Investors were disappointed with the announced $1.87 billion sale of Southwestern Energy Co.'s Fayetteville Shale operations to a young, private-equity-backed driller, but the sale could be good news for midstream operator Boardwalk Pipeline Partners LP, analysts said.
Southwestern's shares fell 5% in heavier-than-normal trading Sept. 4, to $5.34, after the company announced it was selling its wells, leases and midstream gathering and processing operations in the play it pioneered more than a decade ago.
Buyer Flywheel Energy LLC, backed with $700 million in new capital from Kayne Anderson Capital Advisors LP's Private Energy Income Funds, said it would borrow the remainder of the purchase price from lenders led by Wells Fargo Bank NA and Citibank NA. Flywheel, the successor to Valorem Energy LLC and built around a CEO and COO who were previously vice presidents at Bakken Shale pioneer Continental Resources Inc., will operate the Arkansas play alongside its current holdings in the Bakken Shale. Kayne has invested in both Flywheel operations.
While the purchase price comes close to analysts' expectations, Southwestern's plans to use $600 million of the proceeds to expand gas and liquids production in southwest Appalachia might have disappointed some.
"Proceeds will be used to reduce debt ($900 million), repurchase shares ($200 million), and accelerate activity in SW Appalachia ($600 million)," Jefferies LLC oil and gas analyst Zach Parham wrote as he outlined the deal for his clients. "While getting a sale completed in a tough market for gas assets will likely be viewed positively, we believe investors may have wanted more debt reduction/cash return versus utilizing proceeds to outspend cash flow to drive additional growth."
B. Riley FBR Inc. oil and gas analyst Rehan Rashid said the purchase price was a little light, but paying off $900 million in debt gives Southwestern a lot more flexibility for its future in Appalachia. "Even though value realized of $2.3 billion [$1.9 billion cash and roughly $400 million of contracts for future pipeline capacity] is slightly below our expectation of $2.5 billion," Rashid said, "we believe that this is still a very good outcome for corporate capital structure and should allow for stronger enterprise and investor focus on growth/value maximization of Appalachian assets and equity valuation."
With Southwestern's northeast and southwest Pennsylvania shale operations at neutral cash flows, Rashid argued, the company can grow production cheaply and direct that cash to further buybacks or debt reduction.
An eventual winner in the deal could be the midstream operator Boardwalk, as the new owners will be more focused than Southwestern on the Fayetteville's future production, CreditSights pipeline analyst Charles Johnson predicted.
"Flywheel Energy, backed by Kayne Private Energy Income Fund, will assume [Southwestern's] firm Fayetteville contracts, and we have seen a number of [private equity] backed producers move into legacy dry gas basins and ramp up production because they don't own acreage elsewhere to shift capital to," Johnston said.
In October 2017, Boardwalk and Southwestern renegotiated their Fayetteville contract, cutting committed capacity to 100 MMcf/d from 800 MMcf/d until October 2020, when contracts on Kinder Morgan Inc./Energy Transfer Partners LP's competing Fayetteville Express Pipeline expire. After Fayetteville Express' commitments roll off, Boardwalk has firm transportation contracts for 800 MMcf/d with any production beyond that level committed to Boardwalk, CreditSights said.
Flywheel CEO Justin Cope was a vice president of business development, then vice president for Southern development for Continental, after being an investment banker with Goldman Sachs' energy group. COO Heath Mireles was Continental's vice president for resource development after starting there as a completions engineer in 2010.
JP Morgan Securities LLC was Southwestern's financial adviser on the deal, with Latham & Watkins LLP serving as legal adviser. Wells Fargo Securities LLC was Flywheel's financial and technical adviser, with Vinson & Elkins LLP providing legal advice.