Bold Move: Earthstone Adds Midland Acreage At Bargain Price

Roughly six months after entering the Permian Basin, Earthstone Energy Inc. (NYSE: ESTE) has landed a transformative acquisition for 20,900 net surface acres in the Midland Basin—at a surprisingly low price.

Earthstone will combine with EnCap-backed Bold Energy III LLC, which owns acreage in Reagan, Upton and Midland counties in West Texas. Bold’s assets consist of 62,500 net effective acres in the Midland core with net production of about 2,320 barrels of oil equivalent per day (boe/d) predominantly from Wolfcamp wells.

Baird Equity Research estimated that Earthstone paid roughly $15,000 per acre for Bold based on the transaction’s preliminary details, far less than other recent deals that have cost three times as much.

The all-equity Earthstone-Bold deal is “an attractive valuation in light of recent Permian transactions at twice that figure or more,” Daniel P. Katzenberg, the firm’s senior research analyst, said in a Nov. 9 report.

Bold’s inventory includes more than 500 gross operated drilling locations, which is expected to increase with further de-risking of the Spraberry and Wolfcamp intervals, said Frank A. Lodzinski, Earthstone’s president and CEO.

Earthstone said Nov. 8 it agreed to acquire Bold’s outstanding membership interests including producing assets and undeveloped acreage, in an “Up-C” transaction. Such a transaction enables a private partnership to take itself public while retaining certain tax benefits, similar to an MLP.

At the close of the deal, Earthstone will own about 39% of the combined company's Class A and Class B stock. Bold’s unitholders are expected to own about 61%.

Throughout 2016, the Permian Basin has been the epicenter of North American A&D activity with seemingly every deal increasing acreage prices.

In June, QEP Resources Inc. (NYSE: QEP) upped the ante in its acquisition of about 9,400 net acres in the northern Midland Basin for $600 million. The deal doubled the average amount paid per acre, said Chris Stevens, an analyst at KeyBanc Capital Markets Inc.

Assuming $40,000 per thousand boe/d for the production value, QEP paid roughly $58,000 per acre—one of the highest amounts so far in a Permian deal, Stevens said.

The price war may just be getting started, according to Bernstein Research. The firm recently predicted that Permian acreage could reach $100,000 per acre.

Bold Energy is no stranger to the highly competitive deal-making environment of the Permian. Since early 2013, the company has worked to assemble its position in the basin’s coveted Wolfcamp shale play, Joseph L. Castillo, Bold’s president, said on a Nov. 9 conference call.

“As everyone working in the Permian knows, putting quality acreage together in the Midland Basin is hand-to-hand combat and trench warfare,” Castillo said. “And our land and business development team has done a remarkable job of identifying great opportunities and negotiating deals in a pretty highly competitive environment.”

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Katzenberg said Earthstone’s merger with Bold opens the window for a new leg of operated Permian growth.

The deal brings “multiple strategic positives, including increased exposure to the Midland Basin’s economic opportunity, higher ownership of operated locations, a broader base of production that should permit economies of scale and scope and a larger balance sheet to pursue additional A&D activity,” he said.

In May, Earthstone made its debut in the Permian with its acquisition of Lynden Energy Corp. The all-stock transaction, valued at about $67.2 million, gave the company about 14,765 gross (5,883 net) acres in the core of the Midland Basin.

Following its combination with Bold, Earthstone will grow to about 26,783 net acres in the Midland core. The company doesn’t plan to stop there—Lodzinski said Earthstone intends to continue its growth in the Permian via direct leasing, development and M&A activities.

“With this combination, our strategic focus is clearly directed toward further building our operated asset base in the Permian Basin. Our Eagle Ford and Bakken assets provide a strong source of cash flow to support a significant combined borrowing base and to fund our acquisition and development activities,” he said in a statement.

Earthstone also has assets in the Eagle Ford trend of South Texas and the Williston Basin of North Dakota.

As part of the Bold transaction, Earthstone will recapitalize its common stock into two classes—Class A and Class B. All existing outstanding common stock will be converted into Class A common stock.

Bold will purchase about 36.1 million shares of Earthstone's Class B common stock for nominal consideration, with the Class B common stock having no economic rights in Earthstone other than voting rights on a pari passu basis with the Class A common stock.

In addition, Earthstone has formed Earthstone Energy Holdings LLC (EEH), a Delaware limited liability company.
After closing, Earthstone will conduct its activities through EEH as its sole managing member.

The transaction is expected to close in first-quarter 2017, subject to the approval of Earthstone stockholders and other customary approvals.

Emily Moser can be reached at emoser@hartenergy.com.