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Chesapeake Haynesville Buy A 'Steal' for Exco

Exco Resources Inc. is paying Chesapeake Energy Corp. $1 billion for something wet and something dry: about 55,000 acres in the liquids-rich Eagle Ford Shale of Texas and about 9,600 acres in the drier Haynesville Shale in North Louisiana (see related story). The deal's dry gas component is viewed by analysts as a steal while the Eagle Ford acreage is considered to be marginal.

The acquisitions last week by subsidiary Exco Operating Co. LP of producing and undeveloped assets are consistent with the company's plan to expand in core areas and target new plays, said Exco CEO Douglas Miller.

"The Eagle Ford acquisition establishes our position in the high-value oil core area of the Eagle Ford Shale and delivers immediate production and reserve additions, significant resource potential and solid economic returns. The Haynesville acquisition adds to our leading core position and provides an expanded platform to apply our technical expertise, best-in-class drilling and completion focus, and project execution skills."

Following the deal's announcement, investors cheered what was perceived to be a wise buy by Exco, lifting its shares more than 8% to close at $8.05 on Wednesday. The deal value had apparently already been priced into Chesapeake shares as they closed up by less than 0.5% at $21.01. On Friday, Exco closed at $8.15 and Chesapeake at $21.04.

"We estimate that the deal is accretive on nearly all metrics, NAV [net asset value] being the main exception, and transforms Exco from a levered natural gas player with a declining production profile to a more levered gas player, but one with greater cash flow, enabling increased spending and production growth visibility over the next couple of years," said Phillip Jungwirth, an analyst who follows the company for BMO Capital Markets Corp.

In the Haynesville, Exco is paying $320 million to acquire Chesapeake's interests in 9,600 net acres in Louisiana's Desoto and Caddo parishes. Included are 11 units operated by Chesapeake and 42 units operated by Exco. Average net daily production from the Haynesville properties was 114 MMcfe/d during May. The acquisition adds about 55 identified drilling locations, Exco said.

"In our view, the Haynesville looks like a steal, and we'd almost expect the $1 billion purchase price to be weighted equally between the two assets," Jungwirth said in a note Friday. "Haynesville deal metrics were about $2,800 [per] Mcfe/d, and we estimate $1.86/Mcf PDP [proved developed producing] and 4.1 times enterprise value/earnings before interest, taxes, depreciation and amortization [next 12 months]. This is significantly less that we estimate the production to be worth, plus we believe the locations should have meaningful value as we model Tier 1 Haynesville as being very economic at today's natural gas prices."

Exco's Haynesville operations have performed well in recent years; however, when gas prices were lower the company was dropping rigs in the play (see NGI, May 7, 2012; Feb. 27, 2012). At the end of the first quarter, company-operated Haynesville/Bossier production was nearly 1.07 Bcf/d gross (316 MMcf/d net). Production contributions from wells operated by others brought the total to 338 MMcf/d net, the company said in its first quarter earnings announcement. "While our current plan is to maintain three rigs through 2013, we will continue to assess product pricing and project economics to make further decisions on our drilling activity," Exco said in April. During the first quarter, Exco's Haynesville focus was DeSoto Parish where well costs were averaging $7.8 million each.

In the northern Eagle Ford Shale, Exco agreed to acquire 55,000 net acres in the Zavala, Dimmit, La Salle and Frio counties, including about 120 producing wells that had 6,100 boe/d net during May. The assets account for $680 million of the aggregate deal value, giving Exco 300 identified drilling locations and a farm-out option on an additional 147,000 net acres, the company said.

Jungwirth was far less enthusiastic about this component of the acquisition from Chesapeake. "Exco views its acquisition of Eagle Ford properties as establishing a new high-value oil core area, although we believe returns need to improve either in the form of greater recoveries or lower drilling costs for returns to be competitive with the Haynesville," he said. "...[I]nitial oil recoveries in this area [of the acquisition] have been lower than those achieved to the south and on Chesapeake's McMullen County acreage. Also, we'd note that prior Chesapeake acreage packages have carried a significant amount of near-term lease expirations, and we wouldn't expect this package to be any different."

Overall, Eagle Ford Shale production has been climbing month by month as producers continue to favor the play's oil and liquids. La Salle County was the third-highest oil-producing Texas county in April, according to the Railroad Commission of Texas.

The effective dates of the Eagle Ford and Haynesville acquisitions are April 1, 2013 and Jan. 1, 2013, respectively. The Haynesville acquisition is subject to an affiliate of BG Group plc.'s preferential right to acquire 50% of the Haynesville properties. Exco said it anticipates completing the transactions this month with the Haynesville acquisition closing first. About 90% of the purchase price is to be received by Chesapeake upon closing of the deal, with the remainder subject to post-closing contingencies. Exco expects to finance the Haynesville acquisition under an existing credit agreement. The company has secured a commitment from J.P. Morgan to replace an existing credit agreement with a new one that has an initial $1.6 billion borrowing base, including a $400 million bridge loan, that would finance the Eagle Ford acquisition.

The undeveloped Eagle Ford locations are expected to be drilled and developed with units/affiliates of Kohlberg Kravis Roberts & Co. LP (KKR). Exco and KKR have a struck nonbinding agreement for KKR to fund $133 million, which represents 50% of certain undeveloped acreage included in the Eagle Ford acquisition. KKR would become the drilling capital partner in the acreage. Exco is to hold a conference call Monday to discuss the deal.

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