Turnaround Letter Buy-rated Midstates Petroleum (MPO) announced that it is combining with Amplify Energy in a merger-of-equals. The deal combines two post-chapter 11 companies with a high degree of common ownership by investor group Fir Tree Capital. We recommend MPO investors keep their shares as the post-merger company’s valuation looks inexpensive and is likely to produce strong free cash flows, much of which should be returned to shareholders.
We expect the transaction to be completed as it was unanimously approved by both companies’ boards of directors and is an all-share combination (with no financing issues). The deal is expected to be completed in the third quarter.
While the deal is technically a merger, it is essentially a sale of Midstates. Amplify shareholders will receive 0.933 shares of new MPO common, but the company will be renamed Amplify Energy and it will be run by current Amplify management in Amplify’s Houston offices.
The new board of directors will include four members from each company, although both companies have David Proman (new chairman) and Evan Lederman on their current boards. These directors are both executives at investment firm Fir Tree Capital that holds large stakes in both Amplify (30% stake) and Midstates (23% stake).
Amplify Energy is a $159 million market cap oil and gas producer that emerged from Chapter 11 bankruptcy in 2017. It carries $270 million in debt, and has more leverage than Midstates at 2.1x EBITDA (vs. 0.5x at Midstates), although the debt is partly offset by $31 million in cash. Amplify’s oil and gas production of 23,800 barrels of oil equivalent per day is about 45% higher than Midstates.
Fir Tree Capital is a New York-based private investment firm with an estimated $3 billion in assets. Founded in 1994, it specializes in public and private companies, real estate and various credit instruments. In addition to Amplify and Midstates, the firm owns stakes in Sandridge Energy and Halcon Resources.
Our view – keep MPO shares for now
With the overlapping ownership, we are a bit surprised at the discrepancy in the value-sharing. Amplify shares gained 40% yesterday while Midstates shares fell 16%. In a typical merger-of-equals, the respective share prices tend to move little.
Nevertheless, the deal has enough merit for MPO shareholders that we recommend investors keep their MPO shares. From a financial perspective, the pro forma valuation, at about 3.1x EBITDA, is inexpensive and in-line with peers. The capital structure holds little debt, at only 1.4x EBITDA, which provides it with financial flexibility. Cost savings from eliminating overhead and other expenses (estimated at $20 million, or 8.3% of pro forma EBITDA) are meaningful and likely to be realized. The combined company would likely produce a free cash flow yield of at least 15%.
As a larger company, with a combined $440 million market cap, it will be better-positioned to attract investor interest, which should boost its EBITDA multiple.
With production in several regions, including Oklahoma, Eagle Ford, Rockies, California and East Texas, the company has more opportunities for value creation.
Importantly, as nearly all board members are investors (rather than oil drillers), many who represent investor groups with sizeable ownership, the company will likely maintain its expense and capital spending discipline, and emphasize returning capital to shareholders, rather than aggressively sinking surplus cash into growth-producing but low-value new drilling.
We retain our Buy rating on pre-merger MPO shares with a $30 price target.
Following the completion of the merger, we anticipate changing the target to reflect the changes in share count and capital structure of the post-merger company.
We continue to rate Midstates Petroleum (MPO) Shares a BUY with a $30 price target.
Disclosure Note: An employee of the Publisher owns MPO shares.