Anadarko Petroleum Corp. is well known for its skill in managing the various assets in its global oil and natural gas portfolio. Normally, it’s a challenging task to appropriately allocate scarce resources to various regions competing for capital. But what if a new opportunity arises that in itself offers a funding solution?

Such was the case with Anadarko’s $2-billion acquisition of assets in the deepwater Gulf of Mexico (GoM) from Freeport-McMoRan Oil & Gas. The purchase would require significant external funding—courtesy of J.P. Morgan Chase & Co.—but free cash flow from the assets being acquired will enable Anadarko to accelerate activity in its key, higher-margin Delaware and Denver-Julesburg (D-J) basins.

Anadarko cited some $3 billion of incremental free cash flow it expects to generate from the new GoM assets at strip pricing over the next five years. This capital will be used to help drive production growth in its onshore Delaware and D-J basins, where Anadarko forecast output more than doubling to over 650,000 barrels of oil equivalent per day (boe/d) through 2021.

Significantly, in a year that was characterized by equity offerings to repair balance sheets early in the year—followed by A&D activity largely aimed at consolidating acreage in the Permian Basin later in the year—Anadarko’s acquisition in the GoM easily represented the largest equity acquisition financing completed in 2016.

For making such a bold splash, this transaction wins the Oil and Gas Investor Excellence Award for Financing of the Year.

Turbulent waters

None of this would have been possible without funding for the acquisition. And here J.P. Morgan played a pivotal role—and a role in which it assumed substantial risk.

First, there was the sheer size of the deal, which ended up raising gross proceeds of about $2.2 billion, including the exercise of the full overallotment option.

Second, the fact that J.P. Morgan was to be the sole underwriter of an offering of this magnitude—an offering with a stated size of 35.25 million primary Anadarko shares before the overallotment option—made the financing for Anadarko the largest sole underwritten primary block trade that has ever been successfully undertaken. The latter accomplishment in terms of sole underwritten primary block trades is not specific to energy, but applies across all sectors.

Obviously, this is something that competitors without the balance sheet strength of J.P. Morgan would find hard to contemplate. Even in cases in which J.P. Morgan had previously worked with only one other joint book-runner, the largest offering undertaken by the two book runners was in raising considerably smaller proceeds of just under $850 million.

Third, despite turbulent market conditions during the day prior to pricing, the financing for Anadarko was priced tighter than average large block trades. J.P. Morgan went ahead with the deal—just one day after the Dow fell to an intra-day low of down 394 points—and priced the primary share issue at $54.50 per share, a discount of 5.7% from the last close of $57.79. By contrast, the discount for the prior top 10 largest E&P block trades—albeit ones smaller than Anadarko’s—averaged 7.8%, according to J.P. Morgan.

In addition, positive investor reception resulted in substantial aftermarket buying of Anadarko stock, leading to over 10% outperformance in terms of first-day trading relative to a peer group of E&P stocks. After pricing the issue at $54.50 per share, Anadarko’s stock traded up 5.7% to close at $57.59 on the first day of trading, while its peer group of E&P stocks traded down 4.6% on the same day, resulting in 10.3% relative outperformance.

What were the underlying fundamentals that made a deal of this magnitude not only feasible in terms of financing, but also immediately appealing to investors on its merits?

While Anadarko is better known for pursuing a path of organic growth, it’s hard to argue that in this instance its departure from that strategy was not justified in light of the compelling acquisition metrics.

For example, relative to the enterprise value (EV)-to-proved reserves ratio of roughly $24/boe that was reflected in Anadarko stock at the time of acquisition, Anadarko was able to buy proved reserves at a discounted rate of around $13.50/boe. And while Anadarko’s stock reflected an EV per flowing boe/d valuation of about $64,000, the acquisition carried a purchase price of $21,000 per flowing boe.

In addition, each barrel produced from the acquired properties generated approximately $36 of EBITDAX, as compared to $19.50 of EBITDAX/boe for corporate Anadarko. Thus, adding some 80,000 boe/d—and roughly doubling the company’s GoM production to approximately 160,000 boe/d—would be highly accretive immediately. On an EBITDAX per net debt-adjusted share basis, the acquisition would be 22-26% accretive in 2017 and 27-31% in 2018, according to the company.

Importantly, with a focus on the further development of discoveries in the GoM, the acquisition also resulted in a doubling of Anadarko’s working interest in its strategic Lucius deepwater facility. Following the acquisition, moreover, Anadarko is poised to be much more heavily weighted to oil, which is projected to comprise 80% or more of total production, up from 42% previously.

Historically, Anadarko has been judicious in its issuance of equity, being unwilling to risk diluting its investors if acquisitions deliver simply growth rather than growth plus value. Recent equity issuance by the industry as a whole has been largely linked to A&D activity related to the Permian Basin and, to a lesser extent, the Scoop/Stack plays. In A&D, Anadarko has continued its sale of “noncore” assets, but—until recently—stood on the sidelines as regards major acquisitions.

So what were key factors in Anadarko’s “big picture” view of taking on a $2-billion acquisition that required equity financing and added portfolio assets in the relatively out-of-favor deepwater GoM?

“In a difficult commodity price environment, there are obviously significant challenges, but we knew there would be tremendous opportunities as well,” said Anadarko’s CFO, Bob Gwin. “While we have focused on high-grading our asset base through divestiture of attractive assets that just don’t compete for capital with our top two basins, we’ve also continued to look to capture bolt-on acquisitions in areas where we have scale or other competitive advantages that we can leverage.

“In the case of the Freeport-McMoRan assets, we found a complementary asset footprint in an area where we already were an industry leader, and in which high-margin oil production would generate substantial cash flow in the intermediate term,” continued Gwin. “Not only were the assets a great fit in and of themselves, but they enabled us to redeploy the free cash flow to accelerate activity in two of the most prolific onshore oil basins, the Delaware and the D-J, where we have top-tier positions, very large resource bases and strong rates of return even at today’s prices.”

Since completing the acquisition in December, Anadarko has already increased its rig activity in both basins, noted Gwin.

“We are currently running 11 operated rigs in the Delaware Basin and six operated rigs in the D-J, up from seven rigs and one rig, respectively, in the third quarter of last year,” he added. “The acquisition of the Freeport-McMoRan properties, coupled with the cash flow generated by our international oil assets in Algeria and Ghana, allowed us to internally fund our five-year oil growth objective of 12% to 14% on a compound annual basis.”

Offshore upside

The transaction also offered Anadarko a chance to cement what was already a very strong position in the deepwater GoM, enabling it to further leverage its offshore infrastructure. With three additional operated production facilities, bringing its total to 10, the company is positioned with the largest number of floating production facilities in the deepwater GoM. This provides greater scope for developing its “unmatched inventory” of low-cost subsea tieback opportunities, as well as offering additional optionality for new exploration prospects.

The complementary nature of the Freeport-McMoRan and Anadarko deepwater assets is exemplified best at the Lucius facility, where the transaction raised Anadarko’s working interest to about 49% from its previous 23.8%. Lucius was the company’s “best-performing GoM asset,” according to Anadarko at the time of the acquisition, with gross production from six wells surpassing 100,000 boe/d—well in excess of Lucius’ nameplate capacity—and a seventh well ramping to 15,000 boe/d.

Coinciding with the acquisition, Anadarko raised its EURs for Lucius to more than 400 million boe, up from a previous 300 million-plus EURs. Factors cited by the company included 30%-plus porosity and up to a 60% recovery factor. “Well deliverability remains excellent through favorable connectivity, strong aquifer support and high quality oil pay,” it noted.

In terms of further upside, Anadarko estimated the deal would add some 20 tieback opportunities, plus several third-party opportunities, as well as 15 or more identified exploration prospects. The 20 tiebacks, capable of achieving over 50% before-tax rates of return at strip prices, expand an already healthy inventory of tiebacks. In close proximity to Lucius, for example, is the Hadrian South gas field. More significant is Anadarko’s Phobos discovery, located 12 miles south of Lucius, where an appraisal well encountered more than 90 net feet of oil pay in the secondary Pliocene-aged objective and about 130 net feet of oil pay in the primary Wilcox objective. Anadarko holds a 100% working interest in Phobos.

In addition to its balance sheet strength, how was J.P. Morgan able to execute a primary share offering of this record amount so smoothly?

The fact that Anadarko was able to raise over $2 billion at an “extremely tight discount of 5.7%, and subsequently see its stock dra-matically outperform in aftermarket trading, was a clear validation of the company’s strategy of being judicious in issuing equity, and only doing so with a very accretive transaction that will create a lot of shareholder value,” observed Yaw Asamoah, a managing director and head of energy capital markets at J.P. Morgan. “The market rewarded Anadarko for that strategy.”

Another key element was keeping the transaction under wraps until the full strategy—that is, the use of the very significant incremental free cash flow from the GoM to accelerate drilling at Anadarko’s two higher-margin onshore basins—could be communicated to the market.

“Confidentiality was critical, because Anadarko management wanted to be in a position to lay out the strategy and explain how transformational it would be for the company,” recalled R. A. McDonough, a managing director at J.P. Morgan and the firm’s lead investment banker for Anadarko. “Investors were, frankly, shocked at the accretion metrics and at the really strong cash flow which Anadarko could deliver from known assets to support growth in the Delaware and D-J basins.”

Freeport-McMoRan had earlier signaled it would look to exit or materially scale back its oil and gas activities in the GoM—and Anadarko was viewed as a natural buyer of the assets—but the GoM was far from investors’ favorite investment option. In a year in which E&P equity financings were used mainly to fund acreage and asset acquisitions in the red-hot Permian Basin, the likely reception by investors to a major acquisition of out-of-favor GoM oil and gas assets could have been in doubt.
However, Anadarko was clearly successful in being able to craft—and communicate—the rationale for its GoM transaction. Over the course of a few hours, J.P. Morgan was able to build an order book that comprised over 160 institutional investors from leading investment centers.

Given the incremental free cash flow generated by its GoM deal, which regions are expected to have received the biggest slices of the pie when capex allocations are made public at Anadarko’s March investor conference?

“The lion’s share of what we’ll be talking about in March will be capital being allocated to the Delaware, the D-J and the deepwater GoM,” said Anadarko CEO Al Walker, to no surprise, on the company’s 2016 full-year earnings call.

But of these, Walker focused on the organic opportunities being developed in the Delaware.

The Delaware, he said, was “probably one of the largest greenfield developments that is likely to be seen in the careers of most engineers and other petroleum professionals.”

That probably deserves an extra big slice.