Description

Silver Run Acquisition Corp (SRAQU) is blank-check/SPAC for former EOG Resources CEO Mark Papa and represents a risk-averse way to play a cyclical recovery in North American upstream energy.   Silver Run raised $450mm in a late February IPO led by Deutsche and the units trade at around $10.30, which is a 30c premium to the issue price if you ignore, for the moment, the potential future warrant value.  While it would obviously be preferable to buy at or below $10, the modest premium reflects a cheap ticket to ride alongside Papa and energy/power private equity juggernaut Riverstone in their effort to acquire attractive oil and gas assets at a good price and manage them in a way that creates long-term shareholder value.  As no deal has yet been put forth for shareholder approval, the assessment of the risk/reward rests in large part upon a belief in Papa as a value creator as well as the premise that the market presents good opportunities for him to do so.

EOG was spun off from Enron in the late 80s and Papa took the helm in 1999.  From that time until his departure in late 2013, he built EOG into the largest producer of crude in the lower 48 states and a pioneer in the extraction of shale oil through horizontal wells and fracture stimulation.  During his 15 year tenure as CEO, the stock compounded at over 20% with dividends reinvested.  The S&P 500 returned 4%, the S&P 500 Energy Index did 11% and the version of the index that includes only upstream producers like EOG compounded at 7%.  One would be hard pressed to find another major E&P leader with a long-term record that approaches that of Papa.  Across the major cycles that span his career at EOG he was typically a net seller of undeveloped acreage or other less productive assets during boom times and a net buyer in bad times.  This stands in sharp contrast to peers like Chesapeake in this growth obsessed and often value-destroying sector.

The other relevant player in Silver Run is the energy focused private equity firm Riverstone, which created a separate wholly owned affiliate to house Silver Run and float the IPO.   Riverstone was founded in 2000 and is led by Pierre Lapeyre and David Leuschen.  The firm has deployed over $30 billion in 120 deals across the energy value chain out of nine private equity funds and two listed closed end vehicles.  While Riverstone has a good reputation and track record but the way I am looking at it, the key driver is Papa but the Riverstone relationship allows him to better source, vet and hopefully close (including the potential for additional needed equity and debt capital) one or more major deals than he could with a small, newly built team.

As to the climate for an acquisition, there is definitely carnage in this market and likely more to come given that despite a rebound in the markets since mid-February, only $2bn in bonds were issued in the US by energy companies in the first quarter of 2016.  This is one of many signals that there should be plenty of stressed and distressed sellers of upstream North American assets in the coming few quarters.  The main question or concern, in my opinion, is the degree to which large amounts of capital from the likes of Apollo, Blackstone, Encap, NGP, etc. are waiting for larger blocks of unconventional acreage in the more attractive basins (Permian, Marcellus, SCOOP, Wattenberg) such that the currently wide bid-ask spreads on these bigger deals closes on the offer side, i.e. in favor of the seller. 

A few things give me some degree of comfort in the risk/reward setup despite the uncertainty in the ability to buy attractive, large scale oil and gas assets at compelling prices.  If they don’t consummate a deal either because they don’t find and win one that meets their criteria or because enough shareholder’s don’t vote in support of the deal, the company is unwound and the cash currently held in escrow (net of a few million or perhaps around $0.60 per share of underwriting commissions and deal costs) is returned to shareholders.  Now clearly they are incentivized to get a deal done given that the sponsors will own approximately 20% of the acquired asset which they can then use to grow and likely target additional deals as EOG did.  So, notwithstanding the information asymmetry, the ability of shareholders to opt out and have your cash returned is valuable.  Also, the units contain a one-third warrant struck at $11.50 which expire on 4/31/21.

Note that the shares and warrants also trade on a detached basis (tickers SRAQ and SRAQW) though the volume of each is very low.  The warrant likely appreciates should Papa announce a transaction that gives the market confidence that he is working off of the value-creating playbook that made EOG such a huge success.  Note that this stapled warrant is really why you often see arbitrage  focused  hedge funds dominating the shareholder registries of SPACs since they can opt out of the deal, have their  cash returned and  keep the warrant for “free” upside depending on the price paid for the units and amount of deal expenses incurred.  In this case however, I note that MSD Partners (Michael Dell’s family office investment vehicle) shows up as a holder of 6% of the units.  MSD has a long history of successful investing in energy and runs an energy focused hedge fund.  Likewise Wellington is a top holder and though I can’t confirm which entity/fund the position resides in, they too run a very long-standing and well regarded energy focused hedge fund.  So some fundamentally focused  longer-term investors on the ledger as opposed to the usual SPAC arbitrageurs.

Catalyst

announcement of an acquisition.