Antares: shale of the century?

We admit that we were slightly nervous. Antares Energy was due to repay $60m of debt by the end of this year and wasn't generating enough cash flow to do it. The company had rebuffed two takeover offers and drilling on its properties had seemingly stopped. Management was silent and shareholders nervous as the repayment date loomed.

Management broke its silence to announce that Antares had sold its primary production asset, Southern Star, to US based Breitburn Energy for about $140m. Antares will receive US$50m in cash and 4.3m units in Breitburn equity, worth US$73m at current prices.

Along with the asset sale, the company has repaid and refinanced its debt for another 5 years at attractive rates (LIBOR plus 4%). With cash up its sleeve, the company now intends to drill the larger Northern Star shale to prepare it for eventual sale.

The market showed initial enthusiasm for the deal but now appears nonchalant about it. Is that reaction warranted?

A good deal?

On first inspection, the deal appears attractive. Antares gains 55c per share in cash and securities as well as the financial firepower to drill and test the promising Northern Star shale.

After repaying $60m in debt, Antares holds net cash of $80m, about 30cps. The company also has $60m of convertible notes outstanding that it could repay with surplus cash or convert into 90m new shares. We assume the notes are bought back, leaving the company $20m of net cash and US$200m from a new debt facility to finance drilling activity.

The deal values Southern Star at about US$30,000 per acre and is in line with our expectations (see Antares Energy on sale from 26 Jun 13 (Speculative Buy – $0.47)). The case for buying Antares today, however, rests on how much Northern Star is worth.

Northern Star is currently producing just 80 barrels of oil equivalent per day (boepd) from vertical wells. That will have to increase dramatically to attract a buyer.

A sale in the North

Changing to horizontal drilling typically result in about 800boepd. Increasing output ten fold may sound impressive but horizontal drilling also entails significantly higher costs and higher risks. Such an outcome might attract a valuation of about $10,000 per acre, suggesting a value of about 45c per share for the asset.

Taking into account tax and debt that would be needed to fund drilling, the current share price is right – with perhaps a mild premium – if we expect typical production rates at Northern Star.

Peers along the same shale formation, however, have generated production rates as high as 3,500boepd, dramatically boosting the economics of each well. If Antares can match those rates it should attract prices similar to Southern Star, about $30,000 per acre. This suggests a value of about $1.40 per share for the asset.

While we cant know ultimate production rates, today's share price appears to bake in low expectations. The market suggests that Northern Star will produce at average rates which, given the uncertainty, isn't a silly expectation. 

The best location

The area Antares is drilling, however, is better than average. It is among the most productive locations anywhere in North American, where BHP Billiton has announced outstanding success and where smaller peers have replicated that success. Although that bodes well for Antares, it doesn't create certainty. The prospect of elevated production isn't outlandish but we do need to be careful about how much to pay for it.

We must also consider that management has rejected two bids for the business that, in hindsight, would have released more value for shareholders than the current deal and that falling oil prices can swiftly destroy the economics of shale oil production.

Several producers are due to drill targets along shales adjacent to Northern Star later this year and early next year. Results from that drilling will be crucial to allocating a value to the asset and hence to Antares.

We're not going to provide a price guide until we have seen those drill results. That will give us a better indication of how much Northern Star is worth. It is prudent to get a better understanding of the odds before placing bets. The share price has fallen 9% since Antares sells Southern Star (Under Review – $0.45). HOLD.

Note: The model Growth portfolio owns shares in Antares Energy.