Callon is obviously not done acquiring assets. The company's high-multiple stock equips it with a formidable currency to pursue additional acquisitions which can effectively "anti-dilute" the NAV… The company has grown through acquisition so far and, given where its stock price currently is, has little choice but to continue to do the same, in my opinion.
Additional equity-funded acquisitions make tremendous sense and should be expected.
While such acquisitions are likely to result in more reasonable trading multiples while equity financing may provide funds for accelerating cash flows via drillbit, the valuation bar is set high.
The prediction was on target. Callon (NYSE:CPE) did not wait long to announce another aggressively-priced acquisition funded with equity. Based on my estimate, Callon is paying ~$45,000 per undeveloped acre to expand its position in Howard County, Texas.
Moreover, my view remains unchanged: Callon's current stock valuation leaves the company no choice but to continue to acquire. In the absence of a meaningful improvement in oil price, the stock may become vulnerable if rapid growth via acreage consolidation and equity capital raising runs out of steam. Therefore, I expect the company to do everything possible to sustain the acquisition marathon for some time.
Valuation
Callon is paying $327 million in cash for 5,667 net acres, primarily located in Howard County, Texas. In addition, Callon is receiving overriding royalty interests in three 480-acre units offsetting the acreage, one of which is operated by Callon.
Current net production from the properties is ~2,300 Boe/d, of which 86% is oil, from 9 gross horizontal and 16 gross vertical wells. Assuming 82% working interest and attributing 20% of production volumes to vertical wells, average gross production per horizontal well appears to be ~250 Boe/d currently.
Callon estimates net proved reserves associated with the properties at 12.2 million barrels of oil equivalent, of which 87% is oil. The estimate is unaudited and is as of September 1, 2016.
Based on these data points, I estimate the fair market value of existing production in the $60 million range. I use an "illustrative guestimate" of $10,000 per acre for the overriding royalty interests covering 1,440 gross acres (the valuation is impossible, given the lack of detail, but, judging by the scarcity of disclosure, is probably immaterial to the transaction).
Based on the above assumptions, the implied acreage valuation in this transaction is ~$45,000 per undeveloped acre, which is significantly higher than what Callon paid in its previous acquisition in Howard County.
Callon believes it has 112 net horizontal drilling locations in the Wolfcamp A, Lower Spraberry and Wolfcamp B zones on the acquired acreage. Assuming average lateral length of 7,500 feet, this estimate appears to imply 8 wells per zone on average in full development mode. Assuming 90% of the price paid is attributable to this identified inventory, the implied price paid per location is ~$2 million.
This is noticeably higher than what other operators paid recently. The demonstrated strong well productivity in Wolfcamp A in the immediate vicinity of the acquired acreage justifies the premium paid for at least a portion of this inventory. However, the high effective price being paid for the less proven Wolfcamp B and Lower Spraberry potential appears to be a riskier bet.
The Seller
Callon is acquiring the assets from Plymouth Petroleum, operated by affiliates of Element Petroleum. Both entities are indirectly owned by ArcLight Capital Partners, LLC (and management).
This is another example of a transaction where a publicly traded acquirer with a stock trading at premium multiples is acquiring acreage from a private equity firm that is happy to exit at the current price levels for undeveloped acreage.
Equity Funding Is A "Staple"
Immediately following the acquisition announcement, Callon sold ~30 million shares of common stock (assuming the green shoe is exercised in full), raising ~$437 million in gross proceeds. Of note, the amount raised significantly exceeds the amount paid for the undeveloped acreage.
The large equity raise may reflect the company's view of the stock's valuation as highly favorable. It may also indicate that additional acquisitions will follow soon.
A Sweet Spot Acquisition
The high price paid by Callon appears to be driven by an expectation that the acquired acreage is located in the sweet spot of the Wolfcamp A zone. Most of the acreage is immediately adjacent to Callon's Silver City A #1H well, the company's first operated completion in the WildHorse area. This Wolfcamp A well is notable for its outstanding performance.
The well has attained a 30-day average peak rate of 2,123 Boe/d (90% oil), or 288 Boe/d per completed lateral foot, and cumulatively produced over 110,000 Boe (90% oil) over the initial 60 days since the date of first production. The well has a lateral length of 7,363 feet and is located within five miles of over 75% of the pending acquisition acreage.
Callon's Silver City well confirms the success of two Wolfcamp A wells, the Adams 4231WA and Adams 4201WA, previously drilled by Occidental Petroleum (NYSE:OXY) on the offsetting lease.
I should also note that the Silver City well is the strongest well result so far in this area and may not represent average well performance.
In Conclusion…
While the strong well results in the Wolfcamp A in the immediate vicinity of the acquired acreage are truly impressive, the average price per location being paid by Callon is quite high and will make a big dent in the fully-burdened drilling returns. It is debatable if a compelling return can be earned on this investment without oil price providing support at some point.
However, the acquisition has its logic. Being financed with equity, it is in fact accretive on an "acreage basis." The valuation per core acre implied by the current stock price is reduced, albeit moderately, on a pro forma basis. New shareholders, however, are paying a high price to fund the acquisition and "anti-dilute" the company's existing net asset value with cash. I illustrated this financial mechanism in detail in "The Permian Basin: Acquisition Fever And The 'Evergreen Stock Rally' Conundrum."
From an operating perspective, the acquisition represents a perfect fit for Callon, being a meaningful step toward the much needed operating critical mass in Howard County. The acquisition creates opportunities for additional bolt-on consolidation that will hopefully come at a lower cost per acre.
As I have argued before, acquisitions will remain the most important theme for Callon in the near term. I would expect additional significant acreage acquisitions by Callon, again financed with equity.
