Earlier this month, Talos Energy Inc. (TALOS) completed their strategic merger with Stone Energy Corporation. Talos Energy LLC and Stone Energy both became owned subsidiaries of the new holding company called Talos Energy, which is now a publicly-traded entity.
Upon completion of the $2 billion merger, Talos shareholders now own 63% of the newly combined company, while Stone Energy shareholders own 37%. Trading of the new company began on May 10, 2018 on the New York Stock Exchange under the ticker title “TALO”. Talos Energy will remain headquartered in Houston, Texas.
But just what is so strategic between the two energy companies marriage? Here’s an inside look at what makes this merger so promising. For those unfamiliar with the pre-merger companies, a brief company profile might be pertinent.
About Pre-Merger Talos Energy Inc. and Stone Energy Corporatio
Talos Energy Inc.
Talos Energy Inc. was founded in 2012 by Timothy Duncan. Initially backed by the large private equity firms Apollo Global Management and Riverstone Holdings, Talos Energy Inc. focused its efforts on the exploration, development, and acquisition of oil and natural gas properties, chiefly in the Gulf of Mexico Developed Deepwater and Shelf as well as on the Texas and Louisiana Gulf Coast.
It took little time for the independent exploration and production company to become one of the premier deepwater wildcatters in the region, taking risks in politically-unstable Mexican waters. During 2015, Talos utilized their technical and operational expertise in the Gulf of Mexico and expanded their operations to include two shallow water exploration blocks off the Mexican Coast. More on this later.
Stone Energy Corporation
Stone Energy Corporation was also an independent oil and natural gas exploration and production company but operated out of Lafayette, Louisiana. Founded by James Hiram Stone in 1993, Stone Energy Corporation also engaged in the acquisition, exploration, development, and production of properties in the Gulf of Mexico basin. Amongst the collapse in oil prices that occurred in 2016, Stone Energy Corporation was forced to file for bankruptcy protection. In 2017, Stone Energy Corporation emerged from bankruptcy by successfully completing conditions precedent to emerging from chapter 11 which included a restructuring of ownership, eliminating $1.2 billion in outstanding debt, and the appointment of a new board of directors.
The Combined Efforts of Talos Energy Inc. and Stone Energy Corporation.
Talos Energy is now a technically-driven independent exploration and production company operating in the Gulf of Mexico and the shallow waters of the Mexican Coast. The company will turn its attention towards the exploring, acquiring, and developing of both deepwater and shallow water assets close to existing infrastructure. The shallow waters off the Mexican coast provide the best opportunity for high-impact exploration in the emerging basin.
Chief Executive Officer Timothy Duncan recently commented, “This is a transformational combination, in which shareholders will greatly benefit from our increased scale and liquidity. Talos is very well positioned to capitalize on its high-quality asset portfolio and returns-focused capital programs in the U.S. Gulf of Mexico and offshore Mexico, as well as take advantage of potential business development opportunities. We deeply appreciate the efforts of everyone involved in getting us to this point.”
Redefining Corporate Obligations
As per the reverse merger, existing warrants to acquire Stone Energy’s common stock will transfer to warrants to acquire Talos Energy common stock with closely similar terms and conditions to Stone Energy’s past terms and conditions. Talos Energy Inc. stakeholders were issued an aggregate of roughly 34.2 million common shares. The new Talos Energy board of directors will consist of six members designated by Talos Energy, and four members from Stone Energy’s board of directors at the time of the merger.
While Talos Energy has always held aspirations to go public, the reverse merger with Stone Energy saved the company the expense of an initial public offering. Stone Energy’s Board of Director’s approved the merger in November 2017, at which time Talos Energy Inc. was estimated to have an enterprise value of nearly $2.5 billion.
Greater Than the Sum of Its Parts
Talos Energy Inc. and Stone Energy Corporation’s merger will create a streamlined offshore independent E&P company that will maintain an expanded quality asset base and leading cost profile. The reemerged company should have a 2018 daily average production of almost 47 thousand barrels of oil equivalents and proved reserves of 136 million barrels of oil equivalents. Further, the new E&P company will take advantage of a large list of identified exploration and expansion prospects along with a massive swath of acreage in the Gulf of Mexico. Some of this Gulf of Mexico inventory includes over 1.2 million combined gross acres, of which approximately 160,000 acres being off the coast of Mexico.
One of the perks of the merger between the two companies will be increased financial flexibility. The new company has announced that it will provide more detailed Financial and Operational guidance soon but as of the merger closing, Talos Energy has:
- Entered into a new credit facility agreement with an initial Borrowing Base of $600.0 million, of which $300.0 million is available
- Liquidity of $450.0 million, inclusive of approximately $150.0 million of cash on hand, net of transaction-related costs
- Pro-forma Year-End 2017 2P Reserves, at SEC pricing, of approximately 205 MMBoe (roughly 80% liquids), of which approximately 150 MMBoe were Proved Reserves
To summarize, the combined company will enjoy increased funding flexibility, no significant long-term note maturities until 2022, and unfettered access to public capital markets. These advantages will allow the company room to exploit attractive growth opportunities. It is apparent that the combined company is positioning itself to be the premier alternative for drilling opportunities in the deepwater Gulf of Mexico.
Some of the more auspicious assets of the newly combined Talos Energy will include:
- Tornado II and Rampart, two newly discovered opportunities for near-term growth
- A stable of long-term growth assets, grounded by the world-class Zama oil discovery in the shallow waters off the Mexican coast
- A robust pro-forma balance sheet and credit profile, featuring low leverage and plenty of liquidity
One of the more promising assets Talos Energy inherited from Stone Energy is the Pompano platform in the Gulf of Mexico. Discovered in 1981 by ARCO and Kerr-McGee, the Pompano platform was acquired by Stone Energy in 2011. Since acquiring the platform, Stone has taken significant measures to improve the pipeline infrastructure of Pompano to capitalize on the strategic location of the platform. Specifically, the platform’s subsea intervention kit was in serious need of an overhaul.
Stone Energy, realizing the potential to make Pompano a hub for bordering oil fields, implemented a cutting-edge technology to refurbish the platform’s twenty-year-old TFL system. Stone Energy worked with a company called Cost Group to develop a triple bore selector or dynamic funnel.
Larry Klentz, vice president of operations for Cross Group, explained, “It’s a hydraulic actuator that shifts from whichever of the three bores that is selected, and that allows you to select whatever bore in which you need to work. Under that adaptor is a valve block that gives you the ability to isolate the other bores, as well as pump in ports, full circulation capabilities, giving you full access to your toolstrings.” One of the perks of the new package is that it allows platform work to be done from a small boat, which saves money in the long-term.
This technology implemented at Pompano combined, with Talos Energy Inc.’s huge subsea infrastructure, will allow the combined company to tether new discoveries to the existing infrastructure. Timothy Duncan refers to this optimization as the “developed deepwater model.”
Getting It Done from the Top Down: A Look at Talos Energy’s Leadership
The combined company is in good hands with world-class leadership joining the team from both Stone Energy and Talos Energy Inc. Talos Energy Inc.’s CEO, Timothy S. Duncan, will be the CEO of the combined Talos Energy. Duncan is an industrious maverick who has a reputation of hard-earned success in deepwater wildcatting. The son of an oilman, Duncan had a diverse upbringing having grown up in Egypt, Florida, and Texas.
Timothy Duncan received his BS in Petroleum Engineering from Mississippi State University, where he was honored in 2012 as a Distinguished Fellow of the College of Engineering. He then went on to earn an MBA from the Bauer Executive Program at the University of Houston. He is an active member of the Society of Petroleum Engineers (SPE), National Ocean Industries Association (NOIA), Independent Petroleum Association of America (IPAA), and the Young Presidents’ Organization (YPO). In addition to his role at the new combined Talos Energy, Duncan serves on numerous academically-focused boards like the Foundation Board at Mississippi State University and the College of Engineering Dean’s Advisory Council.
Before his time with Talos Energy, Timothy Duncan was the Senior Vice President of Business Development and a founder of Phoenix Exploration Company LP and was responsible for Phoenix’s business development evaluations and negotiations, including the sale of the company to a group of buyers led by Apache Corporation.
Proven Success: Turning Typhoon Troubles into a Profitable Phoenix Field
Nearly 100 miles off the Louisiana coastline sits a region formerly known as Typhoon Field. Discovered in 1984, Typhoon Field sits at a water depth of 2,000 ft. To say that Typhoon Field was hit by calamity would be an understatement. In 2005, the production platform that serviced Typhoon Field was hit by Hurricane Rita. The field’s tension leg platform (TLP) was damaged during the hurricane, which caused the 13,000-ton platform to lose its mooring and eventually capsize.
The Phoenix platform freely drifted the waters for almost a year. The fate of the Phoenix field was almost sealed until Duncan, acting as Sr. Vice President of Phoenix Exploration Company LP, undertook the daunting task of making Phoenix field profitable again. In 2006, Phoenix Exploration Company LP acquired interest in Phoenix field from Cabot Oil and Gas Corporation. Duncan played a pivotal role in developing the field from that point, turning the infrastructural disaster into a booming hub of productivity.
After Rita, work on the Phoenix platform commenced with recovery of the original flowlines, risers, and umbilicals that had sunk to the seafloor, as well as the restoration of the oil and gas export pipelines.
Talos Energy now pumps 16,000 barrels a day from Phoenix field and continues to maximize the asset. For example, Talos Energy is currently increasing production at the Phoenix field, with the Tornado II deepwater well producing more than 12,350 barrels of oil equivalent per day (boe/d) during a two-week test run this last December.
Speaking on the Tornado II project, Duncan commented, “Our technical and operational teams for the Phoenix field have worked tirelessly on this project, resulting in first production less than one year after the commencement of drilling operations.”
For a more recent example of Talos Energy’s calculated risk-taking translating to determined success, one must look no further than the Zama-1. In 2014, Mexico’s Congress passed a constitutional amendment that opened up their oil and natural gas sector to private investors. This policy shift was lead up by Mexican President Enrique Peña Nieto and ended the nearly 8-decade long nationalization of the country’s oil fields.
In 1938, Mexico nationalized their oil sector to prevent excessive profiteering by American oil companies. Up until 2014, the Mexican constitution made it illegal for any entity other than the state oil company, Pemex, to own a barrel of Mexican oil. Furthermore, no risk-based production sharing contracts or joint ventures with any other international oil companies were allowed.
This nationalized oil sector worked for Mexico for a while, especially with the success found in the Cantarell Oilfield. However, further development remained stagnant as the Mexican Government used Pemex’s revenues to fund roughly a third of the federal budget, leaving the national oil company severely undercapitalized to develop beyond Canterell. Enter President Enrique Peña Nieto.
When Mexico began auctioning off rights to their oilfields in 2015, Talos Energy was eager to join in the development. A consortium of E&P companies, including Talos Energy of Texas, were the first to bite and purchased the rights to develop the Zama-1 field. Bigger oil companies were averse to taking such geopolitical risks without the guarantee of a portion of the earnings in the event that Zama-1 proved fruitful. But as we have seen time and time again, Talos Energy thrives under such risks.
In 2017, Talos Energy’s risk paid off, as a major oil deposit was found in the Zama-1 field. Talos Energy successfully spudded the Zama-1 well, only to find a tremendous subsea formation below. Zama-1 is now one of the 20 biggest shallow-water fields discovered internationally over the past twenty years. Hesitant to detail how big of a discovery this is, Duncan stated it was much larger than expected.
Oil Fields that rival Zama-1 in size usually produce 100,000 barrels per day. But the cost of doing business in Mexico will take a toll on profits. Once Talos recoups its development costs from Zama, the Mexican government will take roughly 80% of the oil and gas produced as royalties and taxes. But the newly combined Talos company anticipates receiving up to $25 million in annual pre-tax synergies from supply chain management and other operational efficiencies by the end of this year.
Combining Talos and Stone: A Personal Achievement for Timothy Duncan
Securing the $2 billion-dollar merger with Stone was a personal achievement of Duncan. He tirelessly worked on negotiations for months prior to the merger. Acquiring the once bankrupted Stone required a healthy dose of risk and a whole lot of effort on Duncan’s part. But the pay-off to the merger was equally enticing as Talos Energy became a public entity without having to go through the troubles of an initial public offering. It was Duncan’s vision and dedication that made the combination of the companies a reality.
If this task does not sound difficult enough already, four months into Stone Energy and Talos Energy merger, Duncan’s efforts were hampered by Hurricane Harvey. In 2017, Duncan’s home was flooded by the hurricane, forcing him and his family to retreat via a FEMA boat. Such catastrophe was sure to prevent the merger from happening on time, but Duncan would not allow a little storm to stop him. Through endless days and sleepless nights, Duncan was able to complete the intricacies of the deal on schedule. It was his unwillingness to fail that put the new combined company in capable hands.
The Future of Talos Energy
Talos Energy is situated to take advantage of its strategic assets that are primarily in the Gulf of Mexico. The combined company has a low-risk balance sheet, $700 million in debt as opposed to the $2.3 billion in assets, that is sure to attract long-term investors. When asked about the company’s prospects, Duncan said, “There certainly are exciting things happening on the exploration side for large firms able to drill $150 million-$200 million wells and be involved in billion-dollar development projects. But I think mature deepwater properties that still have active production, although far less than their peaks, with some exploitation upside, while maybe material for the larger firms, could be better suited for appropriately capitalized smaller operators with a history in the area.”