“We debated long and hard about whether to sell the company,” says Jim Henry, president of Henry Resources.
?Last summer, when oil prices neared their height, when it looked like oil demand was on a runaway train with no end in sight, privately held Henry Petroleum decided to sell out—lock, stock and every last barrel.
Henry was a private Midland-based E&P with operations in the Permian Basin of West Texas and southeastern New Mexico. It held a leading position in the Spraberry-Wolfcamp oil play, where it had drilled more than 500 wells since 2002. (For more on this play, see “The Wolfberry,” Oil and Gas Investor, January 2008, at OilandGasInvestor.com.)
The company was financially stable and was drilling assets economically, with plenty of room to grow. So why bail on such a good thing?
“We debated long and hard about whether to sell the company,” says Jim Henry, an oilfield veteran of 50 years, the previous president of Henry Petroleum and now president of Henry Resources. “At the time, the price of oil at the El Paso Hub was about $120 per barrel.”
A contributing factor to the sale was a dire energy report penned in early 2008 by industry guru Henry Groppe, founder of Groppe, Long & Littell and an industry advisor for more than 55 years. Groppe forecasted a precipitous and potentially disastrous fall in oil prices even as prices continued to soar.
“As a general philosophy, we like to keep a simple capital structure, so we only have senior debt,” says Tim Leach, chairman and chief executive, Concho Resources Inc.
“We use Henry Groppe as a consultant, and when we approached him with the idea of selling the company, he strongly agreed with the concept,” says Henry.
This was not the first time Henry followed Groppe’s advice. “In 1984, we sold half of our production based on Groppe’s report that oil prices were going to fall substantially,” he says. “Other reports predicted a rise, but it actually did fall in 1985. So his 2008 report predicting another fall was a major factor in our selling the entire company. Twice, in a 25-year period, we have sold large assets based on his reports. He has been on retainer with us for quite a while.”
Estate planning and tax strategies also factored into Henry’s decision to monetize the company, but debt obligations did not. “We have been debt-free for several years, even prior to the sale, and as I like to tell my managers, no one ever went bankrupt by not owing any money,” says Henry.
At the time of the sale, Henry’s net production was about 33 million cubic feet of gas equivalent per day. The company had about 163 billion proved cubic feet equivalent (70% oil, 62% proved developed) and 283 billion identified unproved reserves, with a reserve-to-production ratio of 13.5 years. Also, it was operating eight drilling rigs in the Wolfberry play and executing a nine-year development of some 1,651 drilling locations (312 proved undeveloped), including 1,420 in the Wolfberry.
“For Henry Petroleum, it was particularly appealing to deal with Concho, because Mr. Henry was very keen on keeping the staff employed,” says Jack Harper, vice president, business development and capital markets, Concho Resources Inc.
In April, Henry Petroleum, represented by the Winstead PC legal firm and by Al Cummings, began divestiture talks with Concho Resources Inc., a public company also based in Midland.
“When we were looking for a buyer, we decided to sell to Concho because of (chairman and chief executive) Tim Leach’s reputation as a good manager and his concern for his employees,” says Henry. “Steve Beal, Concho’s president and chief operating officer, has a good reputation as well. Steve Guthrie, who is an asset manager at Concho and an ex-Henry employee, made the transition a lot easier.”
Also key was Concho’s agreement to keep most of the Henry Petroleum employees for at least two years. The balance—about 20 individuals—stayed with Henry’s new company, Henry Resources.
Jack Harper, vice president of business development and capital markets for Concho, says, “For Henry Petroleum, it was particularly appealing to deal with Concho, because Mr. Henry was very keen on keeping the staff employed. I think it would have been more difficult for a non-Midland company to do this transaction.”
Henry says, “We let them keep a lot of good people, about 80, so they could get the job done. They also got enough assets to keep eight rigs busy for about 10 years.”
Debt, equity facilities
To get the $565-million cash purchase rolling, Concho enlisted Banc of America Securities LLC. “We were brought into the deal fairly early to help consider all the financing alternatives,” says Scott Van Bergh, co-head, energy and power, Americas, for the investment banking and brokerage firm.
“We jointly underwrote a new credit facility for $960 million with J.P. Morgan (Securities Inc.) to fund the cash acquisition of Henry Petroleum and to refinance Concho’s existing credit facility. Their hedges allowed them to maximize the amount of the borrowing base and lock in the economics of the transaction.”
“We were brought into the deal fairly early to help consider all the financing alternatives,” says Scott Van Bergh, co-head, energy and power, Americas, for Banc of America Securities LLC.
KeyBanc Capital Markets Inc. provided Concho certain advisory services for the transaction while law firm Vinson & Elkins LLP represented Concho in connection with the transaction and financing.
Concho increased the size of its bank facility and group for the deal. “We started the process with our lead banks,” says Harper. “Prior to this deal, we had grown from six to 19 banks in our credit facility. The new credit facility currently totals 22.”
Although the credit facility was sufficient to fund the transaction, it didn’t leave Concho much financial flexibility going forward. BofA Securities advised Concho to rapidly go to the equity markets with a private placement of common stock, in a PIPE (private investment in a public entity) structure.
Van Bergh says, “Given the size of the purchase, Concho would have had to prepare audited financials on the Henry acquisition and pro forma financials on the combined company, before it could access the equity markets with the traditional SEC-registered offering.
“But being privately held, Henry didn’t have GAAP-based, audited financials. Had Concho waited for those, to offer registered stock, the company may not have been able to access the equity markets until October or November.”
By mid-September, the financial markets were in turmoil as investment banks failed, debt capital dried up, the equity markets significantly devalued practically every listed stock, and the oil and gas A&D market ground to a standstill. What’s more, oil had fallen from a high of $140 per barrel in June to $51 at the end of November.
“By November, the market for new issues in the E&P space had deteriorated,” says Van Bergh. “It’s unlikely we could have achieved the same financing at that time.”
Harper was on board with the strategy and timing. “The PIPE deal closed simultaneously with the transaction closing. Had the transaction failed to close, we would not have sold those shares,” he says. “An important component of the transaction is that we were able to price the deal and know how many shares we were going to sell and at what price, prior to closing the acquisition.”
In July, just a few months before the equity markets began to fall, Concho privately placed 8.3 million shares (at about $30 each, representing a 5% market discount), pulling in about $250 million.
“A number of our large, existing investors participated in the PIPE transaction,” says Harper. “This equity financing allowed the company to maintain its financial flexibility while significantly growing the asset base.”
Concho was very familiar with Henry Petroleum’s assets and their potential. “This acquisition was a good way to establish a big position in that play.”
Leach adds, “Our relationship with Jim Henry went back a couple of decades. We were very familiar with the owners of the company, the quality of the management team and their goals and objectives.” Henry started development of the Wolfberry play in 2002, giving Leach confidence in the staff’s ability to prove and produce from it. “We were very happy to get all their experienced technical people in the transaction.”
Concho acquired about 1,000 producing wells and an inventory of more than 1,500 drilling opportunities in the Wolfberry. Henry Petroleum did not own infrastructure, but the assets are close to existing infrastructure. Concho also acquired Henry’s saltwater-disposal facilities, which are integral to the play’s development.
Blockbuster hedging
One could believe Concho paid top-of-market for the Henry assets and now holds production that came to be worth a third as much by year-end. But the declining oil prices posed no problem for Concho: It literally had it covered.
“As a general philosophy, we like to keep a simple capital structure, so we only have senior debt,” says Leach. “We mitigate risk on acquisitions by hedging proved, developed producing production.” And hedge the company did. Once more, the timing was perfect. Concho locked in prices on up to 85% of the oil production (when combined with existing hedges that Henry had in place) it acquired with the Henry Petroleum deal. The new hedges are priced at about $125 per barrel until 2012.
“This transaction was truly a good deal for both sides,” says Harper. “Henry Petroleum achieved what it wanted, and so did we.”
Meanwhile, Concho’s stock has not been completely shielded from volatility. Leach says, “To give you some scope of what our stock price has done, we went public in August 2007, at $11.50 a share.
“We sold a secondary offering in December 2007 at about $18 a share. Then, in 2008, our stock reached a high of $40.97, but fell to about $15 toward the end of the year. The whole market has been very volatile, and everyone is experiencing that.”
As for the new Henry Resources, it is doing well. “After the sale, we have money and are looking for new producing- or undeveloped-reserves projects, primarily in the Permian Basin,” says Henry.
“We are drilling in the Wolfberry trend and looking for new acreage. We are not size-constrained, and we prefer resource plays. Where people are cutting back on their drilling budgets, but still have obligations, we would be glad to help with something like that.”