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Seth Klarman Investment Holding Energy XXI in a Whopper of a Deal

November 22, 2010 | About:

There are transactions and then there are transactions. Bermuda based Energy XXI announced a big one today.

I noticed in August that Seth Klarman owned shares of Energy XXI (NASDAQ:EXXI) that he appears to have picked up in Q2 of this year after the BP oil spill. As of his last regulatory filing for the September 2010 quarter end he was still holding shares.

I’m sure that after the BP spill Klarman went to where trouble was to see if he could purchase assets on the cheap and wound up with EXXI. I had the same thought and put together a basket of Gulf of Mexico related stocks early this summer (I already owned ATP prior to the spill).

Ensco July 1


Cobalt July 29


Stone Energy Aug 15


Diamond Offshore Jul 31


These purchases have all worked out very well thus far and looking back on it the timing of the investment seems like a no-brainer. It certainly wasn’t that easy to pull the trigger back then though with the BP spill on the television 24 hours a day and all kinds of headlines about the end of drilling in the Gulf of Mexico.

I wish I’d spent a little more time getting to know Energy XXI however. Today the company announced a huge deal with Exxon where Energy XXI is buying virtually all of XOM’s shelf properties for a very reasonable price of about $20 per BOE of proven reserves and about $15 per BOE of proven and probable reserves.

The transaction doubles Energy XXI’s reserves and production and makes them the 3rd largest producer on the shelf.

What you won’t see in the numbers that make up the transaction however is that fact that Exxon’s property is likely very under-exploited as many drilling targets which were not worth bothering with for Exxon can be very value accretive for a firm the size of Energy XXI.

EXXI is a stock that is likely worth the time getting to know better. After this acquisition I believe we are going to see a company that trades at a very reasonable multiple of both reserves and cash flow and offers exposure to potentially one of the largest discoveries in the United States in decades.

And that is what I kind of look for when investing in an energy company. I like to pay a fair or discount price for the company’s current known reserves and cash flow and get exposure to value enhancing exploration opportunities. And what an exploration opportunity EXXI has. Here is a snippet from an interview that EXXI CEO John Schiller did last week with Forbes that discusses the ultra-deep drilling that EXXI is doing with partner McMoran on the GOM shelf:

“Schiller is feeling flush these days, fresh from raising $550 million in an equity offering the week before. Above the bar filled with rare single malts, a flat-screen TV charts the reason for his confidence. It's a live feed of data from a well being drilled off Louisiana in the Gulf of Mexico. Lines and squiggles mark the depth of the drill bit (now at around 22,000 feet), as well as the resistivity and porosity of the rock that it's cutting through.

This is the second well to be drilled into the Davy Jones field by five-year-old XXI and its bigger partner, McMoRan Exploration ( MMR - news - people ). In a few weeks, when the bit hits 30,000 feet, Schiller will be watching for a repeat of the results from the Davy Jones discovery well last January--which struck a 200-foot-thick reservoir of highly porous sand brimming with natural gas. Success, says Schiller, "will allow us to connect the reservoir to the first discovery," a couple miles away. "If you can connect those sands up, you're talking big numbers."

How big? Add the potential of Davy Jones to that of their similarly ultradeep Blackbeard discovery (where results from a second well are expected "any day now") and Schiller thinks he's looking at 10 trillion cubic feet. Pile on the 12 other ultradeep prospects they plan to drill, and the prize climbs to 100 trillion--enough to supply the whole of U.S. demand for four years, the energy equivalent of roughly 15 billion barrels of oil. If it pans out, these would be some of the biggest finds in the Gulf ever. "What we're seeing so far is not making anything look smaller," says Schiller, 51.

Despite the impact XXI's 20% stake in these wells could have on his small-fry $550 million (revenues) company, Schiller knows better than to get too giddy. "I thought we were going to relax this summer and take some time off," says Schiller. Then came BP ( BP - news - people )'s Macondo blowout. As investors fled anything with exposure to the Gulf, shares of XXI plunged from $22 to $13.

Which raises the question: How is it that these guys get off drilling ultradeep wells in the Gulf when every other operator has been stymied by Washington's drilling moratorium or scared out of the water altogether, unwilling or unable to stomach tightening regulation and soaring insurance rates?

Although these wells are some of the deepest ever drilled anywhere in the world (and much deeper than BP's 19,000-foot Macondo), they are not deepwater wells at all. XXI's rigs sit right on the coastal Louisiana seabed in less than 100 feet of water. Their blowout preventers are above the waterline, and the wells, says Schiller, are engineered more conservatively than BP's--built to deal with downhole pressures as high as 25,000 psi and temperatures of 400 degrees. The federal government's new Bureau of Ocean Energy Management feels confident enough that it granted XXI and McMoRan the only new ultradeep permit since BP's disaster--to start drilling another prospect called Lafitte in October.

With these potentially mammoth ultradeep, shallow-water discoveries, McMoRan and XXI could soon lure in the supermajors seeking a replacement for the deepwater game that BP complicated. This would mean an about-face away from shale gas plays like the Marcellus Shale that have spurred multibillion-dollar acquisitions by Exxon, Shell and most recently Chevron ( CVX - news - people ). Why? At a current natural gas price of $3.50 per million cubic feet drillers can barely make money on many shale wells, which require costly and water-hogging hydraulic "fracking," suffer precipitous volume-decline rates of 80% a year and lack easy access to pipelines.

Davy Jones and Blackbeard, in contrast, are conventional reservoirs, from which gas will flow unaided for far longer. And they are situated amid a warren of existing subsea pipeline infrastructure. McMoRan figures the break-even point on Davy Jones will be less than $1.50 per thousand cubic feet. And though the vast majority of the riches recovered from these wells will be natural gas, Schiller says its entirely possible that they'll get some oil as well--a nice kicker, considering that oil sells for $87 a barrel while the same amount of energy from natural gas fetches only $25.”

The rest of the article is here:


I’m going to try and do a deep dive on this company to understand it better. It all comes back to the old Pabrai idea of “heads I win, tails I don’t lose much”. It may be that EXXI is a “heads we hit the motherload in the ultradeep, or tails it is just a good company at a fair price based on the regular reserves it has”

And heck, if it gets past Klarman who is careful as they come it is definitely worth looking further into.

If anyone has thoughts on EXXI please shoot me an e-mail at [email protected]. I’m excited to learn more about the company.

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