ENDEAVOUR INTERNATIONAL CORP END
July 09, 2012 - 8:35am EST by
jcoviedo
2012 2013
Price: 8.44 EPS $0.82 $3.15
Shares Out. (in M): 47 P/E 10.3x 2.7x
Market Cap (in $M): 392 P/FCF 0.0x 1.0x
Net Debt (in $M): 642 EBIT 128 401
TEV ($): 1,034 TEV/EBIT 8.1x 2.6x

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  • Low multiple
  • Highly Cash Generative
  • FCF yield
  • Small Cap
  • E&P
 

Description

Disclaimer

The author of this article works for an investment advisory firm (the “Firm”) that advises hedge funds. This article does not represent a recommendation or offer to buy or sell any securities or a solicitation of any kind.  The Firm and the author make no representation as to the accuracy or completeness of the information contained herein. The Firm buys and sells securities for the hedge funds it advises. The Firm may be long or short the securities of the issuer that is the subject of this article. Neither the author nor the Firm undertakes any responsibility to update the information contained herein should its views change.

 

Thesis

Trading at under 3x 2013 EPS, under 2x 2013 EBITDA, and with a roughly 100% 2013 free cash flow yield, END is one of the cheapest E&P companies in the world. With several high impact development wells coming online over the next 6 months, as well as the closing of the remainder of its acquisition of North Sea assets from Conoco Phillips, END’s production will grow from roughly 4,200 boe per day at the end of Q1 to an exit rate of around 25,000 boe per day by year end; Endeavour is currently producing at 12,760 boe per day. This production growth will allow Endeavour to grow into its currently over levered balance sheet and exit 2013 at around 1x gross debt to EBITDA. At a more reasonable 3x 2013 EBITDA, END would trade to ~$24 per share by the end of 2013. In addition, END has significant contingent resources in the North Sea and roughly 100,000 net acres in the Heath Shale which could provide significant additional upside as these assets get derisked over the next 18 months.

 

Overview of Company

Endeavour International is a small cap energy exploration and production company focused on the North Sea. In May 2012, Endeavour completed the majority of a transformational acquisition (~7,000 boe per day) of North Sea assets from ConocoPhillips with the remaining pieces (interests in the MacCulloch and Nichol fields) of the acquisition to be completed by the end of Q3. In total the ConocoPhillips acquisition is expected to add ~ 10,000 boepd to END’s production.

 

Endeavour’s current asset base has a 1P PV-10 value of $1,288MM and a 2P PV-10 value of $2,467MM. END has 76MM barrels of 2P reserves.

 

Endeavour produced 4,174 boepd in Q1 2012. According to management comments at the recent Global Hunter conference, Endeavour is currently producing at 12,760 boepd and has a clear pathway to exit this year around 25,000 boepd of production.

 

Endeavour’s major North Sea Properties are as follows:

Bacchus

Endeavour has a 30% working interest in the Apache operated Bacchus field. In April 2012 – after months of delays-- the first of 3 Bacchus wells came online with a 5 day IP rate of 6,000 boepd – at the high end of the company’s expectations. The second Bacchus well is expected to come online in July 2012 with the third well coming online in the September/October time frame. The second well is likely to flow at a materially higher rate than the first Bacchus well.

Rochelle

Endeavour has a 44% working interest and is the operator of the Rochelle field. Rochelle is currently under development and is scheduled to have its first flow in Q4 2012. Rochelle will produce natural gas to be sold into the U.K. (and is therefore priced off of Brent.) The Rochelle project is currently scheduled to come online in Q4 2012 at roughly 7,000 boepd net to END.

Alba

Post the closing of the Alba transaction with ConocoPhillips, Endeavour has a 25.68% working interest in the Alba field which is operated by Chevron (23.37% wi) with Statoil, BP, Total and CIECO having significant working interests. The Alba field is currently producing around 30,000 boepd gross with production expect to grow towards 35,000 boepd in H2 2012.

MacCulloch

Upon closing the remaining COP assets, END will have a 40% working interest in the MacCulloch field and will become the operator of the field. ENI, Noble Energy and Talisman are the other partners in the field. Macculloch is currently producing roughly 6,000 boepd gross.

U.S. Assets

In addition to the North Sea assets, Endeavour has interests in the Marcellus, Haynesville, and Heath shales in the U.S. Given current U.S. natural gas prices, END’s 7,100 net acres in the Haynesville and 16,000 net acres in the Marcellus have minimal value. END has 94,000 net acres in the Heath Shale in Montana. Endeavour will be drilling its first horizontal wells in the Heath in Q3 and should be able to report results from the play in November.

 

Capital Structure

 

Pro Forma for its recent $61.4MM equity offering, as well as the purchase of the Alba property:

 

 

Cash                                                                                      $187.9MM

 

13% Revolving Credit Facility due 2013                                    $100MM

 

12% Senior Notes due 2018                                                    $500MM

 

11.5% Convertible bonds due 2016($16.52 Strike)                   $62.2MM

 

5.5% Convertible bonds due 2016 ($18.51 Strike)                    $135MM

 

12% Subordinated Notes due 2014                                          $32.2M

 

Total Debt                                                                             $829.4MM

 

 

Series C Convertible Preferred Stock ($8.75 Strike)                   $37MM

 

 

Shares Outstanding                                                               46.5MM

 

Fully Diluted Shares if all the converts are in the money           64.8MM

 

 

Share Price         $8.40

 

Mkt Cap              $391MM

 

EV                      $1032MM

 

 

The recent $61MM equity offering gives END sufficient on balance sheet cash to ensure it can complete the $166MM in capex it has remaining under its 2012 capex plan. Once the capex associated with the Rochelle project is finished, END will become significantly free cash flow positive (management has guided to $400MM in free cash flow in 2013.)

 

Production Growth

 

Endeavour is halfway through a transformational growth phase with the completion of the Alba acquisition from COP as well as bringing on the first Bacchus well. Endeavour tripled its production in Q2 2012 and is expected to roughly double its production from current levels by year end.

 

 

Current Production                                                                         12,760

 

+ Bacchus #2      (July)                                                                     2,000

 

+ Bacchus #3      (September)                                                          1,800

 

+ Closing Remaining COP Assets (September)                                    3,000

 

+ Rochelle                                           (December)                           7,000

 

-  Decline in current production                                                       - 1,500

 

= 2012 Year End Production Exit Rate                                            ~25,000                

 

 

Cash Flow

 

At 25,000 boepd, and assuming $100/barrel Brent Crude pricing, END should generate $500-$550MM in EBITDA and ~$400MM in free cash flow ($6.17/fully diluted share.) Operating costs on END’s Alba field are $15/barrel, on Bacchus are $8/barrel, on MacCulloch $40/barrel and on Rochelle are $8/barrel. The Alba field is subject to PRT tax which reduces its cash flow.

 

After the $200MM 2012 capex program is finished, END will only need to spend $50MM/year to maintain the current production rate for 3 years before entering into a gradual natural decline. Cash Interest expense is roughly $90MM.

 

Endeavour has $356MM of NOLs in the United Kingdom which will shield the 2013 cash flow from taxes. END generates additional NOLs from the development capex of Bacchus and Rochelle which should shield 2014 cash flows from UK taxes. END would become a cash tax payer in the U.K. starting in 2015.

 

 

2013 EBITDA                       $540MM

 

- Capex                                 $50MM

 

- Interest                             $90MM

 

= Free Cash Flow              $400MM

 

Management has indicated its preferred use for free cash flow will be debt pay down over the next 18 months. The 2013 revolver is the first piece of debt that will be paid down. After that, END is likely to start repurchasing the 12% Senior Notes. Citibank owns $200MM (due to guarantees it made when syndicating the bond issue) of the 12% bonds and would be more than happy to sell these back to company. Paying down the $100MM revolver reduces interest expense by $13MM and improves EPS by $0.13/share. Paying down $200MM of the 12% bonds would further reduce interest expense by $24MM and improve EPS by $0.24/share.

 

Note: The credit market has started to pick up on the significant improvement in END’s production and cash flow profile. While END’s equity has been essentially flat since early May, END’s 12% bonds have seen their yields fall 200bps over the same time period to 10%.

 

Value in 2013

 

3x 2013E EBITDA of $540MM, would imply an entreprise value $1,620MM. END will generate $400MM in Free cash between now and the end of 2013 which would reduce net debt to $241.5MM. At this enterprise value, the converts would all be in the money so taking the converts out of net debt (reduces net debt to $44MM) and fully diluting the share count (64.8MM shares) implies a share price of $24/share. Any value from END’s Heath Shale or contingent North Sea resources would be upside to this number.

 

Management Ownership

 

Management and the board collectively own 3.45MM shares of stock and were repurchasing shares at levels similar to the current share price in November 2011. Since that time, the company announced and closed part of the Conoco Philips transaction as well as brought on the first Bacchus well at a rate at the high end of expectations.

 

Additional Sources of Value

 

North Sea Contingent Resources

 

In addition to its producing North Sea assets and its 2P reserves, Endeavour has 150MM barrels of contingent resources in the North Sea. On June 13th, Cairn Energy made a 414MM pound ($642MM) offer for Nautical Petroleum (NPE LN), a company whose principal asset was 93.9MM barrels of contingent resources in the U.K. North sea adjacent to END’s fields implying a value of $6.83/contingent barrel in the ground. Applying a $6/contingent barrel multiple to END’s contingent reserves would imply a value of $900MM ($13.88/share) for END’s contingent resources in the North Sea.

 

Heath Shale

 

END controls 94,000 net acres in the Heath shale in Montana. The Heath has not yet been proven to be economic and therefore the street ascribes little to no value today for END’s acreage. That said recent well results from other operators have been encouraging. Cirque Resources – a private company operating in the Heath – has completed 2 wells. The Rock Happy 33-3H well tested 271 boepd and the Hit Parade well tested 90 boepd. MDU Resources’ Fidelity Exploration and Production drilled and completed the Schmidt 44-27H well with a test rate of 248 boepd.  Well costs are $3-$4MM. Assuming 160 acre spacing and EURs of 250,000 barrels per well would imply roughly 125 million recoverable barrels net to END. At a value of $2-$4/barrel in the ground the Heath alone would be worth $250-$500MM or $3.85 to $7.70/share. Cirque and other offset operators are expected to release additional well results and further derisk the play in the August/September time frame. Endeavour will start drilling its first Heath wells in Q3 with results expected to be released in November.

 

Catalysts

 

1.      Completion of the remaining asset purchases from COP. Adds ~ 3,000 boepd of production. Expected to be close by end of Q3.

 

2.      Bacchus well #2 expected in July. Should be north of 2,000 boepd net to END. Bacchus #3 expected in September/October. Should be around 2,000 boepd net to END.

 

3.      Turning on the Rochelle field in Q4 2012. Adds 7,000 boepd

 

4.      Offset operator well results in the Heath Shale. Expected in August/September. Endeavour well results in the Heath Shale expected in November.

 

5.      EPS accretion from paying down high cost debt. Moreover the higher EBITDA in 2013 should give END the opportunity to refinance its very high cost balance sheet into something much more reasonable. A 300bps+ reduction to the company’s cost of debt seems reasonable once the company has successfully achieved 20,000+ boepd of production.

 

6.     Potential additional acquisitions of working interests in END’s existing North Sea fields. Statoil, Total and BP are all potentially looking to sell their interests in Alba. END purchased the COP assets at 1x EBITDA.

 

Risks

 

Declines in Brent Oil Prices. Pro forma for Rochelle coming online, 57% of END’s production will come from oil that receives Brent pricing. That said, END hedges 75% of its production with either financial hedges or with a physical agreement with Shell.

 

Decoupling of U.K. natural gas prices from Brent Crude prices due to increased LNG supplies, overdevelopment of shale resources within Europe, changes in European natural gas supply/demand dynamics, et cetera could impair the margins on the Rochelle project.

 

Further Project Delays. END has a history of taking longer than expected to bring projects into production or to close acquisitions. That said, END did close the first tranche of the COP deal in spite of delays and did eventually bring Bacchus online after 6 months of delays.               

Catalyst

1.      Completion of the remaining asset purchases from COP. Adds ~ 3,000 boepd of production. Expected to be close by end of Q3.

 

2.      Bacchus well #2 expected in July. Should be north of 2,000 boepd net to END. Bacchus #3 expected in September/October. Should be around 2,000 boepd net to END.

 

3.      Turning on the Rochelle field in Q4 2012. Adds 7,000 boepd

 

4.      Offset operator well results in the Heath Shale. Expected in August/September. Endeavour well results in the Heath Shale expected in November.

 

5.      EPS accretion from paying down high cost debt. Moreover the higher EBITDA in 2013 should give END the opportunity to refinance its very high cost balance sheet into something much more reasonable. A 300bps+ reduction to the company’s cost of debt seems reasonable once the company has successfully achieved 20,000+ boepd of production.

 

6.     Potential additional acquisitions of working interests in END’s existing North Sea fields. Statoil, Total and BP are all potentially looking to sell their interests in Alba. END purchased the COP assets at 1x EBITDA.

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