Description

Misunderstood recent spin off (completed August 8^th) with potential to double in next 12 months as EBITDA will increase ~250%

BUSINESS DESCRIPTION

Riviera Resources (“RVRA”) is an oil and gas midstream operator and exploration and production company trading on the OTC market. RVRA was spun out of Linn Energy (“LNGG”) on August 8^th 2018. LNGG emerged from bankruptcy in February 2017 with the majority of the company owned by Fir Tree, Elliott and York and these holders now also own RVRA. We believe that the presence of these holders will ensure favorable capital allocation at RVRA and provide downside protection from a potential take-private transaction.  Over the past year the company has repurchased ~$800m of stock (or ~25% of the outstanding stock between LNGG and RVRA) with plans to continue the repurchases now that the entities are separated.

RVRA has two business segments: 1) Blue Mountain, a midstream company centered in the core of the rapidly growing Merge play in the Anadarko Basin and 2) an E&P with mature low-decline acreage in the Hugoton Basin, East Texas, North Louisiana, Michigan/Illinois, the Uinta Basin and Mid-Continent regions.

Blue Mountain successfully commissioned its Chisholm Trail Cryogenic Gas Plant located in Oklahoma in the Merge/SCOOP/Stack play in 2Q 2018. The Merge/SCOOP/STACK is one of the highest growth regions in the US with well economics on par with the Permian basin Midland play. In July the plant had 150 MMcf/d of processing capacity and will ramp to 250 MMcf/d by 4Q 2018. This capacity is contracted under long-term agreements with Roan Resources and other third-party operators. Management has guided the first train to generate $100-$125M of EBITDA by mid-2019.

Based on producer commitments and anticipated production growth from the region, the Board has approved Blue Mountain’s plan to initiate the engineering and design of a second plant servicing the Merge/SCOOP/STACK with up to 250 MMcf/d of additional capacity. This second train will generate an incremental $100-$125M of EBITDA once the project is completed in the second half of 2019.  Given the drilling growth in the region, we believe there is a likelihood that additional trains (after the first two) are built in the Merge and potentially the NW STACK, which would provide incremental upside not considered in our valuation.

Blue Mountain hired a best in class Management team from Enbridge to grow the asset organically with plans to expand services to crude and water storage which would provide incremental upside to our forecasts. That said, we believe at $200-250m of EBITDA and an acreage dedication for 75,000 core acres, the asset would be a strong acquisition target for many local Oklahoma MLPs. Enlink, Enable, Oneok, Enterprise among many others could acquire the asset for 7-8x EBITDA, financed with ~4x of leverage for a highly accretive tuck in. 

RVRA’s E&P asset has 1,968 Bcfe of proved reserves, of which approximately 70% is natural gas, 22% is NGL and 8% is oil. At the end of the 2017 fiscal year these proved reserves had a PV-10 of ~$1 billion at $2.98/MMBtu natural gas and $51/bbl.  We believe that there is upside to the PV-10 as the company has >60,000 core acres in the NW Stack that has minimal production today and significant growth potential.  On the company’s August 23^rd 2018 call, RVRA highlighted their plan to add an operated rig to the region to de-risk the asset.  We believe the acreage could be worth ~$4,000-10,000 per acre or $250-600m vs. a PV-10 of ~$28m, supported by recent M&A activity in the region and an active rig count of >30 horizontal rigs within 30 miles of the core.

THESIS

RVRA is a compounder as we expect the company’s adjusted EBITDA to grow from $135M in Q4 2018 run-rate to >$300M run-rate by Q4 2020, driven by high ROIC (2-3 year paybacks) midstream projects in the Merge/SCOOP/STACK. RVRA’s primary customer is Roan Resources, the newly renamed Linn Energy (see  write up on LNGG for more information). Roan has over 150,000 net acres in the Merge/SCOOP/STACK with 2,500 drilling locations (and the potential for down-spacing). Roan has an estimated 2bn BOE net resource potential and has been proving out the region with some of the most prolific wells drilled in the country with recent IP-30s ranging from 1.7k-2.5k Boe/d. We expect Roan to significantly ramp up production over the next few years and Blue Mountain will be a primary beneficiary. We believe that Blue Mountain will be an attractive target for several MLP operators in the region or could be taken public through a spin-off and up-listing.

Cash Cow E&P assets with low decline rates and maintenance capex to be used to return cash to shareholders. RVRA had >$250M of net cash on its balance sheet as of 6/30/18. We expect the company to use this cash and incremental free cash flow initially on share repurchases (board recently announced $100M authorization) and to invest in the high growth/return midstream business and in de-risking the NW STACK. Longer term, we believe these assets are an ideal candidate for private equity or a high yield dividend royalty trust.

VARIANT PERCEPTION

Hidden Asset Value – We believe there is hidden value across RVRA’s E&P portfolio that the company can monetize over time. The company has a proven track record of monetizing assets, having sold $2B of acreage at a multiple of 1.5x PV-10 since Linn’s emergence from bankruptcy.

RVRA’s assets were developed with conventional vertical well technology. Over the past decade, drilling technology has evolved dramatically toward hydraulic fractionation and horizontal drilling.  The new technology has increased the efficiency of capital, lowering the cost of extracting the resources, making previously uneconomic oil and gas highly profitable.  We believe that RVRA’s assets have significant potential to be converted to modern unconventional technology, particularly in the Uinta, Arkoma and NW STACK. Further, the Hugoton assets have a highly lucrative helium contract and gathering and processing contract that generate ~$20-30m of recurring free cash flow which is uncorrelated with oil and gas prices.  We believe the Hugoton assets could be monetized to private equity for a minimum of $500m.

Blue Mountain’s growth is also not reflected in the current share price as the company is finalizing train 2 in the Merge (expected FID in Q4 2018) and planning to further expand in the NW STACK.

Poor Investor Sentiment – RVRA is currently an overlooked spin-off from a post-bankruptcy equity with all of the impediments to being fairly valued.  The company currently trades on the over-the-counter market, has low liquidity and no sell side coverage, making it un-investable for many traditional asset managers. The Board is currently evaluating a potential up-listing to the NYSE or NASDAQ.

KEY INVESTMENT FACTORS

·         Merge/SCOOP/STACK production growth – while we have a high degree of certainty that the Chisholm Trail train 2 will be built, it will depend on continued favorable drilling results of E&P operators in the region

·         Oil & Gas prices – as an E&P, RVRA has exposure predominantly to gas prices.  A $0.25 decline in NYMEX natural gas prices drives a ~$20m decline in EBITDAX and a ~20% decline in E&P NAV.

RISKS

·         Oil & Gas prices – the single largest risk is oil and gas price.  We believe gas prices are range bound between $2.50 and $3.50 while oil will likely stay between $50 and $70.  We assume $2.80 NYMEX natural gas prices and $60 WTI

·         A $0.25 move in natural gas increases unlevered free cash flow by $20m while a $5 increase in oil drives a $12m increase in unlevered free cash flow (assuming no hedges)

·         Customer concentration risk – Blue Mountain will derive the majority of its sales from a single operator, Roan Resources; we feel comfortable with this risk given the close relationship of the companies, the very healthy balance sheet at Roan, and the long-term contracts already signed by the two parties

VALUATION

We value RVRA on a free cash flow basis

Base Case FCF Valuation

·         The MLP will generate ~$225m of EBITDA less ~$15m of maintenance capex = ~$210m of cash flow

·         The E&P assets are forecast to generate ~$135m EBITDAX less $25m of maintenance capex for cash flow of ~$110m (assuming $2.80 NYMEX HH and $60 WTI)

o    Excludes growth capex associated with the NW STACK

o    Effectively trading at 1.1x PV-10

·         $320m of FCF at a 10% yield implies $3.2 bn + $100m cash for a total value of $3.3 bn with ~76m shares = $43/share.

Risk Case FCF Valuation

·         The MLP will generate $175m of EBITDA less $15m of maintenance capex = $160m FCF

o    Assumes a 150-250MMCF/d plant vs 250 MMCF in Base Case in line with Train 1

o    NGL prices at Conway trade at a discount to Mt Belvieu driving a negative spread

·         The E&P assets are forecast to generate ~$110m EBITDAX less $25m maintenance capex = $85m FCF (assuming $2.55 NYMEX HH and $55 WTI)

o    Excludes growth capex associated with the NW STACK

o    Effectively trading at 0.8x PV-10

·          $245m of FCF at a 12% yield = $28 per share

o     No value for cash

Catalyst

Ramp up of Blue Mountain Plant 1 and construction of Plant 2, potential spin off of Blue Mountain midstream, potential accretive E&P asset sales above PV-10