Comstock Resources CRK
February 02, 2018 - 3:29pm EST by
Woolly18
2018 2019
Price: 8.35 EPS 0 0
Shares Out. (in M): 15 P/E 0 0
Market Cap (in $M): 130 P/FCF 0 0
Net Debt (in $M): 1,050 EBIT 0 0
TEV ($): 1,180 TEV/EBIT 0 0

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Description

Investment Thesis:

Comstock Resources (“CRK”) is a house rich, cash poor company that is in the mid/late innings of a strategic transformation that could yield sizable results. This is a levered equity on steroids. If we are right, we could see 100-300% upside in 3-6 months and if we are wrong, we think the downside is around 30%.

CRK is in the late stages of transitioning to a pure-play Haynesville Shale asset company that could grow production by 30%+ annually. To successfully accomplish this, the company needs to monetize non-core oil assets and repair its balance sheet. Our thesis is as follows:

1.       Company monetizes non-core Eagle Ford assets. The company has formally announced a sale process and expects $200-300 million of proceeds. According to the sell-side, we could get an announcement as early as next week.

2.       Proceed with a refinancing: assuming $200mm of proceeds, company will have several options which should reduce leverage from 6x LTM EBITDA to 2-4x NTM EBITDA.

3.       Enhanced liquidity should fuel production growth.

4.       As the stock trades higher (presumably on the EF sale), an interesting phenomenon is going to occur. At $12.32 (after 15 consecutive trading days), the 2nd lien holders ($450mm total) automatically get converted to equity. The forced conversion will eliminate 40% of the company’s debt vastly increase the stock’s liquidity (albeit with dilution to the current equity holders, which only own a fraction of the enterprise today).

5.       Simultaneously, the company is trying to refinance the existing capital structure to forego some of the dilution from the converts. There will be tradeoffs between dilution, leverage, and dry powder for further production growth.

6.       If some iteration of the foregoing occurs, the company would transition from a 6x levered, $150mm micro-cap company with a hodge podge of assets to a 2-4x levered, pure-play Haynesville producer with $1 billion in market cap (don’t forget the dilution from the converts will limit some of the upside). We think the stock price would be $18-30/share (including dilution) in these scenarios.

The Crux of the Thesis: Consummation of an Eagle Ford Sale

In order for the thesis to work, investors need to believe that the Eagle Ford asset sale will consummate and the price will be somewhere around $200mm. Management has publicly stated they believe the assets are worth $200-300 million. Anyone investing in this sector knows that valuing these types of assets as a public equity investor is very difficult. Here is how we got comfortable with the valuation:

·         The assets are producing roughly 2,300 barrels/day and the market currently ascribes a 40,000-45,000 multiple, which is around $100 million for the producing assets.

·         This value foots with the PV-10 value of the assets of $109mm that was given in a 1/25/18 release which was calculated at $48.71 oil, 20% less than today’s price.

·         Those values exclude the 200+ undeveloped locations, which CRK had invested significant capex in over the years. Assuming $500k in value per location site, adds another $100mm+ of value.

·         Triangulating further, the book value of the assets is $238 million. That value was also determined at around $45 oil and written down significantly in 2015.

According to sell-side analysts (see Seaport and Johnson Rice notes on 1/25-1/26), first round bids were due in late January and a final sale could be announced in early February.

So What are the Likely Outcomes?

There are many potential outcomes. For each scenario, we assume EF proceeds of $200 million, $250mm of 2019 EBITDA (consensus) and a 5.5x multiple. In reality, if the company is successful, we believe EBITDA could be 10% higher (more capital for drilling) and the multiple could be 6x+. The toggle here is the dilution from conversion of the 2nd lien notes. Management has publicly stated that they have been in ongoing discussions with debt holders since last year about a refi. We believe some of the convert holders want equity in the company while others do not. Here are the mostly likely scenarios we expect:

1.       The stock trades through the mandatory conversion price and all of the convert holders get converted to equity.

2.       30% of convert holders exchange into a new debt instrument (be it RBL or HY) while 70% convert into equity.

3.       50% of convert holders exchange into a new debt instrument (be it RBL or HY) while 50% convert into equity.

4.       Company is able to refi entire balance sheet, 2nd lien debt is called/tendered, and there is no dilution.

There are tradeoffs in each scenario: increased dilution/market cap/liquidity, leverage profile, and dry powder from a brand new facility.

As you can see from the table below, the range of outcomes is quite large and if the thesis works, we could see 100-300% upside.

 

Current

Scenario 1

Scenario 2

Scenario 3

Scenario 4

2018E EBITDA (consensus)

228

228

228

228

228

2019E EBITDA (consensus)

250

250

250

250

250

           

2018 EV/EBITDA

5.2x

5.2x

5.2x

5.2x

5.2x

2019 EV/EBITDA

4.7x

5.5x

5.5x

5.5x

5.5x

           

Enterprise Value

1,179

1,375

1,375

1,375

1,375

Net Debt

1,050

398

534

624

850

Equity Value

129

977

841

751

525

           

Price

8.35

18.74

20.46

22.24

34.07

Upside/Downside

 

124%

145%

166%

308%

S/O (mm)

15

52

41

34

15

           

Net Debt/2018E EBITDA

4.6x

1.7x

2.3x

2.7x

3.7x

Net Debt/2019E EBITDA

4.2x

1.6x

2.1x

2.5x

3.4x

 

Where Could We be Wrong?

The biggest near-term risk is that either the Eagle Ford sale does not consummate or the proceeds are far less than expectations. We do not believe expectations are high (ie. from conversations with the sell-side and other shareholders, we believe proceeds >$150mm will satisfy the market). If proceeds come in below this level but the transaction is consummated, it could jeopardize the company’s refinancing ability. Additionally, if the sale process is terminated, we think this would be a big negative and would likely send the stock to the $5-6 range. Given that the process is almost complete, oil has been very strong (even including the last several days), we think this is more of an outlier.

The other biggest risk is that credit markets shut down, which has become a higher risk today than it was last week. The sell-side believes a refi would be completed by April so we’ll leave it to you to make your own judgment on whether the credit markets will remain open between now and then.

 

Finally, natural gas has given up all of its recent gains. While the investment could work quite well in the low price environment, ultimate upside will be determined by 2019+ EBITDA and the associated multiple the market ascribes. That value is less today than it was last week.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1. announcement of Eagle Ford asset sale

2. refi

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