DEC-a-dance
SPV disposal enhances value by over $111.5m! (or £1.81 per share) + Benefits!
Diversified Energy Company PLC (LSE: DEC, NYSE: DEC) is pleased to announce that it has closed an innovative transaction (the "Transaction") that has allowed the Company to unlock additional value from its current asset base at an attractive multiple while further enhancing liquidity and reducing leverage.
Nice to see DEC is up 83p today. Based on the current 47,923,726 shares in issue a $111.5m gain works out at £1.81 per share. So the market has recognised less than half of the gain!
How do I arrive at an $111.5m gain? Read on, reader.
DEC Balance Sheet
“$200m proceeds used for working capital and reduction of the RCF.”
Debt as at 30/09/23 was $1,510m (per the Q3 Trading Update)
We also read there is a “12% reduction in debt.” Using the 30/09 number that is ~$181.2m
So revised Debt 02/01/24 is an assumed $1,328.8m
The RCF facility at 30/09/23 had a balance of $290m (this assumes zero cash and a $425 RCF limit - since the Q3 update states $135m liquidity)
New RCF balance 02/01/24 is an assumed $108.8m (the $181.2m reduction)
Liquidity per Q3 Trading Statement ~$135m. Therefore Working Capital Increases $18.8m to an assumed ~$153.8m.
Finance Cost Reduction 2024 $15.7m (RCF Interest rate 8.65%)
Production per Q3 Trading Statement 806 MMcfepd therefore assumed production 02/01/2024 736 MMcfepd (factoring in a 50 MMcfepd sale to the SPV and 20 MMcfepd reduction in flow in Q4).
Sale was for PV10 of $230m. The totality of DEC’s future value on a PV10 basis is approximately $8,000m (this is given in their presentations). Therefore this represents a (230/8000) = 2.875% reduction - assuming pro rata:
Assets reduced:
30/06/23 $2690m of Natural gas and oil properties, net. Reduction $77.3m
30/06/23 $465m Property, plant and equipment, net. Reduction $12.8m
Liabilities reduced:
30/06/23 ARO. Reduction $12.9m
30/06/23 DD&A. Reduction of $3.3m
SPV
SPV EBITDA profitability is $35m.
20% ownership assumes $7m EBITDA to DEC ~$3m dividend PAT for DEC. $3m annual gain.
Sale of 80% equity in SPV for $30m implies 20% ownership for DEC should be valued at $7.5m
This therefore means a gain on disposal of $111.5m!
These are estimates and there are based on “as at 30/09” last available numbers - the absolute amount of debt for example will differ from the quoted numbers.
But the key point to bear in mind is the $111.5m gain is a DELTA - the amount of change - rather than the specific balances.
(In actual fact in simple terms you’re getting $200m of assets (Cash) for a net cost of $69.7m (assets less liabilities) so the true gain on disposal might be $130.3m. I’m taking “general corporate purposes” for the amount beyond $181.2m to mean it’s been expensed to the P&L.)
P&L year 2 is an approximate $11.4m net reduction in profit…. offset by the $111.5m gain and the $11.4m “loss of profit” would be negated (or perhaps even there’s a net gain?) by one or more of the upsides below.
Other Upsides
a/ SPV Operator income - I’ve made no allowance for the P&L impact of operating these wells e.g. admin cost. But DEC won’t be doing that for free! But I don’t know what profit that will generate so have conservatively assumed zero.
b/ Firepower - Working Capital of $182.3m and RCF headroom of $192.7m gives firepower of $375m too! We know that Rusty hates cash sitting idle so there will be a plan - but what will it be?
bi - Another Tanos-type acquisition?
bii - Zap the RCF entirely? Saves a further $9.7m finance cost per annum.
biii - Tender offer - make them land lubbing DEC-tractors walk the plank!
biv - Something else entirely?
c/ What’s in the SPV?
ci/ Has DEC offloaded a motley crew of its worst wells to insulate itself? I think this unlikely as the 80% owner of the SPV would have to be incredibly gullible (and also ignorant of recent news concerning DEC) and besides these wells were linked to the sustainability-linked loan so have good ESG criteria, one would think.
cii/ What’s more likely is the SPV contains wells with little or no upside available through workovers and development. They are the steady eddies and not the star players. With SAM we know there is a plethora of data. Can you picture Rusty with his “Peter Brand” analyst(s) working through the stats to work out which wells to trade. This video analogy is a good one, reader.
d/ Hedges
Nor have I made any attempt to calculate the value (positive or negative) of any hedges which have transferred (or not) to the SPV. I’m assuming no hedges transferring. We know 80% of 2024 production is hedged …. so I believe the percentage of hedged production has just increased to ~85% in 2024 at $3.31/mcf and from 70% to ~75% in 2025 at $3.26/mcf.
e/ Tax Credits
DEC as at 30/06/23 has deferred tax credits of $176.7m. Using the 22% tax rate, this makes the next $800m of taxable earnings “tax free”. These tax credits largely exist through Federal Credits (although the IFRS9 profit after hedging also drives a tax gain/loss). What are Federal Credits you ask? It took a bit of digging to find the answer, but found it I did. In the DEC 2020 annual report (!) states:
“The effective tax rate is primarily impacted by recognition of the federal well tax credit available to qualified producers in 2020, who operate lower-volume wells during a low commodity pricing environment. The federal government provides these credits to encourage companies to continue producing lower-volume wells during periods of low prices to maintain the underlying jobs they create and the state and local tax revenues they generate for communities to support schools, social programmes, law enforcement and other similar public services”
Two thoughts here:
a/ Will Federal Credits occur again in 2024? Election year. Safeguarding jobs. Henry Hub is at a low price.
b/ These tax credits did not transfer to the SPV so there is an accrued gain of federal credits, even on wells DEC no longer directly owns!
Conclusion
Disecting the deal there is clearly accretive value for DEC-hands so when Rusty says the deal is “At an attractive multiple” - yep, it sure is!
This is not advice
Oak
I remember Rusty once joked about buying back the company over a year ago. I hope we see a tender buyback offer announced with the increase in liquidity. Thanks for all the post Oak Bloke.
Oakbloke; I think I am singular in thinking this is a bad deal, and mere financial engineering. My start point is, if you really believe in the value of your assets, why would you sell them? Selling them as they have done, says to me either, they need the cash pronto, or they don't believe they have a value beyond that committed to the original debt.
Yes, you have got rid of 80% of the ARO, but you've also lost 80% of the value/gain. That you so believed was undervalued when you originally bought it.
This transaction doesn't speak of strength.