Forest Oil Corp.'s sale of a 50% interest in its core Eagle Ford shale holdings to its service contractor—global oilfield service giant Schlumberger—seems a bit curious on the surface. Is the gas-weighted independent so desperate that it grasped a lifeline from a nontraditional partner? Or might the deal be a masterful partnership that will slingshot the company to fast prosperity?
While far from its first option, this deal might indeed prove to be the catalyst for a company that has struggled to find its footing since the bottom fell out of the market in 2008.
Denver-based Forest was one of many E&Ps that used leverage to stockpile unconventional gassy assets during the boom, only to be left upside down when prices tanked. And shifting its revenue model to "liquids-rich" production on a dime hasn't proven easy. Forest has seen its share value erode over the past two years, from $38 in early 2011 to $5 today. Out with the old chief executive officer last June, in with the new.
Yet, with a $900-million untapped credit facility currently available, access to cash wasn't the impetus for the unusual Eagle Ford partnership. Avoiding piling on to a 4.0x debt-to-EBITDA to fund capex certainly was. Last July, new chief executive and president Patrick McDonald, pulled from Forest's board, put a hold on production growth to hammer away at debt, which stood at about $2 billion when he took over. Forest has since sold more than $600 million in assets to offset that debt.
The sales have garnered Street cred for the new management team in its ability to execute the deleveraging plan, but the Schlumberger deal may be the turning point. Forest's Eagle Ford package has languished for two years, and Schlumberger was probably the last option considered.
But consider the option. Forest is giving Schlumberger a 50% interest in future Eagle Ford wells drilled in trade for $90 million in applied service costs. Forest, in essence, gains cost relief on drilling and completing the wells. It can now ramp up to four rigs in Gonzalez County from two, and anticipates drilling an additional 10 wells this year beyond prior plans and 20 next. That move adds an estimated additional $75 million revenue in 2014 from some 3,800 additional barrels of oil equivalent per day.
The cost of this growth to Forest is 12,500 net acres. Forest now has some 110,000 acres in the Eagle Ford, but anticipated capturing only 40,000 net acres in its solo program before lease expirations. With the Schlumberger acceleration, the partners can hold 55,000 total acres. But Forest's take is reduced to 27,500 acres when done.
Tudor, Pickering, Holt & Co. analyst Brian Lively says, "The deal allows Forest to accelerate activity without incrementally taxing the balance sheet and to bring forward $250 million of (PV-10) value. But the deal comes at a pretty big price tag, considering a value of $3,300 per acre for an asset that could be worth more than $10,000 an acre."
So, yes, Forest does need the boost in cash flow more than the dirt.
But Forest, a small company with a $500-million market cap, gains access to the vast technical knowledge and completion efficiencies of Schlumberger. "We believe Schlumberger's extensive experience in developing unconventional shale resources across the globe will allow us to optimize all facets of our drilling and completion operations to achieve the best possible results," McDonald said in a post-deal conference call.
Score for Forest. That's one heck of an R&D team that will improve efficiencies in all its programs.
Forest continues to shop its 100,000 acres for sale in the Permian Basin, and it would like to share its capex load in the Granite Wash, where it has 100,000 acres. McDonald implied that Schlumberger is also a candidate in a farmout of its Granite Wash program, so don't be surprised to see the oil-field service provider sampling a bit more E&P.
R.W. Baird analyst Maggie Savage bestows on Forest an "Outperform" rating and a target price of $9, albeit longer term. "Forest continues to execute on strategic initiatives, having successfully paid down debt in 2012, with focus now shifting to accelerating production from core assets." Stock price outperformance will likely correlate to 2014 production growth, she said in an April 15 research note.
So, finally, the future looks bright for Forest, which is putting its capex into the Granite Wash and liquids-rich East Texas plays, as well as the Eagle Ford. "We'd like to turn our attention to getting the company back to growth," McDonald said in a February conference call preceding the deal, but he added, "there's more work to be done."