Exco, Harbinger Form MLP

Formation of natural gas-driven MLP between Exco Resources Inc. and Harbinger Group Inc.

Exco Resource Inc. (NYSE: XCO) plans to form a master limited partnership in a joint venture with Harbinger Group Inc. to develop conventional non-shale assets in East Texas, North Louisiana and West Texas, a new venture valued at a combined $725 million.

In exchange for about 198,157 gross acres (123,706 net), Exco will receive $597.5 million and a 24.5% limited partner interest in the partnership and a 50% interest in the general partner of the joint venture. HGI, a privately-held management consortium, will contribute $372.5 million in cash and receive a 73.5% limited partner interest and 50% interest in the general partner of the new company.

Exco will contribute its Cotton Valley properties in its Holly, Waskom, Danville and Vernon fields in East Texas and Louisiana. All depths from the base of the Cotton Valley and above will be included. In addition, all of Exco’s rights in its Canyon Sand Field in Irion and tom Green counties, Texas will also be part of the partnership.

The conventional assets include 1,420 gross wells producing 1,714 barrels (bbl) of oil per day, 1,435 bbl of liquids per day and 81.2 million cubic feet (MMcf) of natural gas per day. Total production from the assets includes 100.1 MMcfe per day. Total proven reserves for the joint venture is 528.6 billion cubic feet equivalent (Bcfe). Approximately 84% of the reserves are natural gas (55% of current revenues), 8% are oil (35% of current revenues), and 8% are natural gas liquids (10% of current revenues).

About 91% of the acreage is held by production. In West Texas, the acreage includes 145 undrilled locations which are weighted towards oil and natural gas liquids and which are economic at current prices.

Exco said it expects its current $1.3 billion borrowing base will be reduced to $900 million while the borrowing base of the partnership is expected to be around $400 million. Once the partnership is formed, Exco said its net consolidated pro forma production will be around 457 MMcfe per day.

The joint venture will continue to produce and develop the contributed assets and will actively pursue conventional asset acquisition of long-life natural gas and oil properties.

The partnership is expected to make quarterly distributions of available free cash flow after capital expenditures and debt service. The distributable cash, after a 30% to 50% dedication to debt service, will be distributed 2% to the general partner and 98% to the limited partners until a certain threshold is met, when the distributions will then be 25% to the general partner and 75% to the limited partners.

Exco chief executive Douglas Miller said, “The venture will operate and develop the existing oil and natural gas assets and pursue acquisitions of long-life natural gas and oil properties with a significant proved producing component with undeveloped upside. This transaction allows Exco to monetize certain of its assets and maintain a significant interest in the assets and future development upside.”

Harbinger said the deal was a continuation of its plan to develop alternative energy sources.

“This is an exciting transaction for HGI that adds a long-life, proven conventional oil and gas business with strong cash flows to our group of diversified businesses,” said HGI's president, Omar Asali. “We believe this deal will create long-term value by anchoring our new energy operating business with a long-duration gas asset at a time when natural gas is trading near historically-low levels.

Harbinger’s strategy is to buy valuable businesses at opportune moments and supporting their growth with capital and proven management teams. The joint venture will allow HGI to create value through a potential cyclical upturn in natural gas prices. It plans to hedge a large portion of its production to generate reliable cash flows and to protect it it from unexpected declines or extended soft natural gas prices. In addition, Harbinger believes the acquisition will allow it to further diversify its sources of revenue and cash flows because the oil and gas industry has traditionally shown low correlations to consumer products, insurance industry and financial services, HGI’s other business lines.

Harbinger believes its position will benefit from a long-term perspective on natural gas prices. “Our permanent capital structure enables us to take a long-term view on the value of natural gas, while we benefit from reliable cash streams from conservatively-hedged producing wells. The cash flow from the partnership, together with dividends from our other operating subsidiaries, is expected to comfortably exceed $100 million and more than cover HGI’s existing annual interest and dividend payments. At the same time, we expect the Partnership will retain ample cash flow to reinvest in the business, maintain production and position it for further growth,” Asali said.

Dallas-based Exco is an upstream energy company with a strong emphasis on natural gas. Its main areas of operations are East Texas, North Louisiana, Appalachia and West Texas. Privately-held Harbinger Group Inc. is a diversified holding company based in New York.

KeyBanc Capital Market analysts said the deal was an important piece of Exco’s plan to reduce debt. Once the deal closes, Exco’s net debt will be reduced from $1.86 billion to $1.3 billion, with a net debt to capitalization ratio falling to around 67%, from its current level of about 755. “We view this as a confirmation that the company's deleveraging plan is gaining traction and expect the next catalyst for shares to come from the company's monetization of its midstream subsidiary TGGT. We expect shares to react favorably on the news today,” Keybanc analysts wrote in a report shortly after the deal was announced.

Baird Equity Research also thought the deal would be good for Exco once the market had time to study its details and said the new joint venture was "long awaited." The deal values Exco’s assets at $725 million, or $7,250 per Mcfe per day in production and $1.56 per Mcfe in proven reserves.

Baird estimated the assets have annual EBITDA (earnings before interest, taxes, depreciation and amortization ) of about $75 million, making the price about 9.7 times that value. Baird called that valuation of its asset base as “healthy.”
The new partnership is likely to be accretive to Exco’s earnings, Baird reported.