Description

Description

Recent “spin off” trading on the OTC market with potential to double in the next 12 months. Imminent up listing on the NYSE or Nasdaq for end of Q3 2018 is a catalyst to re-rating

BUSINESS DESCRIPTION

Linn Energy (“LNGG”, soon to be called Roan Resources with ticker “ROAN”) is an oil and gas exploration and production company trading on the OTC market. LNGG emerged from bankruptcy in February 2017 with the majority of the company owned by Fir Tree, Elliott and York. We believe the sponsors provide strong oversight over capital allocation and downside protection through a potential take private in the event LNGG stock trades weak.

LNGG is a catalyst rich investment opportunity with the potential to double in the next 12 months. Key catalysts include a listing of LNGG equity on the NYSE or Nasdaq by September 30th, publishing of equity research highlighting the extensive resource base and increased liquidity from secondary offerings which are expected in Q4. 

Pre-bankruptcy, LNGG was structured as a Master Limited Partnership. LNGG’s strategy was to buy end-of-life oil and natural gas assets with low decline rates that required limited maintenance capex. The company used leverage to acquire assets and paid out excess cash flow as distributions. LNGG acquired Berry Petroleum in February 2013 increasing debt by ~$3bn. As oil and gas prices dropped in 2015, LNGG struggled to refinance the debt which ultimately led to its filing for bankruptcy in May of 2016. 

Upon emergence from bankruptcy, $8bn of liabilities were expunged and the Berry assets were divested. LNGG’s new strategy was three-fold: (i) divest non-core assets and (ii) invest in its growth asset in the Merge/SCOOP/STACK in Oklahoma and (iii) return cash to shareholders. 

In early August LNGG spun off RVRA to shareholders. RVRA assets include (i) a mature low-decline predominantly natural gas focused E&P, (ii) an MLP called Blue Mountain Midstream which has contracted volume with LNGG and, (iii) un-tapped acreage in the NW STACK with significant upside potential. We have highlighted the RVRA asset in a separate write up (email if interested).

LNGG owns a 50% stake of ~150,000 net acres in the Merge with well economics that are in line with best in class well results from the Permian Basin. LNGG contributed 70,000 net acres in the Merge/SCOOP/STACK to a joint venture with privately owned Citizen. We believe the strategic partnership was sound as many of LNGG’s wells were co-owned by Citizen, and they shared contiguous acreage allowing for longer laterals and higher working interest. We expect Citizen to convert their 50% interest in Roan into LNGG shares before the up-listing. Importantly, LNGG hired a world class management team from EOG Resources to optimize drilling, completion and capital allocation. The new CEO (Tony Maranto) brought on 50 former EOG Mid Con employees with extensive knowledge of the Anadarko Basin and best in class drilling techniques.

LNGG will be the first “pure play” Merge/SCOOP/STACK E&P providing investors with direct exposure to one of the largest ”rate of change” resource plays in the US. LNGG recently announced that it plans to double production in the next four quarters (from ~45,000 BOE/d in Q3 2018 to ~90,000 BOE/d in Q4 2019) with liquid production increasing from ~55% to >62% while growing unhedged EBITDAX from ~$355m to $675m (assuming $65 WTI and $2.75 NYMEX HH). The above is based on a type curve from 2017 and we believe that the EOG team has the potential to increase production even faster as they optimize both drilling and completion techniques.

Assuming the above, LNGG is trading at 4.5x EV/EBITDAX vs other high growth peers (CXO, CLR, PXD, etc at 7-9x EV/EBITDAX. If we assume 7x (at the low end of the range) the stock would be worth ~$32/share or double the current $16 share price with upside potential through further de-risking of the asset in 2020 and beyond.

THESIS

LNGG/ROAN is a compounder with strong paybacks of 12-18 months at current hydro carbon prices and significant upside from well optimization, inventory de-risking and tuck-in acquisitions. We believe that LNGG/ROAN can compound production growth per debt adjusted share at 100% in the next 12 months driving a 250% increase in EBITDAX and a doubling of the stock. Over the next 5 years, we believe LNGG can grow production per debt adjusted share at 25% per annum resulting in EBITDAX growth of ~400% and a potential tripling of the stock.  

VARIANT PERCEPTION

Underappreciated unit economics: 

The Merge has unit economics that are in line with the best wells in the country. At $65 WTI and $2.75 NYMEX natural gas prices wells pay back in 12-18 months with potential upside from enhanced drilling and completion techniques. The Merge wells benefit from their geology and geographic location. The geology of the Merge has the best attributes of both the SCOOP (South Central Oklahoma Oil Province) and the STACK (Sooner Trend, Anadarko, Canadian and Kingfisher counties) plays in the Anadarko Basin. The SCOOP is known for its liquid rich content that ranges from 50-80% liquid by volume. With WTI and NGL at ~20x and 2-3x natural gas prices the liquids content makes the wells much more profitable. The STACK is known for its over pressurized wells with extremely high initial production rates driven by high gas to oil ratios. The higher the initial production the faster the pay back on the wells. The Merge also benefits from its shallow depth which drives lower drilling costs and faster drilling times. 

The geographic footprint of the Anadarko Basin is ideal in that the long history of vertical drilling left the region with significant midstream capacity reducing the cost to build out infrastructure. The region is also ideally positioned near the Gulf of Mexico where they can get the best netbacks in the country as they can send their oil to Cushing and local refineries, NGLs to Mt Belvieu and gas to the petrochemical plants and LNG export terminals. 

The result of these attributes are break-evens in the high $30’s for oil and $2.75 natural gas. In a world where energy prices are expected to remain range bound, these assets are even more valuable as they provide strong volumetric growth to whomever owns them.
 
Poor Investor Sentiment: 

LNGG is a post-bankruptcy equity with all of the impediments to being fairly valued. LNGG currently trades on the over-the-counter market, has low liquidity and no sell side coverage making it un-investable for many traditional asset managers. Further, we believe there are some investors that are skeptical of LNGG’s asset value due to the recent negative headlines on well results from Alta Mesa and Devon. We would note that both drillers are in inferior regions of the STACK where there is less liquid and a higher probability for well to well interference as the reservoir gross to net is less favorable.

UNIT ECONOMICS

We believe there is upside to each of the key unit economic variables. To value an E&P you need to understand how each well performs, the uniformity of wells throughout the acreage, the cost of the wells and ultimately the price of the hydrocarbons. 

The estimated ultimate recovery (EURs) for “parent” wells in the Mayes (Meramac) and Woodford wells are 1.7mm and 1.4mm BOE, respectively. Price implied expectations imply an acreage wide EUR that is a fraction of “parent” wells (likely at ~50%). We believe that the realized EURs will likely be at 1.1-1.3mm BOE as the EOG team has dramatically improved their “on-target” drilling (from ~60% in 2017 to ~95% in 2018 – see investor presentation from 7.30.18). By more effectively targeting the reservoir, each well has a dramatically improved production profile, allowing for more uniform pressure and lower probability of well to well interference. 

IP-30 (initial production for 30 days) are currently assumed to be ~1,500 BOE/d and 740 BOE/d for the Mayes and Woodford wells based on pre-2018 drilling and completion techniques. The EOG team started drilling in Q1 2018 and has subsequently improved the curves by ~10% and ~25% respectively. 

With >150,000 acres (of which 117,000 are in the Merge, 29,000 are in the SCOOP and 8,000 are in the STACK) the uniformity of the acreage is critical. ROAN has largely delineated its acreage position with over 100 operated horizontal wells and is moving from “exploration” to “production” through an increase in spacing trials which should prove out the repeatability of drilling. LNGG currently assumes well spacing of 6 wells per section (1 square mile) in each of the Mayes and Woodford for a total of 12 wells per section. We believe that this is the minimum number of wells per section in the Merge and SCOOP acreage as many in the industry are testing 8 and 10 wells per section. For context, the Eagleford has >30 wells per section in its best locations. In total, we assume 2,400 wells throughout the companies acreage but with potential for 3,000-4,000.

Drilling cost/AFE or “authorization for expenditure” is currently forecasted at ~$8.5m/well and we expect this to fall to $8m/well as drilling times continue to fall and the company gains economies of scale in purchasing local services to offset potential drilling cost inflation as industry utilization improves.

We assume a range of $50 WTI to $75 WTI/bbl and NYMEX natural gas prices of $2.50-3.25 and a long-term base case price of $65 WTI/$2.75 NYMEX natural gas. Netbacks will be best in class as the assets are strategically located near some of the best demand regions in the country.

KEY INVESTMENT FACTORS

Oil & Gas prices – as an E&P, LNGG has exposure to oil and gas prices. The company hedges production over the next year and will likely continue to extend the duration of the hedges but this will have limited impact on net asset value.

Unit economics of Merge/SCOOP/STACK – this is the key driver of our reward case. We assume that unit economics will continue to improve as the EOG team applies best practices to drilling and completion. As an example, the team has reduced drilling days from ~30 days to 17 days on 2 mile Woodford wells, reducing cost by 13 rig days or almost $250k while improving “on-target” drilling from 55% to 95% increasing IP-30 by 10-25%.

RISKS

Oil & Gas prices – the single largest risk is oil price. We believe oil prices are range bound between $50 and $75; A $5 increase in oil drives a $40m increase in unlevered free cash flow (assuming no hedges).

Geology – while the geology is reasonably well understood, there is a risk that interference drives lower EURs between “parent” and “child” wells than we forecast.

VALUATION

We value LNGG on NAV and juxtapose that with EV/EBITDAX. 

Critical base case assumptions include:
• $65 Oil/$22 NGL per barrel and $2.75 NYMEX natural gas 
• 1,200 EUR with 40% oil, 20% NGL and 40% natural gas
• 2,400 wells with a 76% working interest and 20% royalty
• LOE of $3.00, transportation cost of $2.25 and $3.50 G&A/bbl, 7% production taxes
• $0.50 gas differential and $1.50 oil differential
• $8m AFE, 8 rigs drilling 15 wells per year
• 10% discount rate for NAV

Our Net Asset Value is $5.3bn less $450m of assumed net debt. We assume 160m shares (2x current count as Citizen will convert their shares to LNGG before the up listing to the NYSE/Nasdaq). Based on the above the share price would be ~$31 vs $16 current price.

Similarly, our run-rate Q4 2019E EBITDAX is $780m based on 94,000 BOE/d production and similar oil and gas prices. If we apply a 7x multiple (at the low end of the comparable universe) our target price is $32.

Risk case assumptions:
• $55 Oil/$19 NGL per barrel and $2.75 NYMEX natural gas 
• 1,000 EUR with 40% oil, 20% NGL and 40% natural gas

Our NAV is $2bn implying a share price of ~$10 whilst our EV/EBITDAX based valuation implies $16 (assuming a 5.5x EV/EBITDAX).

Reward case assumptions:
• $75 Oil/$26 NGL per barrel and $2.75 NYMEX natural gas 
• 1,250 EUR with 40% oil, 20% NGL and 40% natural gas
• 3,600 drilling locations

Our NAV is $10bn implying a share price of $60 whilst our EV/EBITDAX based value implies $46 (assuming a 9x EV/EBITDAX).

Catalyst

Key catalysts include a listing of LNGG equity on the NYSE or Nasdaq by September 30th, publishing of equity research highlighting the extensive resource base and increased liquidity from secondary offerings which are expected in Q4.