Forest, Schlumberger Form Eagle Ford JV

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Formed a JV to expand and accelerate Forest's Eagle Ford development program.

Forest Oil Corp. (NYSE: FST) will receive $90 million from Schlumberger (NYSE: SLB) as part of a joint venture to expand and accelerate its Eagle Ford development program in a deal that was finalized April 12.

In return for $90 million in drilling carry, Schlumberger will receive 50% working interest in Forest’s Eagle Ford drilling position, primarily in Gonzales County, Texas. After that, the two companies will split all future capital expenditures evenly.

The agreement applies to all wells spud after Nov. 28, 2012, and not in production by April 1, 2013. Forest said it expects the carry to last until the fourth quarter of 2014.

The agreement allows Forest to expand its acreage to 55,000 gross (27,500 net) acres from its previous plans of 40,000 gross and net acres. Forest plans to accelerate development by increasing drilling activity to four rigs, from one to two rigs currently, by the end of the third quarter of 2013. Forest projects that the capital carry amount combined with the accelerated pace of development will bring forward approximately $250 million in PV10 economics.

Forest estimates that its share of capital expenditures in the accelerated development plan for 2013 and 2014 will total approximately $125 million and $220 million, respectively. The accelerated development plan will result in ten and twenty additional net wells being drilled in 2013 and 2014, respectively. The increased acreage position has 688 gross (344 net) locations identified based on 80-acre spacing, and Forest expects to drill 80 gross (40 net) wells per year beginning in 2014. Based on Forest's current estimated ultimate recovery of 300,000 barrels of oil equivalent (BOE) per location, the Eagle Ford acreage contains a potential gross unrisked resource of more than 200 million BOE (100 million BOE net).

The 2013 additional net wells are primarily scheduled to be online later in the year and thus will not materially change Forest's average net sales volumes for 2013. However, average net sales volumes from the Eagle Ford are expected to more than double from an average of 2,800 BOE per day in 2013 to 6,500 BOE per day during 2014 as the benefits from a full year of the accelerated development program are realized. Importantly, the Eagle Ford program is anticipated to generate lease level income of approximately 68% and 80% of the total net capital expenditures for 2013 and 2014.

Schlumberger paid approximately $7,200 per acre for its $90 million drilling and carry commitment, according to estimates from Wells Fargo. Wells Fargo estimates that Forest’s net asset value is around $11.07, compared with its current price of about $5 per share.

A partner like Schlumberger validates the value of Forest’s Eagle Ford acreage, which is something that Wall Street had questioned. The deal will bring forward about 2,800 BOE per day in expected 2014 production and brings forward about $250 million in PV10 value, according to an analysis from Wells Fargo.

Looking forward, Forest still has other potential asset sales that it could make, the most notable of which is a sale of its Granite Wash/Panhandle position, Wells Fargo reported. Wells Fargo rates Forest shares as “Outperform,” meaning it thinks the stocks’ total return will exceed that of the market during the next 12 months.

Other analysts are slightly less optimistic about the announcement. Stifel Nicolaus & Co. Inc. said the deal does not significantly change Forest’s net asset value, but does boost its expected production growth for 2014. In addition, the deal will significantly improve Forest’s projected debt to forward EBITDA (earnings before interest, taxes, depreciation and amortization). In addition, the company’s enterprise value to EBITDA ratio also improves after the deal.

Stifel slightly reduced the company’s net asset value from $9.07 per share to $8.85 per share because of the expected expiration of its non-core Eagle Ford acreage. Stifel maintains its “Hold” rating on Forest shares.

Jefferies also maintained its “Hold” rating on Forest’s stock after the announcement was made early Friday. In Jefferies’ opinion, Schlumberger is acquiring Eagle Ford acreage for a cheap price. “We imagine (Schlumberger) sees this deal as an opportunity to showcase a smarter approach to unconventional development while earning a decent return on investment,” the report states.

Jefferies calculated the cost per acreage slightly differently than Wells Fargo. “This price is very low compared with recent Eagle Ford acreage comps, some of which transacted for over $20,000 per acre,” the report states. In addition, Jefferies estimates the transaction will increase Forest’s 2014 funding gap by about $20 million, even though 2013 funding gap is largely unchanged.

The table below summarizes and highlights the primary benefits of the accelerated development plan as compared to Forest's current development plan.