|Shares Out. (in M):||70||P/E||0||0|
|Market Cap (in $M):||1,043||P/FCF||0||0|
|Net Debt (in $M):||20||EBIT||0||0|
|Borrow Cost:||General Collateral|
Riviera Resources (RVRA) is the spinoff of the midstream and non core upstream businesses of post bankruptcy Linn Energy. Its midstream system being built in Grady County, Blue Mountain Energy, is ramping up and is expected to generate $110-125 million of annual EBITDA when full. And producing oil and gas assets have a pv-10 of about $1 billion, close to the current enterprise value of just over $1 billion.
There are a few problems that may blow a hole in this long thesis and have not yet been priced into the stock:
1) Roan production guide down
Roan Resources, the upstream spinoff from Linn Energy that has committed its land to Blue Mountain's gathering and processing system, caused a magnitude 3.4 earthquake in Grady County, in the core of its Merge shale play. It was forced to stop mid-frac, a first for Oklahoma. Roan is publicly traded, and its is down more than 50% since the spinoff, in part due to lower than expected production growth.
As the gatherer and processor of Roan's oil and gas, Blue Mountain - Riviera is tied to Roan production. If Roan produces less, Blue Mountain's gathering and processing services are less necessary. And with a lower growth rate, Blue Mountain would garner a lower EBITDA multiple in the public market and in the transaction market.
It is intriguing that as Roan's midstream provider, with Roan stock down from $20 to $8 since the spinoff, Riviera is only down from $20 to $15. Midstream stock prices have lagged upstream stock prices in the oil and gas downturn starting in 2014, but eventually they do catch up, as the businesses are fundamentally linked. With the midstream plant only half full and over $130 million of debt, significant further growth may be necessary to simply fill the first plant. And Roan's guidance for 2019 is only 10% growth from the fourth quarter of 2018, leaving the plant still slightly more than half full and likely at well under half of the projected ebitda from the plant being full. Riviera estimates "plant margin" of $8-12 million a quarter for Q4 2018, well under the $110-125 million of ebitda hoped for in the bull case.
2) Disappointments elsewhere
Riviera's two other flagship upstream assets are located near prominent publicly traded blow-ups. Its NW Stack asset is intermingled with and adjacent to Alta Mesa (AMR), which is down more than 90% since inception a year ago. And its cotton valley asset is adjacent to Terryville, which was a high profile purchase and subsequent write-down by Range Resources (RRC). Perhaps Riviera has succeeded where Alta Mesa and Range have failed, but more likely, these were heavily touted assets and Riviera is late to the revised lower expectation "game".
3) Tender offer executed at above current market price
Riviera, like other post bankruptcy E&P re-orgs, has "returned capital" to investors through share repurchases. In particular, Riviera did a tender offer at $22 a share in 2018, buying more than $145 million of stock at that price. This may have propped up the share price, as Riviera shares have outperformed other similar sized upstream and midstream stocks, including companies with adjacent or economically linked assets such as Range, Alta Mesa and Roan. While it is hard to criticize buybacks, many of the area asset underperformance issues were likely known at the time of the tender offer, and so a lower price could have been used to buy those shares if that was indeed the best use of capital.
What is Riviera worth today?
Upstream: With many higher growth E&Ps trading at 4x EBTIDA and at a discount to PV-10, a 4x multiple might be generous for a low growth, low decline non core gassy asset base. Using Rivira guided 2018 EBITDA of $93 million, that would yield $372 million. Bulls may argue that Riviera and its predecessor Linn have executed asset sales at the PV-10 value. However, a reasonable counter is that the low hanging fruit has been picked, and that incremental asset sales may yield lower proceeds than prior sales, particularly considering disappointing results in the NW Stack, Terryville and elsewhere.
Midstream: with Roan growth slowing and the production mix shifting slightly to oil, operating margin is working against the midstream business, and it has already levered up to fund construction. A half-full cryo plant with a challenged upstream partner is hard to value. But ascribing a 10x multiple on $40 million of annualized Q4 2018 cash flow yields $400 million. Net of projected $130 million of asset level debt leaves $270 million of equity value.
This sums to $642 million, or just over half of Riviera's current enterprise value. This calls into question the $22 / share tender offer, which valued Riviera at more than 2x its current sum of the parts value. That cash could have been used to fund the midstream with cash instead of debt, leaving more flexibility in the lower growth, half-full current environment.
Risks to the short thesis?
Riviera could attract 3rd party volumes to its midstream business. However, that has not been achieved to date, and discounting to grow volumes could impair the upside value of the midstream. Riviera also recently signed a water handling agreement with Roan. Water handling will require $60 million of capital expenditure to get up to $18 to $20 million of annual ebitda in 2020. With production disappointments and limitied visibility into the maintenance capital and other requirements for the water handling business, it could be hyped in the market but is probably unlikely to move the needle on Riviera's valuation.
Riviera produces mostly natural gas. While natural gas is broadly understood to be over supplied in North America, there is a risk of a cold winter, more LNG demand than expected, slowdown in associated gas production, or other possibilities that attract investors to businesses such as Antero, Range Resources, and others. This risk can be mitigated through a long position in an undervalued gas producer or basket of producers.
Riviera also has a dispersed asset base with drilling activity near multiple non core acreage blocks. There is a risk that there could be adjacent oil discoveries or improvements in well economics that could increase the value of that land block. It would have to be a big find to move the needle for Riviera's valuation.
Earthquake risk. Disappointing ramp up of midstream and absence of high value asset sales