Are Non-Ops the New Alternative Financing for M&A?

SAN ANTONIO—Earthstone Energy CEO Robert Anderson expects to close an acquisition totaling $1.5 billion within a week—alongside non-op partner Northern Oil & Gas, which is footing a third of the bill as part of an unusual deal structure that may become more common, he said Aug. 10 at the Texas Independent Producers & Royalty Owners Association summer conference.

The three-way deal between Earthstone and NOG to buy EnCap Investments-backed Novo Oil & Gas was born out of necessity. Anderson said he knew going into the evaluation of Novo’s Permian Basin assets that “we weren’t going to be able to write a check for a billion and a half dollars.” He added that Earthstone wasn’t eager to issue debt to EnCap, which is already the company’s largest shareholder.

Instead, the company turned to NOG, with talk of a creative partnership on the deal from the very beginning.

“That was key … getting into the valuation from day one,” Anderson said. “Second of all, it was being like-minded that [Northern] buy the asset or value the asset the same way an operator does and not like some financial institution that may haircut PDP [proved developed producing] non-op at a much greater discount.”

NOG entered discussions looking to buy its portion of Novo’s assets just as an operator would, he said.

“We had to make some concessions [to Northern], commit to a drilling program,” Anderson said. “It handcuffs us a little bit, but we underwrote a certain number of wells per year anyway. So they were a great partner.”

For NOG, it was the second such deal this year in which it has paired with a company in a transaction. In June, NOG closed on a similar purchase of a 30% non-operated stake in Forge Energy II Delaware in a deal that paired it with Vital Energy.

Asked on the sidelines at TIPRO whether non-operated companies might be regular partners for acquirers going forward, Anderson told Hart Energy it depends on several factors.

“It's operator-specific personally, and it's the size, but I think it could,” he said. “I don't know that it's public or private. It's more the size of the transaction.

“Access to capital is a little bit hard, right? So if you can bring in a partner that sees eye-to-eye the way you see the asset, it's better to have 50% of good thing than 100% of a bad thing for your company.”

Anderson noted that reserve-based lending has become far more expensive, as well. Some 18 months ago, rates for RBL debt were 3% and have since skyrocketed.

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Anderson noted that as far back as 2007, he has used a similar strategy with a third party to buy assets in the Giddings Field.

“I'm used to carving down the assets so that we can swallow [an acquisition],” he said, noting that maintaining contacts and knowing the NOG team led them to partner.

Looking to future Permian deals, Anderson gave a sober assessment of the deal landscape.

“I think it's going to get harder,” he said. “I think there's just going to be less Permian deals. So we're going to start to have to look at maybe the fringe plays or plays that don't have three or four–seven zones like we see in the central part of the core of New Mexico.

“And it's going to get harder for the acquirers. And then scale too, right? The big guys are looking for very large transactions. There's probably only a few of those left.”

But, referring to a talk earlier in the day at TIPRO by NGP Energy Capital’s Patrick McWilliams, Anderson said he is encouraged by private equity firms that are raising money.

“All these private equity firms are raising money. They've got to put it to work somewhere. And those guys [have] the creative juices that will create the next play for us to take a look at.”