Memorial Makes a Huge Acquisition

 | May 06, 2014 | 5:00 PM EDT  | Comments
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On May 5, Memorial Production Partners (MEMP), an upstream MLP with ties to private equity, announced a transformative acquisition of oil-producing acreage in Wyoming. This $900-plus million acquisition is the biggest by far in this partnership's short history. The acquisition is of mature acreage that began production in the early 1900s, moved to secondary recovery techniques in the 1970s (water flooding) and finally moved to tertiary recovery methods in the 1980s (CO2 flooding).

At current production levels, estimates are for the reserves of this transaction to last for an amazing 39 years. Three-quarters of the production is oil and one quarter is NGLs. Best of all, Memorial got this acreage at only 7.5x earnings before interest, taxes, depreciation and amortization (EBITDA), making this deal immediately accretive to cash flow. Memorial will initially fund this acquisition through a drastic expansion of its revolving credit facility.

Memorial Production Partners is a "captive" upstream MLP, and its parent company, Memorial Resource Development, was founded by private equity firm Natural Gas Partners. Memorial was, until now, mostly a producer of natural gas on mature, high-margin properties.

MEMP Evolution

As you can see, the partnership has really diversified its asset base, and in doing so it has de-risked and increased its margins (because oil is currently fetching a much higher margin than dry gas).

CO2 flooding, a tertiary oil recovery method, often provides the highest margins in North American energy production today. This is because CO2-flooding is done in traditional oil basins in which oil is still recoverable at shallow depths. CO2-flooding is far less capital intensive than is other prevailing forms of production such as fracking and offshore drilling.

That's why I believe that this acquisition by Memorial has turned the partnership from good to great. With its flagship assets in America's oldest gas field, Cotton Valley, Memorial already had among the lowest natural gas lifting costs in the industry. Now the company has successfully acquired very low-cost oil production in Wyoming. In fact, the average lifting cost in the newly-acquired Bairoil acreage is only $20 per barrels of oil equivalent (BOE). At even $90 WTI, that will provide some great margins.

During the Q&A session of the acquisition announcement, management hinted at just what kind of potential the Bairoil fields have. The proven reserve/production ratio of 39 years assumes an ultimate recovery of under 50% of total reserves. Historically, estimated ultimate recovery ratios have climbed as technology has advanced. Therefore, the partnership's already long-lived reserves might get even longer.

Price/DCF

Memorial is a newer upstream MLP, and because it is less-known than, say, Linn or BreitBurn, it trades at a slightly lower multiple. This paradigm looks increasingly misguided. After all, Memorial has among the lowest production costs in the industry. Its margins are second only to Mid-Con Energy Partners (MCEP). Memorial's hedging policy is now the most long-lived of all the major upstream MLPs.

That hedging policy, depending upon how one looks at it, is also the most extensive. Best of all is Memorial's cushy coverage ratio. While Linn and Vanguard struggle to hit 1x, Memorial conservatively expects distributable cash flow of between 1.1x and 1.2x distributions in 2014.

Despite all the reasons to like Memorial, the partnership is still undervalued. Memorial yields a lofty 9.6% and is worth taking advantage of right now.

Links for quick reference:

http://files.shareholder.com/downloads/AMDA-HU2C0/3120748023x0x751080/c1...

http://files.shareholder.com/downloads/AMDA-HU2C0/3120748023x0x709049/8d...

http://www.media-server.com/m/p/m2hh8ug4 (Unfortunately, no transcript is available for this call.) 

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