RBC Take on deal. Read between the lines. ;-) RBC's view on Newfield
ECA had been studying the Anadarko basin/STACK/SCOOP play for about 5 years and what they have over NewField is strong technical know how as they have demonstrated in the other basins that they operate in. As such, one needs to look at the upside potential that RBC sees for Newfield to appreciate the attraction to ECA. i would expect that the deployment of ECA's Cube development Technology in this basin will quickly acheive the results they are looking for. JMO
November 2, 2018
Newfield Exploration Company
Throwing in the Towel; Downgrading to Sector
Perform
Our view:
NFX's sale to ECA appears to us to be a tacit admission that there is no obvious path to unlocking the undeveloped upside in the Anadarko Basin other than a sale. While we think the deal undervalues NFX's assets,shareholders will be able to participate in the upside through ECA, and hopefully Canadian investors will appreciate the STACK more than US investors have.
Key points:
Encana to acquire NFX. NFX has agreed to be acquired by Encana (TSE, NYSE: ECA, covered by RBC Dominion Securities Inc. analyst Greg Pardy) in an all-stock deal for 2.6719 shares of ECA per NFX share. Based on Oct. 31 closing prices, this equates to $27.36 per NFX share, representing a 35%
premium, although the current deal price is only around a 19% premium. The deal is expected to close in 1Q19, and NFX shareholders will own around 36.5% of the combined company.
Valuation looks modest relative to our NAV. The deal valued NFX at roughly 4.9x/4.1x consensus 2018E/2019E EBITDAX. We think the underlying production base is worth $4.5–5.0 billion, so the deal implies a reasonable valuation of ~$10,000 per Anadarko acre, assuming zero undeveloped credit for the Arkoma, Bakken, or Uinta. The initial implied
deal price of $27.36/sh is also 28% below our NAV (at strip pricing) of $38/sh. However, NFX has never traded particularly close to our NAV, so we do not find a takeout well below our NAV to be surprising. Limited opportunity to sweeten the pot.
The set of larger operators in the Anadarko is relatively limited and includes CLR, DVN, and MRO. However, we do not see any of these names as having a strong desire to grow in the basin, so we do not see a competing bid. While we think some
shareholders may push for a higher exchange ratio, we also think there is significant fatigue in the NFX holder base and see only a small chance of a sweetener. Making a few tweaks to 2018 guide. NFX reported an overall solid 3Q18
operational result, but once again the beat was entirely due to natural gas/ NGL outperformance. This was also the primary driver of NFX's increasein 4Q18 domestic production guidance to 185–200 Mboe/d (from 185– 195 Mboe/d). NFX also bumped its FY18 budget by $50 million to $1.4 billion due to further activity acceleration in the Anadarko Basin and the
continuation of a one-rig program in the Uinta through YE18.
Downgrading to Sector Perform from Outperform and reducing price target to $24 from $38. We downgrade NFX to Sector Perform, as we see limited potential for a superior offer and expect NFX to trade in line with the conversion valuation until closing. Based on the exchange ratio as well
as ECA's current trading price of $8.96, we reduce our price target to $24.
Disseminated: Nov 2, 2018 00:45ET; Produced: Nov 1, 2018 19:44ET
Target price/base case Our 12-month price target of $24 is based on the current implied price for the ECA acquisition.
Upside scenario
Our upside case for NFX assumes the ECA merger ultimately
does not occur. We give the company more acreage credit and
higher EURs in the SCOOP/STACK and Uinta Basin. We assume
NFX is able to exploit a higher percent of the Meramec interval in the STACK. We also give NFX credit for further well cost improvements in both the SCOOP and STACK. This gives us an upside NAV of $61 per share at $80 WTI and $3.00 gas. Ourupside price is $54.Downside scenario
Downside scenario Our downside case for NFX assumes the ECA merger ultimately does not occur. We assume the SCOOP acreage is less oily than expected and has fewer locations, and we give less credit for STACK. We further assume no credit for the company's new plays in the Uinta Basin. At a lower commodity deck of $60 WTI and $2.50 Henry Hub gas, we get a downside NAV of $26 per share. Our downside price is $21.
RBC's view on ECA
Newfield -Giving (Some) Benefit of the Doubt Encana Corporation’s announced $7.7 billion (including net -debt) friendly acquisition of Newfield Exploration (covered by RBC Capital Markets, LLC analyst Brad Heffern) receives passing grades when it comes to cost and financial impact, but its strategic fit — a big driver of valuation multiples — is an open question at this juncture. The company plans to raise its dividend by 25% (to an annualized rate of $0.075 per share) and expand share buybacks to $1.5 billion, following closing of the transaction. We maintain our Outperform recommendation but reduce our one year price target by 13% ($2) to $14 per share. Encana’s all- stock offer for Newfield equated to $27.36 per share (35% premium). Under the merger agreement, Newfield shareholders will receive 2.6719 Encana common shares for each share of Newfield. Encana shareholders will own approximately 63.5% of the combined
company, with Newfield shareholders at circa 36.5% The transaction has been unanimously approved by the Boards of Directors of both companies and is expected to close in the first quarter of 2019. The deal is subject to the approval of a majority of votes cast by Encana shareholders and two- thirds of Newfield shareholders. Institutional investors have embraced Encana’s organically driven 5 - year growth plan and emerging free cash flow generation. Equally so, dilutive threats to this plan — whether they be via capital efficiency erosion or the prospect of anon -core acquisition— have been recurrent concerns amongst the institutional investors
we speak with regularly. Giving up more than one- third of Encana in exchange for exposure to the STACK/SCOOP rang a bell the market didn’t want to hear. Encana’s motivation to acquire Newfield revolves around its circa 360,000 net acres of land in
the STACK/SCOOP play in the Anadarko Basin. The STACK/SCOOP supported
about 144,000 boe/d (60% oil & liquids) in the third quarter. Encana indicated on its conference call that it has studied the STACK/SCOOP over the last five years and considers it ripe for development via its multi-pad cube approach.The company is enamored with the play’s over-pressured reservoir, and 2–4 target benches, supportive of high rate wells, and an estimated 6,000 drilling locations. This rationale has merit, in our view, given Encana’s technical and operational track record. Based on RBC analyst Brad Heffern’s observations, Newfield has beat - and - raised” often
when it comes to natural gas & ngls. The company has met the STACK’s oil rates, but the secuts were typically diluted by higher ngls and gas. Brad models the Anadarko Basin oil- only F&D costs at circa $20/bbl. While this optically appears to be inferior to Permian oil- only F&D costs of about $12/bbl, he notes that Anadarko Basin operating costs are far lower than the Permian at $2/bbl (Permian is $4–
7/bbl,depending on the operator and sub-basin). Proximity to Cushing generally leads to better crude pricing as well. As a result, the economics associated with the Anadarko Basin are generally closer to the Permian than most people might think.
Newfield’s portfolio is somewhat spread out. The STACK/SCOOP accounts for about 70%(144,000 boe/d) of Newfield’s production of 199,000 boe/d, with 11% (21,000 boe/d, 86% liquids) in the Williston Basin, 10% (19,000 boe/d, 84% liquids) in Uinta,
7% (81 mmcf/d in Arkoma), and the balance in China. The company has indicated that the Eagle Ford, Duvernay, Uinta,and Williston Basin will be harvested as free cash flow generators.Encana has demonstrated an ability to streamline its portfolio over time, which is a good thing in our books. Encana has framed $250 million of annual synergies associated with the Newfield deal which it expects to establish during the second - half of 2019. One half of these ($125 million) relateto G&A savings. The other half is a function of cube development synergies of about $1
million/well, or about $125 million per annum. This includes improved cycle-times, supply management, and pad efficiencies — essentially doing things better and faster.
Encana Corporation November 2, 2018 Greg Pardy, CFA