Description

Risk/Reward

From current $10.45, you are risking 45c in a downside scenario (firm $10.00 cash redemption/liquidation floor) to make $7 to $10 in an upside scenario (per the company’s closest and most recent precedent, CDEV) within the next 12 months. You have upside optionality on (1) the separate trading of the common and warrants on or around May 15, (2) deal announcement, and (3) management marketing ahead of the shareholder vote before formal deal close.

Thesis

Silver Run Acquisition Corporation II (“SRUNU”) is a special situations investment where from current $10.45 you are risking 45c to participate in the optionality of a best-in-class operator (former Anadarko Petroleum Chairman/CEO Jim Hackett) and leading energy-dedicated private equity firm (Riverstone Holdings, founded by David Leuschen who built Goldman’s Global Energy & Power Group) sourcing, announcing, marketing, and consummating an acquisition in the upstream or midstream space which, if following the recent precedent of Silver Run Acquisition Corporation I (formerly “SRAQU,” now “CDEV”), could return $7 to $10 within the next 12 months in an upside scenario (CDEV was announced within 5 months of the vehicle’s February 2016 listing). Each SRUNU unit comprises 1 common share (“SRUNU”) with a firm $10.00 cash redemption/liquidation floor plus 1/3rd of 1 whole warrant (“SRUNW”). The separate trading of the common and whole warrants on or around May 15 will result in clear public markers for SRUNU’s underlying components. In the period prior to deal announcement, the common and warrants underlying SRUNU should trade similarly to the few (3 to 4) other special purpose acquisition company (“SPAC”) vehicles with attractive attributes: (1) backing from an accomplished, deep-pocketed financial sponsor, (2) a well-known CEO ready to take the reins with a proven track record of long-term value creation, and (3) a clear sector-specific mandate that plays to the strengths of both financial sponsor and CEO. Besides SRAQU (Riverstone/Papa/E&P), the most analogous of these may be consumer-focused Conyers Park Acquisition Corporation (“CPAAU”), led by former Gillette Chairman/CEO Jim Kilts and former Hershey CEO David West (both partners in Centerview Capital’s Consumer Private Equity Group), which currently trades $11.22 versus its $10.00 offering price from July 2016. Conyers’ common (“CPAA”) trades $10.70 and whole warrants (“CPAAW”) $2.50 which implies CPAAU (1 common plus 1/3rd of 1 whole warrant) is intrinsically worth $11.53 (the 31c leakage versus CPAAU’s $11.22 is a pricing inefficiency likely driven by more limited liquidity). SRUNU is larger and more liquid than CPAAU: its March 24 IPO raised $900 million in actionable cash proceeds from the sale of 90 million units at $10.00 per unit ($1.035 billion from the sale of 103.5 million units including underwriter over-allotments). A larger capitalization and higher average trading volume should support more efficient pricing, as well as greater Street coverage, investor interest, and index inclusions following deal announcement and close. SRUNU’s structure is particularly conducive to the energy sector right now because it solves important strategic problems for sellers. The existing dislocation in the energy markets has resulted in an increasing supply of forced sellers (large corporations seeking to de-lever and private companies less equipped to IPO) who prefer a combination of cash (to take some money off the table) and, significantly, “like-for-like” equity (to participate in the upside of the specific asset they are monetizing, as opposed to receiving the “diluted” equity of a larger strategic with operations across many lesser assets). At the same time, the public market is ascribing premium multiples to focused, single-basin E&P players with strong relative production and cash flow trajectories, pedigreed management, and clean balance sheets (i.e., CDEV). Given the firm $10.00 cash redemption/liquidation floor, SRUNU offers holders a put while enjoying upside optionality on deal announcement, management marketing, and eventual close. CDEV units (then “SRAQU”) listed in February 2016 at $10.00 (1 common plus 1/3rd of 1 whole warrant), were worth $11.53 on deal announcement in July, steadily appreciated in value as management marketed through September, and were worth $17.66 by the time the acquisition formally closed in October, after which the $10.00 floor went away and CDEV became like any other stock. During the period between July deal announcement and October close, CDEV holders enjoyed optionality on commodity pricing developments impacting the acquired business with a $10.00 put in hand. At SRUNU’s current price of $10.45, the market seems to be valuing the underlying common at $10.00 (vs CDEV currently $18.15 and CPAA $10.70) and each whole warrant at $1.35 (vs CDEVW currently $6.51 and CPAAW $2.50). This suggests you are risking 45c in SRUNU for pre-deal-announcement runway to $11-$12 and post-deal-announcement runway to $17+ all while enjoying a firm $10.00 cash redemption/liquidation floor until formal deal close.  

Structure

Silver Run Acquisition Corporation II is a blank check acquisition vehicle of Riverstone Holdings Fund VI, a private investment fund managed by Riverstone. Riverstone is a $30+ billion energy-focused fund founded in 2000 by David Leuschen and Pierre Lapeyre who built Goldman’s Global Energy & Power Group. Silver Run Acquisition Corporation II’s CEO, Jim Hackett, has been a partner in Riverstone’s Houston Office since 2013. He previously served as Chairman of Anadarko Petroleum from 2006 to 2013 and as CEO from 2003 to 2012. Before joining Anadarko, Hackett served as President and COO of Devon Energy Corporation following its merger with Ocean Energy, where he had served as Chairman/President/CEO. At a March 21 pre-IPO meeting for prospective investors held by Citigroup, Hackett suggested that Silver Run Acquisition Corporation II could announce a deal within 9 to 12 months or sooner though perhaps not as soon as 5 months (Silver Run Acquisition Corporation I announced its deal on July 22, 2016 following its IPO on February 29). Hackett said he wants to work with Riverstone to build a long-term, compounding permanent capital vehicle, which he said he prefers to the 5-to-7 year vintage of private equity portfolio companies. He said he wants to capitalize on his team’s operational expertise, Riverstone’s ability to be a first mover in higher-profile trends (i.e., CDEV in the Southern Delaware Basin), the existing dislocation in energy prices, and his view that global crude oil demand remains an underreported story with demand expected to grow 5 MMbpd by 2020. Silver Run Acquisition Corporation II listed last week (March 24) through the sale of 90 million units (“SRUNU”) at an offering price of $10.00 per unit raising $900 million in actionable cash proceeds ($1.035 billion including the underwriters’ 45-day option to purchase an additional 13.5 million units to cover over-allotments). Each SRUNU comprises 1 Class A common share (“SRUN”) plus 1/3rd of 1 whole warrant (“SRUNW”). Each whole warrant entitles the holder to purchase 1 share of Class A common stock at a price of $11.50 per share. The warrants will be exercisable 30 days after the completion of an initial business combination and will have a 5-year life. SRUN and SRUNW will begin separately trading from SRUNU on or around May 15 (52 days from the publication of the Offer Prospectus). Holders of SRUNU will have the option to continue holding their SRUNU (which will remain trading) or to separate their units into the component securities (i.e., after May 15 you will see SRUNU, SRUN, and SRUNW all trading). This event will force the market to ascribe a separate value to SRUN and SRUNW which will provide clear public markers for SRUNU’s sum-of-the-parts. SRUN has a firm cash redemption floor of $10.00 should the holder dissent to an announced deal (even if the transaction is ultimately approved by fellow shareholders), as well as a firm cash liquidation floor of $10.00 in the event Silver Run Acquisition Corporation II is unable to consummate a deal by March 2019 (within 24 months of its March 2017 listing). The floor is a “firm” $10.00 because, per the Offer Prospectus, $900 million in aggregate cash proceeds ($1.035 billion including over-allotments) has been deposited into an interest-earning US-based trust account at JP Morgan Chase NA with Continental Stock Transfer & Trust Company acting as trustee. Riverstone has contributed $23 million in risk capital to the trust to cover $21 million in initial underwriting commissions and $2 million for working capital. Upon redemption or liquidation the $900 million in trust proceeds will be distributed to holders of the 90 million Class A common shares ($1.035 billion and 103.5 million including over-allotments). The warrants have no redemption or liquidation feature and will therefore be worth $0 in the event no deal is consummated within 24 months. SPAC warrants have generally enjoyed a fairly significant appreciation in value upon formal deal announcement as the market discounts the probability of a “no deal” (i.e., $0) scenario. SRUNW should embed a higher probability of deal consummation in a tighter timetable due to Riverstone’s history and Hackett’s presence.

Pre-Deal Precedent: CPAAU

In the period preceding deal announcement, SRUNU should trade similarly to the few (3 to 4) other SPACs with attractive attributes: strong financial sponsors, well-known CEOs ready to take the reins, and a clear sector-specific mandate in their wheelhouse. The most notable may be Conyers Park Acquisition Corporation (“CPAAU”) led by former Gillette Chairman/CEO Jim Kilts and former Hershey CEO David West, both partners in Centerview Capital’s Consumer Private Equity Group. CPAAU listed in July 2016 at $10.00 (comprising 1 common share and 1/3rd of 1 whole warrant) and currently trades $11.22. The common (“CPAA”) trades $10.70 and the whole warrant (“CPAAW”) trades $2.50 which suggests CPAAU should be trading $11.53 on a pure sum-of-the-parts basis. The 31c delta is a pricing inefficiency likely attributable to the illiquidity of the different securities. SRUNU should trade more efficiently than CPAAU due to its larger capitalization and higher average trading volume. CPAAU may be benefiting from the thematic backdrop of consumer M&A (for example, potential divestitures from any larger Kraft deal), press around potential acquisition candidates (such as the Ferrara Candy Company), and the recent success of Hostess which listed through a SPAC vehicle sponsored by the private equity firm Gores Group (“TWNK”). Seth Klarman’s Baupost Group is among the largest holders of Conyers Park (3.7 million CPAA, 1.2 million warrants), Silver Run Acquisition Corporation I (2.4 million CDEV shares), and media-focused Saban Capital Acquisition Corporation led by Haim Saban (2.4 million SCAC shares, 1.2 million SCACW). Other notable vehicles include technology-focused GTY Technology Holdings (“GTYHU”) led by former EMC Chairman/President/CEO Joe Tucci (Elliott Management is the top holder), as well as FinTech-focused CF Corporation (“CFCOU”) led by former Blackstone partner Chinh Chu (who has since founded CC Capital Management) and Fidelity National Financial Group Chairman Bill Foley.

Post-Deal Precedent: CDEV

Silver Run Acquisition Corporation I was an energy-focused blank check acquisition vehicle sponsored by Riverstone that “was established to take advantage of the existing dislocation in the energy markets and to identify an asset that could be a platform for significant potential compounded returns over the long-term” (September 2016 Investor Presentation). On February 29, 2016, Silver Run Acquisition Corporation I completed its IPO of 50 million units (“SRAQU”) at $10.00 per unit generating $500 million in actionable cash (deposited in a trust with a firm $10.00 cash redemption/liquidation floor). The company’s CEO, Mark Papa, like Hackett a partner in Riverstone’s Houston Office, is best known as Chairman/CEO of EOG Resources, which he grew over 15 years into among the largest US crude-oil E&Ps. During SRAQU’s pre-IPO roadshow Papa said he aspired to acquire an oily asset (given his bullish crude oil macro view over the next 5 years) in 1 of the 5 North American basins with in-place oil production that he could ramp in a risk-adjusted fashion through capital infusion and technology upgrades. Papa said he wanted low debt post close and to emphasize GAAP net income as opposed to peers focusing on non-GAAP. Like SRUNU, each SRAQU comprised 1 Class A common share (“SRAQ”) and 1/3rd of 1 whole warrant (“SRAQW”) entitling the holder to purchase 1 SRAQ at $11.50 with a 5-year life. On April 14 Papa announced the separate trading of SRAQ and SRAQW (at which point all of SRAQU, SRAQ, and SRAQW were trading). On July 6 Riverstone entered into a definitive agreement to purchase an approximate 89% interest in Centennial Resource Production from private equity firm NGP Energy Capital Management. On July 22 Riverstone agreed to assign, and Silver Run Acquisition Corporation I agreed to assume, its right to purchase the interest in Centennial (subject to the approval of Silver Run Acquisition Corporation I’s shareholders). The transaction was entirely equity financed, and in structuring the deal Riverstone effectively provided SRAQ holders with the opportunity to participate alongside Riverstone in the acquisition. SRAQU contributed its cash on hand, Riverstone agreed to purchase 81 million shares of SRAQ at $10.00 per share, two institutional investors agreed to purchase 20 million shares of SRAQ at $10.00 per share (Fidelity Management and Capital World), and the seller (NGP Energy Capital Management) elected to retain a 11% equity stake in the company to co-participate in the pro forma upside. On a pro forma basis, Riverstone became the single largest shareholder of the company at 51%. Riverstone said that it would purchase additional SRAQ shares at $10.00 cash per share in the event SRAQ shareholders chose to redeem their shares in connection with the acquisition, ensuring an easy exit for any dissenting shareholders (though with SRAQ trading well above $10.00 it was then more logical/economical to simply sell in the open market) as well as SRAQ’s ability to fund the acquisition. The transaction created a pure-play public Southern Delaware Basin company (42,500 net acres located on private land in West Texas’ Reeves and Ward counties) with a highly attractive relative E&P production and cash flow growth profile, a pedigreed management team, and a clean balance sheet with $100 million net cash. In its September 2016 Investor Presentation, which was used to market the deal to shareholders ahead of the October deal vote, Papa framed the company’s attractive valuation. Assuming a SRUN share price of $10.00, Centennial was being created at 6.6x TEV / 2018E Adjusted EBITDAX ($1.735 billion TEV on 2018E EBITDAX of $264 million) versus peers (CXO, FANG, RSPP, PE, CPE) trading 7-10x. Papa suggested that Centennial should re-rate as the market appreciated its above-peer 2017-2018E oil production growth rate (66% vs peers’ 16-31%; Papa said Centennial’s 6,000 boe/d net oil production could be “multiplied”), competitive cost structure supporting compelling unit economics, inventory (48.6 MMboe of net proved reserves), and the potential for operational improvements to drive incremental upside. Earlier, on the July 22 M&A call, Papa had already begun positioning Centennial as a first-class, single-basin E&P: “So the objectives for this company and where we want to take this company are number one, we expect it to have the highest oil growth rate. Again, this is oil not BOEs, oil growth rate of any company in the small-cap Permian Basin peer group over the next four years, at least. We expect to have clearly the lowest debt. We expect to achieve good ROEs on our ROCEs during that period. And the last — and really one of the most important one — in the small-cap Permian Basin peer group, we expect to become the most technically competent company in that peer group. That’s very important to me. So those are some of the goals we have in the Company. It’s an exciting time. And as we said, we are pragmatically optimistic relating to the oil macro situation, so we think we’re catching the wave at the right time too.” On July 22 the common closed at $10.58 and the warrants at $2.85 for a unit value of $11.53. Management formally marketed the deal to investors in September, shareholders approved the deal on October 7, and the deal closed October 11. On October 12 Silver Run Acquisition Corporation I was renamed Centennial Resource Development with the common trading as “CDEV” and warrants as “CDEVW.” The common closed on October 11 at $15.86 and warrants $5.42 which put the units at $17.66, 53% above their value on July 22 when the Centennial deal was initially announced. Beginning October 12, the firm $10.00 redemption put went away (CDEV became just like any other stock) and the units automatically separated into their underlying component securities. In November CDEV acquired Silverback Exploration from private equity firm EnCap Investments which closed in December 2016. In December four sell-side firms initiated coverage on CDEV (Wunderlich, Canaccord, Deutsche Bank, and Stephens; price targets $24 to $28) with CDEV peaking at $20.97 and CDEVW at $8.70 which put the units at $23.87. CDEV currently trades $18.15 and CDEVW $6.51 (implied unit value $20.32).

Risks & Mitigants

You lose 50c if SRUNU cannot consummate a deal by March 2019. In that scenario, you will receive $10.00 from the trust for SRUN but your SRUNW will be worth $0. If you hold SRUNU or SRUN beyond formal consummation of any announced deal (i.e., after the shareholder vote), you risk capital loss beyond 50c because at that point the firm $10.00 cash redemption floor falls away and SRUN becomes like any other stock. Mitigating these risks, you have months of runway within which to monetize your SRUNU, SRUN, and/or SRUNW while enjoying multiple call options that are currently being mispriced.

Resources

Silver Run Acquisition Corporation II Offer Prospectus: https://www.sec.gov/Archives/edgar/data/1690769/000104746917001986/a2231531z424b4.htm

CDEV July 2016 M&A Call: https://www.sec.gov/Archives/edgar/data/1658566/000110465916133908/a16-15339_2ex99d1.htm

CDEV September 2016 Investor Presentation: https://www.sec.gov/Archives/edgar/data/1658566/000110465916143354/a16-15542_5ex99d1.htm

Catalyst

Separate trading of the common (“SRUN”) and warrants (“SRUNW”) from the units ("SRUNU") on or around May 15.

Deal announcement potential within the next 9 to 12 months and potentially sooner (CDEV was within 5 months).

Hackett and Riverstone marketing the deal following announcement ahead of the shareholder vote.

Formal closing of the deal with sell-side initiations and index inclusions.