Jones Energy

Executive Summary

Jones Energy (JONE) is an exploration and production company operating in the mid-continent, primarily focusing on the Cleveland play in the Anadarko Basin (Texas panhandle) with a south-central Oklahoma Woodford shale kicker.  JONE has become an orphaned equity following a weaker than expected IPO in July 2013. 

Since its IPO, JONE has completed an accretive acquisition in the Texas panhandle.  Despite its orphaned status, JONE appears to have an exciting near term event path including the lockup expiration, well results utilizing a new completion design, and 2014 guidance.

History

Jones Energy has operated as a family owned business in the mid-continent since the late 1980s and has drilled several hundred wells in at least 5 different mid-con plays.  In recent years the company has grown via acquisition and has focused on expanding its leading position in the Cleveland play.

In December 2009, JONE made its first significant acquisition by partnering with Metalmark Capital, a private equity fund, as the winning bidder in the bankruptcy auction of Crusader Energy Group, Inc. The acquisition included approximately 13.7 MMBoe of proved reserves and an extensive drilling runway.  The acquisition price was $241 million.

In April 2011, JONE acquired estimated proved developed reserves in the Arkoma Woodford shale formation of approximately 31.1 MMBoe as of December 31, 2012, which is referred to as the Southridge acquisition. This marked JONE’s entry into an area Newfield Exploration (NFX) refers to as the SCOOP (South Central Oklahoma Oil Province).  This transaction was $165 million.

In December 2012, JONE acquired approximately 22,000 net acres in the Anadarko basin, including 36 gross productive wells, in the Cleveland and Tonkawa formations, from a group of sellers including Chalker Energy Partners III, LLC, a private exploration and production company.  The acquisition price was $250 million.

Finally, in November 2013 (IPO proceeds financed the majority of this transaction) JONE announced the acquisition of Sabine Oil & Gas for $195 million.  The transaction included 26,000 net acres in the Cleveland, Tonkawa, and Marmaton plays in the Texas panhandle and western Oklahoma, 225 drilling locations (~180 in the Cleveland), 3,400 boe/d of existing production, and 92 producing wells (54% liquids).

IPO

JONE decided to conduct its IPO in order to take advantage of an M&A frenzy that has overtaken the Texas Panhandle (mentioned on the Q3 conference call; CEO: “at least 4 data rooms open that I can think of…”).

The IPO was slated to sell 14 million shares in the $17-19 range, but the offering was downsized to 12.5M shares at $15.  Interestingly, the Jones family purchased 1.3 million shares of the offering in the IPO and the CFO acquired 30k shares.  I have never before seen insiders acquire shares in an IPO.  The IPO proceeds of $177 million were used to pay down the revolver (which was then utilized to fund the Sabine transaction).

Metalmark did not sell a share in the IPO.  Therefore JONE’s float is only about 11M (12.5M offered less 1.36M taken down by insiders) shares, or 28% of the capitalization.  The stock is currently not investable for funds looking to amass large positions given the low float.  Part of my thesis is that Metalmark will conduct a secondary offering shortly after the lockup expiration, which should allow larger hands to come into the stock and assist the shares higher.

Cleveland Play

The Cleveland play is an exciting unconventional resource play.  JONE is active in the liquids-rich window of the play.  While the wells are not necessarily explosive (<650 boepd in 30 day rates), the economics can be very intriguing so long as costs are contained. 

JONE’s type curve with 440 MBoe Gross EURs and $3 million well costs suggests that the single well-IRRs in the Cleveland could be in excess of 100% under various pricing scenarios.

Competing operators with less effective drilling techniques and higher single well D&C costs likely do not see as attractive of returns.  Therefore, JONE (now with access to fresh capital in the public markets) is the likely natural acquirer in the play.  We should expect JONE to remain active in the M&A space as deals can be immediately accretive given the company’s superior operating record.

 [Slides from corporate presentation missing - do not translate to VIC interface.  They outline JONE's type curve/well-level economics and position as "Best In Class" Cleveland operator]

New Completion Design

JONE’s shares zoomed to $18 by October, but were sent back to the $13-15 range after the company’s Q3 update, which included a poorly communicated operational adjustment.  The company has committed to a new Cleveland well completion design and thus projected a sizable uptick in capital expenditure for 2014 with no production increase.  This uncertainty scared the shares down below the IPO price.

The capex uptick – almost $1M per well – had to do with the company’s new well design, which includes tighter stage spacing and more perforating.  The new completion design will include 5 times the proppant as the prior design, 3 times the amount of water, and 3 times the perforating. 

For a description of the new completion design, see slide 15 here: http://investors.jonesenergy.com/files/doc_presentations/Jones%20Energy_CapOne%20Energy%20Conference%20December%202013%20vFinal.pdf

Results of this new well design have not been shared with the public, but preliminary results should be imminent (possibly a batch of 30-day IP rates).  I anticipate the company will also provide 2014 guidance after having disclosed the results of its latest batch of wells. 

Valuation – Enterprise Value

Cash - $23.1M

Senior Credit Facility - $473M

Second Lien - $160M

Stockholder’s Equity - $750M ($15.19 per share, 49M shares out as of 1/10/14)

Total Enterprise Value - $1,406M

Liquidity - $125M

Debt/LTM EBTIDA – 2.5x

Valuation - EBITDA Multiples

Street 2014 EBITDA = $300M (assuming 23,000 boepd for 2014)

@ $1,406M EV = 4.68x EBITDA

Pro-forma for Sabine acquisition: Assuming they do $33 EBITDA/boe (like JONE) (3,400 boepd*365 days = 1,241,100 boe * $33 EBITDA/boe (based off Q3 results) = $41M)

Pro-forma 2014 EBITDA = $340M

@ $1,406M EV = 4.13x EBITDA

Valuation – Target Valuation/Share Price Targets

Valuing JONE is a tricky proposition given that there are no other publicly traded Cleveland-focused E&P companies.  And so, a price target has to encompass something other than quantified relative value.  In this case I think it is important to outline the qualitative characteristics of the company that make it a compelling investment and argue how those should promote multiple expansion. 

First and foremost, the company is very well run.  The Jones family has been involved for almost 30 years and are leading Cleveland operators.  Their focus on cost control has been instrumental in JONE becoming the best in class operator in the Cleveland.  See slides 17 and 22: http://investors.jonesenergy.com/files/doc_presentations/Barclays%20CEO%20Energy-Power%20Conference.pdf.  Moreover, JONE is an acreage leader in the play and has been at the forefront of technological innovation in the play for the last decade.

I might add that through Q2 JONE sported a free cash flow surplus while also growing its production by over 25% YoY, which is exceedingly rare among small-mid cap E&P companies.  Although the company reported a slight free cash flow deficit in Q3, relative to its peers JONE remains on very solid financial footing with minimal cash burn.

Argument Summary

1. Excellent seasoned management team with large ownership stake
2. Acreage leader in the play with 30 years operating experience
3. Free cash flow positive while investing in expansion acreages
4. Technological innovator in the play
5. Optional free cash flow upside from further technological innovation

Price Target

Where do I think JONE should be trading? Established E&P companies that have proven themselves as operators and have significant multi-year drilling inventories like JONE can often trade in excess of 10x EBITDA. 

In the spirit of conservatism, my upside EV/EBITDA target multiple is 8x.

@ 8x 2014E pro-forma EBITDA of $341M

Target EV = $2,728M

Less Net Debt: $633 Debt - $23M cash ($610 net debt)

Target Equity = $2,118M

@ 49M shares outstanding

Target Price Per Share: $43

Catalysts/Event-Path

What will lead the shares higher?  There are several near term events that should be instrumental in removing some of the uncertainty that hangs over the company at the moment.

1. Lockup expiration (1/20/14) followed by a Metalmark secondary allowing larger hands to support shares higher

• Result: Remove JONE’s orphaned status

1. New completion design well results successfully increase EURs and well-level economics in the Cleveland play

• Result:  Remove uncertainty about the capex increase

1. Guidance raised above acquisition-adjusted street EBITDA of $340 million on the new well design

• Result: Show effects of technological innovation in terms of earnings power

1. JONE begins operating consistently with a free cash flow surplus – will require several quarters of results

• Result: Build a track record of profitability and ability to cash flow

Catalysts/Event-Path

What will lead the shares higher?  There are several near term events that should be instrumental in removing some of the uncertainty that hangs over the company at the moment.

1. Lockup expiration (1/20/14) followed by a Metalmark secondary allowing larger hands to support shares higher

• Result: Remove JONE’s orphaned status

1. New completion design well results successfully increase EURs and well-level economics in the Cleveland play

• Result:  Remove uncertainty about the capex increase

1. Guidance raised above acquisition-adjusted street EBITDA of $340 million on the new well design

• Result: Show effects of technological innovation in terms of earnings power

1. JONE begins operating consistently with a free cash flow surplus – will require several quarters of results

• Result: Build a track record of profitability and ability to cash flow