Description

Note: WTI / HH strip pricing as of February 7, 2023 utilized throughout

Buy Highpeak Energy 10% Unsecured Bonds due February 2024 at 98.75 to make a 16% IRR over 10-12 months with limited risk of permanent capital impairment. Both the Company’s near-dated maturity wall and recently announced strategic alternatives process should catalyze a capital markets event resulting in the par repayment of these bonds. Highpeak bonds yield over 11% having widened almost 175bps, in-line with HY energy, since the start of the year due to Winter Storm Elliott impacts across the Midland Basin and now trade wide of high yield indices despite an improved liquidity profile from recent balance sheet actions. This is unsecured E&P risk created at a 32% LTV against PDP with additional margin of safety provided by existing cash flows which insulate credit risk from asset development success. Recent transaction activity across the Midland Basin both supports asset coverage and the Company’s prospect of striking a deal; CEO Jack Hightower’s interest in monetizing his 87% equity ownership adds additional incentive to transact at these levels further supporting this short duration, money good bond trade.

Highpeak is Jack Hightower’s most recent oil and gas venture following his successful exit of Celero Energy I/II and Bluestem Energy. The Company IPO’d in August 2020 in a DeSPAC transaction with Pure Acquisition Corp and today is one of, if not the most, successful DeSPACs having outperformed both the DeSPAC Index and XOP by 17.5x and 1.4x, respectively. After purchasing Hannathon Petroleum and Alamo Borden properties for nearly $550 million, Highpeak’s asset profile consists of 110,000 net acres (56% HBP) across the Flat Top and Signal Peak areas of Howard and Borden Counties in the northeastern Midland Basin. The Company’s assets are 98% operated, 97% liquid, and as of December 2022 includes 215 and 165 drilled and online wells, respectively, 55% of which were vertical as of 2021. Highpeak exited 2022 with production of 38,489 boe/d and annualized EBITDA of over $900 million given netbacks in excess of $70/boe. The Company is guiding to a 2023 exit rate of 62,000 boe/d with EBITDA in excess of $1.5 billion assuming a 4-5 rig drilling program. Nearby operators include OXY, OVV, CPE, PXD, and FANG and Highpeak’s properties are contiguous with assets owned by VTLE, SM, and Surge.

The Company’s fiscal year 2021 reserve report details 28.6MMboe of PD and 64.2MMboe 1P reserves, respectively, with PV-10 values of $742 million and $1.3 billion each. Highpeak should provide a fiscal year 2022 reserve report inclusive of Hannathon and Alamo reserves along with 4Q/FY22 results; however, given purchase disclosures we know that Hannathon and Alamo combined 2021 1P PV-10 value was $589 million, suggesting Highpeak acquired these assets at about 1x EV / 1P. Due to the integration of these assets and drilling activity through the year, current PDP PV-10 is likely at least $1.5 billion.  

Highpeak’s $3.7 billion enterprise value includes a Wells Fargo agented RBL Facility with $525 million in commitments, $130 million of which is currently drawn, two unsecured bond issues totaling $475 million, $30 million cash and market capitalization of $3.1 million. The RBL Facility’s borrowing base was recently upsized to $550 million and features several financial covenants, including a 3.0x Debt / EBITDA limit, minimum hedging and cash conditions, and cash flow sweep if balance sheet cash exceeds $75 million. The Company priced $250 million 10.625% Unsecured Bonds due November 2024 in 4Q22 and utilized proceeds to paydown the RBL Facility concurrent with the borrowing base / commitment increase. Additionally, Highpeak raised $85 million equity in a September private placement with Jack Hightower and other members of Management purchasing 17% of the issue for almost $15 million.  Total liquidity is more than $400 million pro forma for these transactions. The Company does pay dividends but their ability to do so is reliant on maintaining at least 25% availability under the RBL Facility. Although the 10% Unsecured Bonds due February 2024 mature ahead of the RBL Facility, there is a springing maturity feature which matures the RBL Facility on October 1, 2023 if these bonds remain outstanding. Leverage is likely to remain under 1.0x EBITDA through 2023 and 2024.  

The near-term maturity wall is a risk, but recent actions suggest the capital structure is positioned for a successful refinancing. Highpeak replaced Fifth Third as RBL Facility agent with Wells Fargo, an institution better suited to service an enterprise of Highpeak’s size. As mentioned, the RBL Facility’s borrowing base and commitments recently increased to $550 million and $525 million, respectively, following the raise of additional unsecured debt and equity capital. An October 2022 credit agreement amendment required an additional borrowing base redetermination by or around December 1, 2022; although the curve has declined over the last year, the December 1 strip was a premium to October 2022 which should help mitigate any surprises with the next redetermination. Both the 10% and 10.625% bonds feature change of control provisions, but at a price of 100 which negates the incremental expense of an acquiror refinancing these bonds at a premium. The Company’s January 24 press release announcing the commencement of a strategic alternatives process likely coincides with accommodative capital market conditions.

The Company averaged over six rigs and three frac crews over the third quarter and anticipates running a ~4 rig drilling program over the next two years with ambition to grow production towards 62,000 to 76,000 boe/d. Highpeak maintains more than 14 years of drilling inventory across 2,500 gross locations and has demonstrated some development success through 2021 and 2022, and ss of 3Q22, 57 wells were in various stages of drilling and completion. Management expects to transition the asset from a development to free cash flow story by the back half of 2023, at which point Highpeak is expected to generate positive levered free cash flow as run-rate EBITDA exceeds $1.5 billion.

 The Company’s hedging program as of 3Q22 is below.

Based on recent capital expenditure guidance, I estimate Highpeak requires about $2.5 billion in total capital to fund development, overhead, and other fixed costs through 2024. At strip, net of differentials, the Company should be capable of capturing cash margins greater than $50/boe, and together with asset cash flows and existing liquidity fully finance their capital need by over 150% while maintaining leverage below 1x. These estimates assume LOE and other operating expenses at a 30% premium to 2023/2024 unit economic guidance and does not incorporate benefit from lease operating expense, workover, or G&A savings initiatives Management has recently detailed. We should expect additional RBL Facility draws through 2023, and I would consider the dividend to be at risk should per barrel economics, hydrocarbon pricing, or development program success disappoint. Cumulative PDP cash flows should exceed $1 billion over the next twenty-four months which provides some margin of safety to maintaining adequate liquidity; Management should be able to pivot the asset base towards de-leveraging with free cash flow should they underdeliver on drilling results.

Liquidity is most sensitive to changes in strip pricing and development program success as illustrated below. Note these figures do not incorporate hedging benefit, so pricing could likely fall further than shown before incremental liquidity is required.

While liquidity need may fluctuate, the balance sheet can support near total development program failure and 25% price declines before the Company becomes non-compliant with their 3.0x Debt / EBITDA maintenance covenant. Excluding the development program, Highpeak only requires about $125 million per year to fund overhead and other fixed costs, which PDP cash flows alone likely exceed per quarter.

The unsecured debt is likely money good when valued against the Company’s production, cash flow, and reserve base. I prefer looking at PDP and think the bonds are created at an average 32% LTV with a discount range between 10% and 25%. We’ll have a better idea of Highpeak’s current reserve value when the fiscal year 2022 reserve report is released in the coming weeks.  

Recent Midland Basin transaction multiples also supports asset coverage of the bonds but might not justify Jack Hightower’s claim his enterprise could transact at 5x EBITDA / $50 a share.

At 98.75 the 10% Unsecured Bonds due February 2024 offer an 11.8% IRR to maturity date with an average 16% IRR were a sale / refinancing event catalyze an earlier repayment.

Catalyst

Strategic Initiatives Process

October 2023 Springing Maturity

February 2024 Maturity