Spending Spree Continues at XTO Energy

One of the largest onshore producers of natural gas in the U.S., XTO Energy is making a name for itself in oil. The company is acquiring $1.85 billion in drilling rights in the oil-rich Bakken Shale region from Headington Oil, a privately held oil and gas company based in Dallas.

In contrast to Chesapeake Energy, which generates about 99 cents of each dollar in revenue from natural gas, XTO is looking to leverage $100 oil by diversifying. As of the first quarter ended March 31, the company generated about 23 cents of every dollar in revenue from the sale of crude.

The Bakken Shale deal instantly makes the company the third largest oil producer in the area, alongside Marathon Oil and EOG Resources, and includes 352,000 acres in Montana or North Dakota, with undeveloped leasehold comprising about 215,000 acres of the total.

The acquisition will add about 10,000 barrels of oil equivalent per day to the Company’s growing production base — increasing aggregate company yield by about 20 percent overnight!

The company estimates proved reserves of 68 million barrels of oil equivalent on the property, of which 60 percent are proved developed, with the primary gusher in Elm Coulee, Mont., according to a recent regulatory filing.

Did XTO pay too much for the deal? In January 2008, Continental Resources paid $60 million, or about $15 million per million barrels in proven oil reserves. XTO is paying $38.5 million per million barrels in proven reserves.

One cannot argue with success. XTO has historically grown through acquisitions, using cash flow, debt and its stock as currency to fund its deals. Management waits for other players to drill the dry holes, choosing instead to leverage properties in areas adjacent to new discoveries. Although execution of this low-risk strategy necessitates paying more for proven hydrocarbon reserves, XTO’s net income has grown 64.7 percent annually in the last five years, and the company’s return on capital is 15.3 percent, above the peer average.

In 2007, XTO did 180 transactions costing about $3.5 billion.

The $1.85 billion Bakken Shale acquisition, however, outdistances the combined purchases of three major acquisitions in the first quarter, which added more than 35 million cubic feet of gas equivalent per day to its reserve inventory.

Only $1.06 billion of the deal will be paid in cash, which will be easily offset by debt issuance of commercial paper. That said, given the upside potential and management’s proven track record, this deal could look cheap several years from now.