Crescent Energy Stock Builds Eagle Ford Position (NYSE:CRGY)

The past article has mentioned how Crescent Energy (NYSE:CRGY) has made the Eagle Ford a core operating area with the acquisition of SilverBow. But KKR runs the show here and the main idea was to take advantage of cheap prices to build a valuable upstream company. Therefore, another acquisition in the Eagle Ford comes as no surprise. At this point, the latest quarterly earnings do not mean much, and the next quarterly earnings will have a lot of nonrecurring items connected to all this acquisition activity. But KKR is very much “all about” cash flow. Therefore, the cash flow statement, over time, is going to be the key to many stated goals. Companies are often built to sell based upon the GAAP cash flow and free cash flow. This is something that KKR is an expert at.

At the same time, management wasted no time offering some notes to free up the bank line in case another deal appears.

Bolt-On Acquisition

As expected, this top-notch management pays a lot of attention to details.

At a very high level, the purchase price of $168 million for 3,500 surface acres is roughly $48K per acre in an oily area of the Eagle Ford. That is well below what a typical deal would look like in the oil area of the Permian (say Reeves County) and of course does not take into consideration all the other things, like midstream, that comes with the purchase.

More importantly, acreage that fits that well with existing acreage often allows more profitable (longer) wells to be drilled on the combined acreage than was the case with two different owners. Management has long swapped small non-core positions with other operators to build contiguous acreage positions that get the same thing done. But this deal appears to be far larger and hence more significant to the future of the company.

Also, very telling (that this is a bargain) is the fact that the debt ratio remains within the boundaries set by management, given that management just made a large acquisition.

Acquired Royalty Interests

It is not all that usual for a deal to also involve the significant acquisition of royalty interests (or at least a substantial amount of royalty interests).

Royalty Interests are paid “off the top” with only certain costs allowed. They can be every bit as valuable as the underlying surface acreage interests. As shown in the slide, this company already has substantial royalty interests. This can significantly change the economics of wells drilled when that royalty expense can be saved.

This can also be a source of cash in the future if the company determines that is a way to go.

Latest Eagle Ford Operations

This has changed so dramatically in the last few months, that an update was due as these acquisitions are made.

One of the more interesting things is that the bottom right-hand-side would appear to indicate that there is still a lot of small Eagle Ford operators.

The only thing about some of these acquisitions is that these small operators often have fairly high breakeven points for any number of reasons. Therefore, it takes some time for the latest technology to become prevalent enough for the average cost to come down.

To some extent, the big decline of first year production that happens with unconventional aids this process. Some operators do all they can to raise production before putting a property for sale. But the coming decline rate from that rapid production increase just makes it easier to replace that production with low-cost production.

Now, it would appear that there is enough acreage for economies of scale. More bolt-on acquisitions like the current one probably have an outsized effect on future profits. But even if there were no more acquisitions starting tomorrow it would appear that there is enough acreage to work with to lower costs substantially from the operators sold the properties to this company.

Clearly, the strategy of acquiring small operators to create a larger position in the Eagle Ford has cost advantages over the previous owners. It may take some time for the initial expenses to become less significant. Often, when properties or even whole companies are for sale, anything not mandatory is not done until after the sale. Much of what gets reported initially (like in the first year after the acquisition, give or take) is therefore due to deferred maintenance in addition to optimization by a larger operator like this one.

Moving Forward

The Eagle Ford is likely to figure in a major way for any future acquisitions. Clearly, this is now a core area where the company has a large enough operation to establish an advantage.

That may well mean that some of the original purchases will likely be sold. If management was successful in decreasing costs as planned, then those smaller purchases will likely be sold at a profit. There is also a possibility of a spin-off to enable a greater focus on the Eagle Ford alone if that would obtain a better sales price.

On the other hand, there may be an effort to establish another core area or two for diversification purposes. It all depends upon the existence of enough “unnatural owners” (to use the company’s own words) that allow for bargain purchases.

Summary

The Eagle Ford purchase continues the strategy of bargain purchases while combining those purchases into something more valuable than the original pieces were. Additionally, there are likely to be economies of scale savings along with using more current technology.

Given the experience of the KKR organization, the promised advantages are likely to show in future earnings. Now, what this will look like years from now is hard to state when the major idea is growth by acquisition of bargains. But KKR and John Goff will usually not get involved unless they can triple their money over 5 years. Whether that actually happens is another matter.

That makes this idea a strong buy. There is getting to be enough stock in public hands, that any one deal is not the stock price depressing event it was in the beginning of the public existence of the company. There are still more private shares that need to convert to public shares. But that process is becoming much less significant than it was in the past.

The Eagle Ford production often gets a premium while the far more popular Permian often ends up with takeaway issues that cause pricing discounts and extra transportation expense from time to time. Whether this situation again occurs in the future is anyone’s guess.

There is likely to be still more acquisitions because growth through acquisitions was a goal. Therefore, expect a lot of revisions to guidance until the company becomes large enough that each acquisition is not that disruptive.

Risks

The growth by acquisition strategy runs the risk that an acquisition can fail to meet expectations (or worse, be costly). KKR and John Goff, Chairman of the Board both have considerable experience making acquisitions and growing companies to sell. While the risk exists, it is much reduced due to the experience of the personnel running the company.

Any upstream company is subject to the volatility and low visibility of future commodity prices. A severe and sustained downturn could materially change the future of the company.

Unlike many KKR ventures, this one has an explicit strategy of a low debt ratio. Therefore, deleveraging and financial risks are minimized. Low debt companies seldom get into serious trouble. Because of this, this may be one of the lower risk ventures that KKR has engaged in.

KKR (the organization) has a larger amount of resources behind this company than is typically the case for similar sized companies. A loss of key personnel is likely to be much more easily replaced by KKR as a result. There may also be access to more good deals than is typically the case due to the nature of the organization backing the company.