Cross Timbers' acquisition strategy underpins explosive rate of growth

Anne Rhodes
Associate Managing Editor-News

Cross Timbers' Financial, Operations Growth [117,762 bytes]
Cross Timbers' Reserves [130,980 bytes]
Changes in Proved Reserves [59,896 bytes]
The right acquisition at the right time gave us the ability to strengthen our balance sheet with equity and to meet our targets ahead of schedule. As a result, we have increased our 1999 cash flow per share goal to $4. Bob Simpson Chairman and CEO - Cross Timbers Oil Company [12,499 bytes]

Cross Timbers Oil Co. has successfully implemented a 5-year, aggressive growth strategy that has converted it from a small independent exploration and development firm to a solid, mid-sized independent.

The Fort Worth-based company's strategy involves targeted acquisitions and careful development. Its modus operandi is to acquire producing properties and increase production, reserves, and cash flow through low-risk development strategies.

This strategy has brought the firm's market value to about $1 billion, and it has done this in what many at the company consider the most competitive acquisitions environment they have seen in the past decade.

"We've had to be quick, creative, and pre-emptive," said Cross Timbers official Tom Petris.

If the company continues to grow at the pace it has established, it soon could be ranked among the super-independents.

History

Cross Timbers was established in 1986 and went public in 1993. Its reserves base-concentrated in Texas, Oklahoma, Kansas, Wyoming, and New Mexico-is more than 70% natural gas.

Major producing areas include New Mexico's San Juan basin; East Texas basin; Major County, Okla; the Hugoton field area of Oklahoma; Wyoming's Fontenelle unit; West Texas' University block; and the Ozona area of Texas (see map, p. 27).

Cross Timbers' reserves typically have a life span of 10-12 years vs. 7-8 for other companies of comparable size. Its East Texas properties are the exception to this rule, with an expected life of 8.7 years.

Cross Timbers targets acquisitions of high-margin, long-lived, operated properties, then reduces costs by introducing efficiencies in operating the properties. The firm further enhances efficiencies by improving gathering and processing systems.

"What we do is buy existing quality production and make it better," said Chairman and CEO Bob R. Simpson. "Initially, we buy at a 12% rate of exploitation or so and move it up to right around 20% over time."

Performance

Simpson says his firm's growth has been within its expectations.

"We're one of the few companies I see that announce goals and objectives in advance," he said. Cross Timbers has tripled its production in the last couple of years. And, in the past 5 years, it has almost doubled its reserves and almost tripled its cash flow.

It also has replaced 454% of its production since 1993, compared with about 120% for major oil companies, as a group.

Of a peer group of 24 independent oil companies, Cross Timbers has a total return analysis of 163.8%, which ranks it second, behind Ocean Energy Inc.'s almost 300%.

In recent years, Cross Timbers has adopted 2-year growth plans. The firm achieved its goals for 1996-97.

Last year was a record year for the company. Daily production increased by 50% during the year. But, because Cross Timbers closed a major acquisition late in the year-on Dec. 1, 1997-average daily production for the year rose by 30%.

The firm's proved reserves at yearend 1997 were 198 million boe, up 49% from the previous year (see table, p. 28). Eighty percent of these reserves are proved developed.

Gas reserves grew 51% in 1997, to 816 bcf. Oil and NGL reserves were up 45% to 62 million bbl.

Earnings available to common stock for 1997 were $23.9 million vs. $19.8 million in 1996. "This significant improvement in earnings was the result of higher gas prices and increased gas production from the 1996 and 1997 acquisitions and development programs," said the company.

Revenues for 1997 were $200.7 million, a 24% increase from the previous year. The increase came almost entirely from gas revenues, which were up $36.7 million, or 50%. Oil revenues remained constant because a 13% increase in oil production was largely offset by a 12% decline in oil prices for the year.

"It was a very dramatic growth year," said Simpson. "We got within 7 or 8% of our (cash flow) goal," said Simpson. The firm probably would have reached its goal had it not been for fourth-quarter oil prices, he added.

Production costs for 1997 were $3.54/boe, down from $4.05/boe in 1996. "This decrease is primarily because of the lower operating costs of gas-producing properties acquired in 1996 and 1997, the timing of workovers, increased production without comparable increases in lifting costs, and other operating efficiencies initiated after acquiring operated properties," said the firm.

At yearend, the company's reserve-to-production index stood at 13.3 years. Its production replacement ratio last year was one of the highest in the industry-628%, replaced at a cost of $4.14/boe. But this pace is unlikely to continue.

"In our strategy, we had announced that we would do $260-280 million in acquisitions by the end of 1999," said Simpson, "and actually we did them all last fall, a couple of years early." This puts Cross Timbers well on its way to achieving its goals for 1998 and 1999, which are 20% growth in both earnings and cash flow.

Simpson points out that those promises were made at gas prices of $2.40/Mcf and oil prices of $20.50/bbl.

"We're quite a way from that number (on oil)," he said, "but we're predominantly a gas company."

Barring a calamity in commodity prices, says Simpson, Cross Timbers will make this growth target in 1998.

"We've got the acquisitions under our belt to do it. It's just a matter of commodity pricing. We're trying to be a growth company within a non-growth industry, which is a very difficult proposition."

"I think gas bodes well for the next couple of years. I think we'll get through this oil deal pretty soon," said Simpson.

Keith Hutton, senior vice-president of asset development, agrees. He believes Middle East producers will begin to take serious action this month.

Recent acquisitions

For Simpson, the high points of the last 5 years have been the large acquisitions his firm has made. These include:

$130 million in Hugoton properties, acquired from Santa Fe Minerals Inc. (OGJ, Apr. 24, 1995, p. 44).
$52 million in Green River basin properties, acquired from EEX Corp. (formerly Enserch Exploration Co.) in December 1996.
$39 million in properties in Oklahoma, Kansas, and Texas, acquired from Burlington Resources Oil & Gas Co. (OGJ, June 2, 1997, Newsletter).
$195 million in San Juan basin properties, acquired from Amoco Production Co. (OGJ, Oct. 6, 1997, Newsletter)

. The first of these acquisitions involved one of the U.S.'s premier gas-producing areas-the Hugoton field in Kansas and Oklahoma. In this deal, Cross Timbers acquired proved reserves of 153 bcf for 66¢/Mcf.

The acquisition of properties in Wyoming's Green River basin included the Fontenelle unit, in which Cross Timbers owns a 97% working interest, and interests in Nitchie Gulch and Pine Canyon fields. Proved reserves attributable to the transaction were 118 bcf.

The acquisition from Burlington Resources involved properties in northwestern Oklahoma, the Oklahoma and Texas panhandles, and southwestern Kansas. The deal involved proved reserves of 36.5 bcfe, of which more than 97% was gas.

Proved reserves attributable to the San Juan acquisition were 61 million boe, comprising 258.6 bcf of gas, 16.4 million bbl of NGL, and 1.5 million bbl of oil. The properties had a reserves-to-production index of 14.5 years.

Its most recent, and largest, acquisition was a $265 million deal with EEX involving East Texas basin properties (OGJ, Mar. 2, 1998, p. 62). Proved developed reserves constitute 94% of the value of these properties, says Cross Timbers.

Starting Jan. 1, 2002, EEX will retain a net interest in about 28 bcf of reserves in exchange for a $30 million reduction in the purchase price. Cross Timbers retains all rights to production and cash flow between the time of the sale and Dec. 31, 2001.

Cross Timbers estimates proved reserves attributable to the acquisition to be 260 bcf of gas and 1.6 million bbl of oil. The reserves are on about 88,000 gross (59,000 net) acres.

Current production is 80 MMcfd of gas equivalent from 784 gross (600 net) wells. Production is primarily from Travis Peak, Cotton Valley, and Rodessa formations at 7,000-12,000 ft.

Cross Timbers operates more than 90% of the properties. The firm says direct production costs, excluding production and severance taxes, are just an average 25¢/Mcfe.

Acquisition successes

Cross Timbers' recent acquisitions already have begun to make a difference in the company's bottom line.

Cross Timbers says the East Texas basin properties have not only given it a geographically concentrated reserve base and increased capitalization by 20%, but also increased cash flow by 50%. Simpson calls this "accreted value."

Vice-chairman and Pres. Steve Palko calls the Cotton Valley play in East Texas "the big enchilada."

"Not only do we have an extensive acreage position," said Palko, "but our holdings are directly offset by recent discoveries."

One of these he says holds 40 bcfe. And this discovery has single wells producing 25 MMcfd.

In the gathering system for the East Texas fields, the firm has reduced line pressures, improved marketing flexibility, decreased hookup times, and reduced downtime in the system.

"On long-lived wells, you're a slave to time," said Rick Seeds, a Cross Timbers executive vice-president.

Seeds says the East Texas system has increased throughput to 115 MMcfd from 80 MMcfd as a result of the changes Cross Timbers has made.

Cross Timbers also has improved its gas revenues by hedging. The company has hedged about 25% of its production at $2.25/Mcf through the summer, traditionally the time of year when prices are lowest.

By doing so, Cross Timbers has reduced its differential between the New York Mercantile Exchange futures price and the Rocky Mountain wellhead price, which used to be about $1/Mcf.

Seeds said, "In the San Juan basin, with the new pipelines taking Rocky Mountain gas to East Coast markets, the differential has been reduced to about 25¢ by hedging."

Development plans

Cross Timbers' acquisition strategy has given it a sizeable portfolio of drilling prospects. It has budgeted $70-90 million for E&D spending this year.

The company plans to allocate 10-15% of its budget to exploration next year, and its development budget will be 25-30% more than in 1998.

The firm has booked a total of 413 wells to be drilled-90-100 of them this year. It also has 425-730 wells planned for unbooked sites.

This means a total of 838-1,143 wells are planned. "And that does not represent the full growth potential, as we are still evaluating the recently acquired properties," Simpson pointed out at the annual shareholders meeting.

"Both the San Juan basin and East Texas basin acquisitions are on target with our expectations," said Palko. "In the San Juan, we have already begun restimulations and compression and artificial lift installations. We also are preparing to drill as many as 20 wells in the San Juan basin this year."

Cross Timbers has 675 operated wells in the San Juan. Its cost to operate those properties is 30¢/Mcfe, said Hutton.

The company already has done 17 wellhead compressions in the area (a number it expects to double by yearend), performed 18 plunger lifts, and returned 10 wells to production. It also has identified 280 potential infill locations, only about 100 of which were acquired from Amoco.

In the East Texas basin properties, 97% of the 784 wells are operated by Cross Timbers.

"In the East Texas basin," said Palko, "we took over operations at the end of April and are making preparations to improve the pipeline infrastructure and to optimize compression and artificial lift. We plan to drill as many as 20 wells in East Texas this year."

The company has identified 100 infill locations with multiple production zones. And it plans to improve wellbore utilization in the basin.

One recent well provides an example of its success in this endeavor. Cross Timbers tested a 1,500-ft interval in the Travis Peak and found 40 pay zones, not all of which had been completed by the previous owner of the well.

In the Hugoton area, Cross Timbers has 2D and 3D seismic programs under way. "We need good-quality reservoir rock, and we've found it in the Hugoton," said Palko.

He says Cross Timbers will drill more wildcats this year in the Council Grove, the target immediately below the Chase interval. "We've bought the deep rights from Burlington."

Elsewhere, the firm recently completed a 3D survey in the Illinois basin, where it has a sizable position. And it is permitting 70 sq miles in central Oklahoma for a 3D survey it plans there.

First-quarter 1998

Cross Timbers' first quarter operating results illustrate its recent growth. However, its financial results tended to be lower than the prevous year, due in part to lower oil and gas prices.

Gas production averaged a record 176.7 MMcfd in the first quarter. This is a 41% increase from first-quarter 1997 production. Oil production increased 15% to 11,959 b/d, which also is a record for the company. NGL production was 2,332 b/d (the firm had no NGL production in first quarter 1997).

Net income was $261,000 vs. $11.1 million for first quarter 1997. Per share earnings zeroed out, compared with $0.26/share for the same period last year (adjusted for a three-for-two stock split in February 1998).

Cash flow from operations, before changes in working capital, was $16.8 million, or 43¢/share, said Cross Timbers. This compares with $27.2 million, or 67¢/share, for first quarter 1997. Total revenues were $50.6 million, a 5% drop from last year.

The average price received for gas during the first quarter was $1.96/Mcf, down 25% from the same period last year. The average oil price was $13.99/bbl, a 35% decrease from 1997. NGL prices averaged $8.47/bbl for the quarter.

"The company achieved record production during the first quarter," said Simpson. "Gas prices have rebounded sharply from their first quarter lows.

"The East Texas acquisitionellipsewill increase gas production by about 80 MMcfd, resulting in a production mix of approximately 75% gas.

"We anticipate record cash flow and production for 1998."

Continued growth

Until recently, Cross Timbers' goals for 1998 and 1999 were identical to those of the 1996-97 plan. As a result of the East Texas basin acquisition earlier this year, however, Cross Timbers raised the bar for itself last month, when it announced new goals for 1999.

"Last year, we challenged ourselves to duplicate our 50% growth goal over a 2-year period beginning Jan. 1, 1998," said Simpson. "Our goals were to achieve cash flow per share of $3.67 and reserves per share of 5.4 boe during 1999.

"The right acquisition at the right time gave us the ability to strengthen our balance sheet with equity and to meet our targets ahead of schedule. As a result, we have increased our 1999 cash flow per share goal to $4.

"Proved reserves per share at yearend 1999 are now targeted at 36 Mcfe of gas or 6 boe," said Simpson. "Our debt per Mcfe target, however, will remain at $0.40. These goals assume commodity price levels of $18/bbl of oil and $2.20/Mcfe of gas, net to the company," he added.

As part of this recent change, Cross Timbers now expects to spend $100-120 million on E&D in 1999. The exact amount will depend on drilling results, property acquisitions, and commodity prices. Higher-risk expenditures, such as step-out development and exploratory drilling, will total 10-15% of total E&D outlays, says the company.

"We expect development expenditures to be funded from cash flow, while acquisitions and stock repurchases will be funded with a combination of cash flow and debt," said Simpson. "With our recent equity offering, we can immediately fund in excess of $400 million in acquisitions with low-cost bank financing. If larger strategic acquisition opportunities arise, we will consider funding them with equity, depending on market conditions."

Cross Timbers' new goals include making strategic acquisitions totaling $150 million between now and the end of 1999. Included in this total is the potential repurchase of 1.5 million shares of the firm's common stock.

"But, if we do buy more, we'll need to blend in some equity this time," said Simpson, "and we guard the equity with our lives. We're very judicious with it, because all of our measurements are per share. But, for the right acquisition, we could do part equity."

If Cross Timbers does make additional acquisitions this year, says Simpson, its purpose will be not to exceed the goals it has set for 1998 and 1999, but to set itself up for growth beyond 1999.

Merrill Lynch & Co. noted:

"ellipseThe company has a large undrilled reserve and hydrocarbon resource inventory to spur future volume growthellipseGoing forward, XTO (Cross Timbers) will blend its existing growth approach with moderate-risk exploration.

"In our view, XTO successfully transitioned from the small to mid-cap ranks without missing a step, while other acquisition/exploitation-driven peers stumbled."