0 number can be maintained with considerably more conservative assumptions. That is likely to happen because this acreage is known to cash flow well.
One of the signs of a bargain is the $1.5 million per undeveloped location. Previously, that ran as high as $3 million when things were really “hot.”
Many times, that $1.5 million is not in the presentation made to shareholders about well breakeven points. The management excuse is that the $1.5 million does not factor into the “drill or not drill” decision. That happens to be true. But it does affect corporate profitability because that amount has to be recovered like any other expenditure for production.
Furthermore, since that location cost is land. It does not depreciate. So, the only place that shareholders see this is the overall corporate profitability. That makes it hard for shareholders to discern what is going on.
One of the things that may help is the authorized buyback. Any large issuance of stock, as in for the current deal, often ushers in a period of stock price weakness. An authorized buyback would help to provide a downside “floor” to the price while giving the company a chance to repurchase shares just issued at a discount to the price used for the deal. In some ways, that makes the announced deal cheaper and of course would help corporate profitability.
This acquisition appears to be a good idea for Civitas Resources, Inc., as it gives the company some basin diversification into an area that is generally supportive of oil and gas. The company becomes less dependent upon the Colorado issues that have been in the headlines which should result in an overall better enterprise valuation.
This acreage has gone for a lot more money than is the case in the current environment. So, this is a chance to purchase something that will likely increase in value as the issues of the past few years fade away. But it is not an overnight solution.
This is a large acquisition that tends to be riskier than smaller acquisitions. Management will likely minimize the risk by keeping the personnel operating this acreage and hopefully successfully assimilating them into the corporation. High turnover is always a risk after a large acquisition like this.
The debt levels are satisfactory for the current environment. But the debt market and Mr. Market are likely to want those same debt ratios using considerably more conservative commodity prices. That is an easy goal as this acreage is known to cash flow generously.
Overall, Civitas is probably a buy consideration as part of a basket of similar stocks because this industry is very low visibility and “things happen.” Therefore, diversification is essential to survive unforeseen events.
A track record of the “new” Civitas will be essential to higher market valuations. But that does not seem to take extraordinary measures on the part of management.