U.S. energy exploration and production company Comstock Resources announced a $333 million debt-financed acquisition of producing properties and acreage in the Delaware Basin.
-- We are revising our outlook on the company to negative from stable.
-- We are revising our recovery rating on the company's senior unsecured debt to '5' from '6' and raising the issue rating to 'B+' from 'B'.
-- The negative outlook reflects the increased debt as a result of the transaction and tighter liquidity along with uncertainty regarding production growth and costs in a new operating area for Comstock.
Dec 7 - Standard & Poor's Ratings Services said today it revised its outlook on Frisco, Texas-based Comstock Resources to negative from stable and affirmed the 'BB-' corporate credit rating. We revised the recovery rating on the company's senior unsecured debt to '5' from '6', indicating our expectation of modest (10% to 30%) recovery for lenders in the event of a default and as a result raised the issue rating one notch to 'B+' from 'B'. The revised outlook on Comstock reflects the incremental debt leverage and tighter liquidity associated with the announced $333 million acquisition of properties in the Delaware Basin, West Texas from privately held Eagle Oil & Gas Co., said Standard & Poor's credit analyst Carin Dehne-Kiley.
The revised outlook also reflects added uncertainty regarding production growth and costs in what will be a new operating area for Comstock. Although the acquisition increases Comstock's projected oil production in 2012, the company remains highly levered to weak natural gas prices. The revised recovery rating and issue-level rating reflect a higher PV-10 valuation based on mid-year 2011 proven reserves as well as the proven reserves associated with the announced acquisition. For the complete recovery analysis, see Standard & Poor's recovery report on Comstock Resources to be published on RatingsDirect following the release of this report. Comstock is acquiring proven reserves of 23.2 million barrels of oil equivalent (75% oil and 10% developed), and 1.4 thousand boe per day of production, which adds 13% to its year-end 2010 proven reserve base and 3% to its total equivalent production.
The acquisition also adds 44,000 net acres prospective in the Bone Spring and Wolfcamp oil shales. The deal establishes a new core operating area for Comstock in the Permian Basin of West Texas (the Delaware Basin is located in the western Permian Basin), where the company has recently acquired 12,000 net acres in separate transactions, and we expect will continue to expand. The acquisition is slated to close by year-end 2011. Comstock will fund the acquisition by drawing down on its revolving credit facility ($700 million borrowing base post-deal), increasing its projected debt to EBITDA to 3.7x at year-end 2011 and 3.3x at year-end 2012, from about 3x for both years prior to the deal. Our estimates account for a substantial increase in capital spending next year to $545 million from $380 million previously, with $170 million allocated to the newly-acquired assets, which we estimate will exceed operating cash flow by about $200 million.
We expect this capital program to increase Comstock's crude oil production to 20% of its total volumes by year-end 2012, up from 4% today. The 'BB-' rating on Comstock reflects our expectation that natural gas prices will remain weak over the medium-term, which will pressure the company's profitability while it shifts capital to oil projects. Additional factors we incorporate are Comstock's small and geographically concentrated reserve base and our estimate that the company will outspend operating cash flows in 2011 and 2012. Our ratings also take into account Comstock's experienced management team and competitive cost structure. The negative outlook reflects our view that the company's debt leverage will increase over the next 12 months to levels slightly above our expectations for the rating category, while liquidity tightens. The outlook also reflects the increased uncertainty regarding production growth and costs in a new operating area for Comstock, and its still high leverage to weak natural gas prices.
We could lower the rating if debt-to-EBITDA exceeds 3.5x for a sustained period, which would most likely occur as a result of oil production from the Permian acquisition not ramping up as expected. We could revise the outlook to stable if debt-to-EBITDA returns to the 3.0x level.