PXP in Deep Water With Offshore Purchases

by Marc Bastow | September 12, 2012 6:45 am

This week’s announcement by Houston-based Plains Exploration & Production (NYSE:PXP[1]) that it entered into an agreement[2] with British Petroleum (NYSE:BP[3]) and Royal Dutch Shell (NYSE:RDS.A[4], RDS.B[5]) to acquire offshore interests in the Gulf of Mexico is, on its face, kind of striking.

The deals will cost PXP a grand total of $6.1 billion, with $5.55 billion headed to BP and $560 million on the way to Shell. The benefit for BP is apparent as it continues to raise cash to pay for the costs of the Deepwater Horizon debacle (which seem virtually limitless); for Shell, it appears to be just a business decision to exit from its 50% share in the “Holstein” fields in the Gulf.

But for Plains, this is a whole different ballgame.

Plains is, generally speaking, in the upstream oil and gas business, acquiring assets, developing and exploring sources of oil and gas from onshore sources.

Indeed, PXP’s largest acquisition up to this point was for Pogo Producing, which it bought for $5.84 billion in 2007 to add onshore U.S. fields, and two years ago the company sold off shallow-water assets to move to onshore production. So the move to an offshore model that requires up to $2 billion in infrastructure before the first drop of oil is produced is a bit of a change for the company.

Of course, buying projects with built-in infrastructure helps, but here is where it gets tricky: The purchase price exceeds PXP’s market value; in fact, to complete the purchase, PXP will need a financing consortium — including JPMorgan (NYSE:JPM[6]), Wells Fargo (NYSE:WFC[7]), Bank of America (NYSE:BAC[8]) and Citigroup (NYSE:C[9]), among others — to borrow $7.1 billion. That’s almost the enterprise value of the company!

All that debt will be larded onto a current debt load of $3.9 billion.

So let’s do the math: $10 billion in debt at a time when oil accounts aren’t falling, but not skyrocketing, and natural gas is fairly inexpensive. Oof.

For the quarter ended March 30, PXP generated ($134) million in cash flow. In its most recent quarter (June 29) PXP generated ($42) million in free cash flow. Those numbers are not exactly heading in the right direction to support the kind of debt service PXP is looking at … although in fairness, year-end cash flow was $382 million, so it’s possible to turn it around to some degree.

Unfortunately, you’ve just pitted yourself against Chevron (NYSE:CVX[10]), Exxon Mobil (NYSE:XOM[11]) and other fairly entrenched offshore players. Nothing like a little competition to stir the soul and scare the crap out of investors — who, by the way, hated the idea on Monday as the stock plunged more than 10% to finish at $36.09, its lowest close in 11 months.

Oh, and Standard & Poor’s put Plains’ credit rating on “Watch” with negative outlook.

I can’t understand why S&P is concerned … other than the fact Plains doesn’t have the cash flow to service the debt. Heck, Reuters’ Christopher Swann likens the deal to a sort of leveraged buyout[12].

PXP Chairman James Fl0res believes the company can ramp down the debt with asset sales of onshore stakes in natural gas fields, and c0mputer models that spit out $1 billion in free cash flow for 2013.

Even still, that takes care of, what? $700 million in interest plus a paydown of $300 million in principle? Maybe, depending on what kind of price tag the consortium can wring from the deal. And don’t forget the fees that will be attached to the line of credit.

Regardless of my method or math, this is a long payback period, and investors will have to wait it out to determine the upside in the deal.

The deal seems like a risk as deep as the Gulf itself … a Hail Mary by a company that decided it didn’t want to be a small-time player anymore.

So good luck, Plains, and please don’t miss a payment. Then you’ll really see what “deep water” means.

Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he was long XOM.

Endnotes:
  1. PXP: http://studio-5.financialcontent.com/investplace/quote?Symbol=PXP
  2. entered into an agreement: http://investorplace.com/2012/09/pxp-acquires-bp-oil-assets-for-5-55b-shares-drop/
  3. BP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BP
  4. RDS.A: http://studio-5.financialcontent.com/investplace/quote?Symbol=RDS.A
  5. RDS.B: http://studio-5.financialcontent.com/investplace/quote?Symbol=RDS.B
  6. JPM: http://studio-5.financialcontent.com/investplace/quote?Symbol=JPM
  7. WFC: http://studio-5.financialcontent.com/investplace/quote?Symbol=WFC
  8. BAC: http://studio-5.financialcontent.com/investplace/quote?Symbol=BAC
  9. C: http://studio-5.financialcontent.com/investplace/quote?Symbol=C
  10. CVX: http://studio-5.financialcontent.com/investplace/quote?Symbol=CVX
  11. XOM: http://studio-5.financialcontent.com/investplace/quote?Symbol=XOM
  12. a sort of leveraged buyout: http://www.breakingviews.com/21040252.article?h=73026157c1a9431f95987d86aaaaeb77&s=2

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