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The Best Long-Term Oil Play Comes At A Discount

I am generally a mild mannered person, but there are certain things about financial markets that frequently make me mad. Some talking heads from big banks or funds on financial news networks, for example, who’s 10 minutes of verbiage can almost always be summarized as “The market may go up or it may go down”, or hedge fund managers complaining about regulations from the very same government that continues to allow them to treat profits as carried interest and therefore pay minimal taxes…

One of the others is when the market punishes a company, by way of a lower stock price, for doing what companies are supposed to do and looking ahead of the next quarter or two. We are at a time of record low interest rates and a buoyant equity market, so selling a stock for using that to make long term investments and adjustments to the balance sheet is particularly crazy right now. I guess I shouldn’t get too mad, though, as sometimes, as in the case of Concho Resources (CXO) this week it does create an opportunity to buy some discounted stock.

(Click to enlarge)

On Monday, after the market closed, Concho management announced that they were making a secondary public offering of their stock, 9 million common shares to be exact. Now I understand that a secondary offering such as this dilutes the value of existing shares (profit has to be split among more shares, therefore lowering EPS), but in this case, a look at what the capital raise was for gave investors a hint that the bad would, in this case, be more than offset by the good.

It was not a question of a company desperate for cash issuing stock to benefit cash flow. The funds raised in this case were targeted for two uses: funding the purchase of some prime land in the Midland Basin and paying down some old debt. The latter obviously makes sense; retiring debt with an 8% coupon in a world of near zero interest rates is a fairly obvious thing to do. The land grab, however, needs a little more analysis to understand.

The Midland Basin is a good place to be for an E&P company. Oil and gas are plentiful and relatively shallow, keeping production costs reasonable. With the days of $100 per barrel oil firmly in the rear view mirror, access to reserves that can be profitable at current prices but could benefit hugely if we continue to climb higher is critical to long term growth, maybe even long term survival. Of course, even with oil depressed, such assets…




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