Apache’s $2.85 Billion Acquisition Raises its Leverage, a Credit Negative

Apache’s $2.85 Billion Acquisition Raises its Leverage, a Credit Negative

Apache Corporation (A3 stable) on 23 January said it planned to acquire Cordillera Energy Partners (unrated) for $2.85 billion, a credit negative move for Apache. Although Cordillera would give Apache a substantial parcel of valuable reserves with a high proportion of natural gas liquids and oil, the agreement raises Apache’s financial leverage, thereby weakening its credit.

Apache will offset some of the cost of the deal with $600 million of equity funding. But the properties it will acquire from Cordillera consist primarily of undeveloped acreage, which will meaningfully increase Apache’s leverage on production volumes and proved developed (PD) reserves from September 2011 levels.

Indeed, the acquisition will raise Apache’s debt/average daily production to levels approaching $13,000 per barrel of oil equivalent (boe), from about $10,100 per boe as of 30 September 2011. Apache’s debt/PD, meanwhile, will rise to about $5 per boe from $3.80 per boe. These increases include not just the Cordillera acquisition, but also the North Sea asset purchase that closed in December 2011, and the pending acquisition of a 65% interest in the Burrup Fertilisers Plant.

Even with this increase in leverage, Apache’s robust cash flow coverage of interest costs and debt will still support its strong credit quality following the acquisitions. About half of Apache’s production volume is liquids, with oil comprising over 40% of production. Oil today trades at historically high prices, which appear set to continue at least over the next year. Natural gas liquids track more closely with crude prices than with natural gas prices, which will persist at historically weak levels into 2013. As for the remaining 50% of Apache’s production that is natural gas, much of that is located in international markets that receive much higher prices than the low prices in North America.
The acquisition expands Apache’s exposure to unconventional resource plays that are conducive to systematic horizontal drilling development with predictable growth in production volume. By buying Cordillera, Apache acquires an additional 254,000 net acres of undeveloped reserves largely adjacent to its existing properties in the Anadarko Basin, and offers many more prospective drilling locations in the Granite Wash and other formations composed of about 50% natural gas liquids and oil. This high liquids content makes the investment returns attractive despite low natural gas prices in North America.

This additional liquids-rich production will enhance Apache’s strong cash margins on its production. We expect the company’s leverage metrics to improve over the course of 2012 as Apache grows its production and PD reserves through internally funded capital expenditures. Apache has a strong track record in its acquire-and-exploit strategy and has extensive operating knowledge in the Anadarko basin.
Still, this transaction entails higher valuation and execution risk than previous Apache acquisitions, given the limited production and proved reserves it has acquired. Most of the purchase price represents undeveloped acreage, unusual for a company that has largely focused on more developed properties. The acquired acreage does offer more running room for future production growth, but the price paid for the acreage will make it more challenging to generate strong returns on this investment.