Empire Building: EQT Targets Balance After $8.2 Billion Rice Conquest

The paradox at the heart of EQT Corp.’s (NYSE: EQT) $8.2 billion acquisition of Rice Energy Inc. (NYSE: RICE) is that two companies known for their high growth rates will form a leviathan producer that will pump the brakes on production.

“Somewhat counter-intuitively, this deal to form the largest gas producer in the U.S. may actually reduce anticipated volume growth out of the Marcellus,” said Ethan Bellamy, senior research analyst for Baird Equity Research. “EQT made this bid to add forward visibility on attaining cash flow breakeven, which management targets in 2019, reinforcing a burgeoning theme among U.S. independent E&Ps.”

The shale revolution is evolving, Steve Schlotterbeck, EQT’s president and CEO, said on a June 19 analyst call, adding that shale gas production is entering a second phase in which breakneck growth and wild spending simply doesn’t make sense.

“I’m a strong believer that the ‘grow as fast as you can at any cost model,’ while probably necessary early in the shale revolution doesn’t work anymore. It isn’t going to work anymore,” he said. “For a company our size that’s far too risky of a strategy.”

The merger will create the largest natural gas producer in the U.S. with savings in overhead and capital efficiency creating $2.5 billion in synergies.

EQT will capitalize on Greene and Washington counties, Pa., where the company and Rice have a significant overlap “amongst the best acreage in the Marcellus Play” by drilling extended laterals, Schlotterbeck said.

The company will be pushing 12,000 ft laterals to maximize production with savings knocking down capex costs by 7%. But with that savings, EQT will target drilling 20% fewer wells in 2018.

The new take on prudent growth is designed to make EQT not merely the largest of the gas producers but the leader in “natural gas cost structure” in the U.S., Schlotterbeck said.

“The high growth models of the first phase I don’t think are going to work in phase two,” he said. “We really need to be focused on creating real value and getting that value directly back to shareholders.”

Bellamy said other E&Ps unable to cross the chasm from economic self-sufficiency “face an ugly future—which may necessitate eventual sale given the mushrooming discount rates placed on equity cash flow estimates in the group.”

Longer laterals, leaner operating costs and lower cost of capital appear to bode well as the company’s business model shifts from outspending for high growth to more moderate growth with free cash, said Gordon Douthat, senior analyst at Wells Fargo Securities.

“This has bullish implications for the commodity and we believe investors stand to benefit as shale enters a more mature phase. EQT is better-positioned post this transaction in our view,” he said.

EQT’s purchase grabs one of its attractive peers at a good price, “given horrid sentiment on natural gas and gassy E&Ps” as well as investor worries over Rice’s inventory, said Tim Rezvan, an analyst at Mizuho Securities LLC. The firm has a $34 price target for Rice, which stock traded under $20 on June 16. EQT will buy Rice at about $27 per share.

EQT is by no means finished now that it has laid a foundation that includes a quarter of a million contiguous net acres including Utica Shale position as well as midstream assets.

EQT said Rice’s midstream assets may be worth $1 billion in dropdowns to EQT Midstream Partners LP (NYSE: EQM). The deal also triples its capacity to move gas to the Gulf Coast.

“Importantly, we immediately increase access to premium Gulf and Midwest markets through the addition of the Rice firm transportation portfolio,” Schlotterbeck said.

Schlotterbeck said the company models spending $100 million to $200 million per year on “tactical acquisitions” for fill-in acreage that allows the company to drill its massive laterals.

“EQT appears to be empire building,” Rezvan said. “EQT estimates 2017 production of 3.6 billion cubic feet equivalent per day for the combined companies, making it a dominant Appalachia producer and fully dedicated to natural gas.”

Brian Velie, an analyst at Capital One Securities, said EQT’s rationale for the deal appears to be built on the ability to drill extended laterals from a pad with at least 12 wells. Lateral lengths will increase by 50%, to an average 12,000 ft from 8,000 ft.

At $3 per thousand cubic feet of gas, EQT models its after-tax internal rate of returns (IRRs) increasing to 137% with 12,000 ft laterals, up from 101% after-tax IRRs with 8,000 ft laterals.

EQT will also be looking at the Utica acreage it stands to acquire from Rice.

“We like that acreage and I think our view will be when we build our business plan for next year, and looking at our capital allocation, we will be putting our capital to work in the highest return areas,” Schlotterbeck said.

Some Utica acreage will make it into the company’s development plan for 2018, he said.

EQT said it expects the transaction to close in fourth-quarter 2017.

Darren Barbee can be reached at dbarbee@hartenergy.com.