Quicksilver’s Shale Deal Is a Game-Changer

by Aaron Levitt | April 2, 2013 8:00 am

As we’ve seen during the past few years, being a natural gas-focused producer hasn’t exactly been the best business to be in. As nat gas prices have plunged, many producers have faced rising costs and lower earnings. Many have idled wells and change direction toward more liquids-rich plays and shale oil[1]. Those that have stayed the course have seen their prices dwindle.

Case in point: Quicksilver Resources (NYSE:KWK[2]).

The company — which tallies about 99% of its production from natural gas and NGLs — has floundered and has seen its share price dip from above $40 in 2008 to the low single digits today, including a 50% decline in the past 52 weeks alone.

However, the producer recently made some big moves via a critical production agreement that values a portion its reserves well above its current market cap. For investors, that sale could help push shares of Quicksilver higher and make it one of the best speculative plays in the energy sector.

A Big Sale

Monday’s 13% gain in KWK surely was a welcome sign for shareholders who have suffered during the past few years as lower natural gas prices have taken hold.

First, a few days ago, Quicksilver announced that its fiscal fourth-quarter and full-year net income and revenue came in higher than first reported in February. This was because of how its various hedges qualified under GAAP rules. As a result, the unrealized gains and losses on these derivatives have been recognized in earnings rather than deferred. (It’s always nice when a company’s hedging program works better than expected[3].)

However, the biggest news for the firm stems from its recent deal to sell a 25% stake in its Barnett Shale oil and gas assets[4] to TG Barnett Resources LP — a subsidiary of Japan’s Tokyo Gas (PINK:TKGSY[5]) — for $485 million. Quicksilver will remain as operator of the assets, and future development spending will be shared in proportion to each party’s working interest.

Quicksilver holds about 130,000 net acres within the Barnett in North Texas, and the acreage currently produces about 275 million cubic feet per day of shale gas and natural gas liquids. This is the first time in which Tokyo Gas participated in shale gas development in the U.S. The utility — which is one of Japan’s largest — has been importing gas in the form of LNG for about 40 years, and analysts expect that the company will want begin exporting the gas “at some point.”

Why It’s a Big Deal

Why exactly is the asset sale a big deal for KWK? After all, we’ve been talking about foreign interests — especially those in Asia — buying stakes in shale formations for months now[6].

Well, it all comes down to valuation and debt.

Like many in the oil and gas sector — think Chesapeake Energy (NYSE:CHK[7]) — Quicksilver took on large amounts of debt in the late 2000s buying up shale assets, with the thought that higher natural gas prices would help cushion the blow of these debt loads. However, as supplies grew and demand waned, falling nat gas prices made life tough for operators, and Quicksilver was no exception. As of the end of 2012, KWK had roughly $2.06 billion in long-term debt. Quicksilver’s management already has stated they plan on using the proceeds of the Barnett sale to pay down this debt, bringing total long-term debt down to near $1.6 billion.

Paying down that debt certainly has some pretty big benefits. Analysts estimate that paying down its IOUs, Quicksilver will decrease interest expenses by more than $40 million per year, which in turn should help boost earnings per share by roughly 22 cents a share. More importantly, Quicksilver would be profitable under this scenario.

Then there is valuation to consider. The amount Tokyo Gas was willing to pay for just a 25% stake was actually more than Quicksilver’s entire market cap. Think about that. The value of all the shares of KWK trading was actually less than value of a quarter of its fields. This transaction single handily changes the company’s valuation in an instant. Based on this, Quicksilver’s Barnett assets are worth about $1.9 billion — basically more than the company’s total debt.

However, KWK isn’t done yet.

In addition to the Barnett Shale, the firm has assets in the Midland/Delaware Basin, the Niobrara Formation, and the South Alberta Basin of Montana. In Canada, Quicksilver has more than 300,000 net acres in a coal bed methane field in central Alberta and 170,000 net acres in the Horn River Basin of northeastern British Columbia.

All in all, there’s plenty of real value left in the firm — potentially far more than its stock’s sub-$3 price tag would have you believe.

Bottom Line

This Tokyo Gas deal changes everything. Investors could have an easy double on their hands in KWK shares.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Endnotes:
  1. liquids-rich plays and shale oil: http://investorplace.com/2013/03/dont-let-this-upstream-mlp-pass-you-by/
  2. KWK: http://studio-5.financialcontent.com/investplace/quote?Symbol=KWK
  3. works better than expected: http://investorplace.com/2013/02/linn-energys-buying-and-you-should-be-too/
  4. sell a 25% stake in its Barnett Shale oil and gas assets: http://finance.yahoo.com/news/quicksilver-announces-sale-tokyo-gas-050500876.html
  5. TKGSY: http://studio-5.financialcontent.com/investplace/quote?Symbol=TKGSY
  6. for months now: http://investorplace.com/2012/10/buyout-bait-in-canadas-energy-supermarket/
  7. CHK: http://studio-5.financialcontent.com/investplace/quote?Symbol=CHK

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