April 08, 2013 - 2:24pm EST by
2013 2014
Price: 64.50 EPS $0.00 $0.00
Shares Out. (in M): 225 P/E 0.0x 0.0x
Market Cap (in $M): 14,500 P/FCF 0.0x 0.0x
Net Debt (in $M): 800 EBIT 0 0
TEV (in $M): 15,300 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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  • Oil and Gas
  • Energy
  • Pair trade


This is a pair trade idea - Long SWN, short COG. Given the market frothiness and the bearish sentiment on VIC (I can't remember a time when the VIC "bargain meter" looked less promising), it seemed like time to share a large, liquid way to potentially extract alpha out of an obvious valuation discrepancy, likely driven by momentum trading in a relatively easy to value, large company, with readily available borrow.
The idea is simple - COG has a higher Enterprise Value and Market Cap than SWN. This is remarkable because they are such similar companies (both produce almost 100% natural gas) SWN produces almost twice what COG produces, and SWN has a material acreage position in the same county as COG in the Marcellus (Susquehanna) where COG has been getting monster natural gas well results, which has been part of what has driven COG's stock up so high. This translates to EBITDA - on a trailing basis, SWN generated $1.65 billion of EBITDA while COG generated $700 million in EBITDA. So COG would have to more than DOUBLE EBTIDA just to get to SWN's current trailing EBITDA level.
One mitigating factor to this cheapness - COG is growing by ~40% while SWN is growing by 15%. Obviously if this continued indefinitely, COG would be way cheaper than SWN. But a) I don't like to bet on perpetual growth b) the law of large numbers makes that kind of growth unlikely and inherently unsustainable and c) COG's growth is driven by drilling high decline rate gas wells - at some point the cascading declines of its production base will make growth beyond 15% per year (and even growing 15% per year) tremendously challenging without dramatically outspending cash flow, which becomes less acceptable as a company gets bigger.
This is really all you need to know about these two companies and this trade (although I will provide more detail below). I did a similar trade in 2010/2011 where I went long COG short EXCO - both companies had approxmiately the same enterprise value despite COG having clearly higher value assets and more production but slower growth. EXCO in that case was expensive because there was a (subsequently failed) attempt at buying it out, rather than being expensive because of stock momentum driven by headline high well results like COG is today, but it still worked out quite well.
SWN is one of the lowest cost natural gas producers, and COG is also low cost and its costs should continue to fall as it hits monster wells in the Marcellus. But it is quite difficult to step down the cost curve much further, due to infrastructure issues and the fact that often headline wells aren't representative of average wells.
One obvious point worth mentioning - natural gas prices have risen a lot recently, and Goldman seems to think they're going to $4.50-$5. If that happens, both SWN and COG will experience higher than expected cash flows, but there will be a greater impact on SWN because of its higher quantity of production and substantially lower valuation.
Also, SWN has much greater capability to ramp gas production, as its Fayetteville core field has substantial additional production capacity (lots of locations and unused pipeline capacity) vs COG's Marcellus which is currently growing at its maximum possible levels due to infrastructure constraints.
And one last thing, SWN has a gathering system asset that is generating over $500mm in EBITDA. It could spin that out or sell it to an MLP for at least 10x, or $5 Billion. Versus a $14 billion EV, this creates SWN at a ridiculously big discount to COG, and could be done in the next 12-24 months, particularly as activism in the energy space increases and boards anticipate potential activism (SWN is not a highly likely candidate, but its possible, and I would argue all mid-cap E&P boards are under stress after CHK, SD, HES and others).
These are both $14-15 billion companies, there is substantial sell side coverage. I haven't dug into the assets in detail, nor many other aspects of these investments, due to substantial existing coverage. I've focused on the points most central to this pair trade, which hopefully is more productive and a better use of VIC member's time than seeing me try to estimate cash flow, margins, basis differentials, etc.
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.


Reversion to comparable valuation levels. Higher natural gas prices. Equity market slowdown (will disproportionately affect momentum driven COG). Potential divestiture of gathering system (or perhaps divestiture of minority ownership of the system, bringing in ~$2 billion).
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