BU FE450

WARREN RESOURCES (WRES.) - LBO FINAL PROJECT

May 4th, 2015

Kevin NgJames Jinghong Yu

Tinna Xinyuan Zhang

Agenda

BUSINESS MODEL SHOULD AN LBO BE DONE?

LBO CHARACTERISTICS INDUSTRY

COMPANY

PURCHASE PRICE CONSIDERATIONS

CAPITAL STRUCTURE REASONING

SOURCES & BACKUP DATA

2Monday, May 04, 2015

SHOULD AN LBO BE DONE? Advantages: Natural gas and crude oil prices are currently at a 10-year low

Potentially an opportunity to take undervalued companies from short-sighted investors

Oil & natural gas prices rebound amplifies EBITDA growth and overall return (see oil & natural gas prices outlook slide 16-17)

Provides the company with greater flexibility to capitalize on potential growth opportunities or protect itself should energyprices continue to drop

Transaction actually reduces the total leverage and interest payments

Aligns incentives with management to stay and grow the company

Sponsor can bring greater industry expertise and recruit talent for the company

Disadvantages: Inherent risk in a company that has revenue primarily dependent on energy commodity prices

Requires a large equity commitment upfront from the sponsor and a committed management team

Operational expertise is required to manage growth through constantly fluctuating industry and talent is not always available or easy to find

Given current capital market conditions, although there is cheaper financing, a higher TEV multiple will also have to be paidso multiple expansion is extremely unlikely


LBO CHARACTERISTICSINDUSTRY PROS

High growth industry, primarily driven by the US shale oil boom Oil production growth 5-yr CAGR: 10.12% (surpassed Russia as the world's second largest crude

oil producer)

Natural gas production growth 5-yr CAGR: 4.51%

Barriers to entry are high Capital requirements and exclusive land lease ownerships prevent larger competitors from taking

business

Oil crisis makes it unprofitable for new players to enter and therefore threat of new entrants is low

A high level of technological expertise is required in exploring and developing oil & gas wells such as knowledge of tertiary recovery processes, flacking, and seismic surveying

Exploration companies possess more leverage in dealing with drilling companies Allows them to pass through price decreases over time since they own the land lease and drillers

need that right to be able to drill on the land


LBO CHARACTERISTICSINDUSTRY (CONT.) CONS Cash flows are highly dependent on prices of crude oil and natural gas

Unpredictable revenues based on commodity prices, extremely market sensitive There is risk in generating consistent cash flows or even paying off interest for high debt levels in poor market

conditions Mitigated by effective use of options (collars and swap agreements) Mitigated by Warren Resources focus on increasing natural gas production after acquiring the Marcellus shale gas asset for

US$300m, given natural gas prices have a much more bullish outlook than crude oil and our conservative assumptions (based on futures prices) on natural gas price rebound (see slide 17)

High capital expenditure requirements Capital intensive business that requires a lot of capital expenditure for expansion and further development of oil

wells Mitigated by the fact that maintenance capital expenditures is low (shown in 2015E projections cutting expansion programs)

and if necessary, the company has enough reserves to continue drilling at the same rate for more than 10 years without additional expansion or development

Potential environmental litigation Mitigated by the fact that there is currently no ongoing or historical litigation that would result or has resulted in

material damages paid maximum litigation allowance in the past was only $3.1mm

Trending towards consolidation (BOTH positive and negative) 8 acquisitions (TV: 500-1,000MM) announced YTD There may be more strategic bidders to bid up the price in acquiring the company

Mitigated by antitrust laws and most energy companies cutting expansion from low energy prices

Small size of the company provides opportunities to get acquired by a strategic buyer as a potential exit


LBO CHARACTERISTICSCOMPANY PROS Hurt by the oil crisis and is trading at a significant discount (see slide share price

performance slide 15)

Strong historical EBITDA and net income margins (See comps chart slide 19)

Ability to sell off underperforming assets if necessary

Management possesses a significant amount of industry experience, but is currently in transition with an interim CEO (BOTH positive and negative)

Vice presidents are all younger and have spent at least a decade at the company so there is a talent pipeline

Current interim CEO is from the acquisition of Marcellus Shale indicating management instability Mitigated by the assumption that the interim CEO would like to stay as permanent CEO given his age (only 54

with over 30 years of experience in the industry) provided proper incentives (options) He would be the person to grow the Marcellus Shale natural gas assets since he founded the company that it was

bought from (Citrus Energy) and knows of all the skeletons buried in the closet

Existing VP of Operations was previously the California drilling manager which means he is extremely experienced with oil production operations and can fill in gaps in knowledge of the interim CEO


LBO CHARACTERISTICSCOMPANY (Cont.) CONS Customer concentration is extremely high

The largest three purchasers of Warrens total oil and gas production accounted for 98% of total oil and natural gas sold in 2014 Mitigated by the fact that refineries get their crude oil regionally since they need to build a pipeline to

receive it (large amounts infrastructure required), there is no risk of the wells being displaced by a cheaper competitor (extremely high switching costs)

There is no risk of losing all their business to another competitor, only reduced prices from market forces Robust domestic demand for crude oil

Might not be able to obtain a favorable credit rating Given the unpredictable revenues, high leverage, and small size for an oil company, the company

might not be able to get a credit rating that would allow the transaction to obtain financing at a favorable interest rate Mitigated by the large amount of collateral in PPE the company has, and previous capital structure is more

levered than the proposed transaction

Board is quite old (late 60s and 70s) and likely to retire soon (negative) Mitigated by the Sponsor likely to have many operational partners that will be able to serve as

independent directors for the company and bring a high level of industry expertise


LBO CHARACTERISTICSCONCLUSION Industry:

Given the low energy prices and trend towards consolidation within the next few years, the oil and gas exploration and production industry is a stellar industry to obtain assets in at the moment. Companies in this industry have high barriers toentry with land leases holding the legal right to drill for oil and bargaining power over drillers and refineries. Although theymust continue to pump oil at depressed prices in the current market, should crude oil and natural gas prices recover as predicted by projections and future prices, companies in this industry would experience explosive growth.

Company:

This company is a decent growth management buyout play for sponsors with expertise in the energy sector that can not only fill the potential gaps in the management team, but also provide guidance for integration of new natural gas assets. This company has a lot more reserves than its competitors for its size (see WRES reserve slide) and therefore has the ability to cut down on capital expenditures and still be able to produce at the same rate for over a decade. Given its recent acquisition ofMarcellus Shale, the company also has an enormous opportunity to expand natural gas production, being able to amplify the returns should energy prices recover. Given its small size for an oil company, there are also more exit opportunities available to larger strategic buyers seeking to acquire more reserves. A sale to financial buyer or an IPO are also feasible exit opportunities given the right market conditions. A dividend recapitalization is unlikely since the interest on additional borrowing is so low,there is no reason for the company to deliver. In fact, since it is a growth play, there will likely be additional borrowing for acquisitions or capital expenditures.

Winners of the transaction: Sponsor, management, current and future creditors, investors

Losers of transaction: Competitors, underperforming operational staff


PURCHASE PRICE CONSIDERATIONS Purchase price is the final bid we assume will allow the sponsor to acquire Warren Resources with the

following assumptions: Common equity will be purchased at a 34.8% control premium

Given the favorable industry and small size of the company, there will be more strategic buyers bidding if it is put into play which is why a management buyout is critical

Capital markets are still frothy given low interest rates so availability of money will likely push the purchase price up so it is doubtful that we will be able to acquire the company below a 30% premium

All debt and preferred shares will be prepaid at the premium given in the credit agreements

Management will be a partner in the transaction and will be rolling over 100% of their equity Enormous option plan (almost the same size as their rollover) Interim CEO has the incentive to cooperate since he will be able to continue to work with the assets his company owned

for the last 25+ years VP of Operations possesses deep operational knowledge of developed company assets and will want to stay with the

company since he has spent the majority of his career here

3% of the purchase price as a transaction fee is reasonable (2% financing/underwriting, 1% other advisory)


CAPITAL STRUCTURE REASONING Proposed capital structure will likely have a reduced revolver commitment at a higher cost than currently due to weaker energy

prices (therefore less expansion potential as shown in 2015E projections)

Still an extremely large revolver as sponsor will want to maximize flexibility to adjust for strategy based on how oil and natural gas prices recover (large capital expenditure requirements for expansion or used to pay interest if continually low prices)

Draw-down an additional $15.3mm in the revolver (compared to current balance) to pay for the transaction due to the low cost of debt

Low rate indicates that the credit line is an asset based loan collateralized by the companys PPE

Higher revolver cost due to likely lower demand for Warrens PPE from weak energy prices (therefore reducing the potential liquidation value and collateral coverage)

Senior subordinated debt is more appropriate for the situation over mezzanine due to lower cost

If necessary, company can draw down on the revolver to pay off interest payments

Size of the amount of debt is high for mezzanine but fits into senior subordinated range which tends to be $150mm or more

In the current capital structure (not pro forma), company has $300mm of subordinated debt used for an acquisition so getting a $250mm commitment should not be an issue despite weakening capital market conditions

Estimated to come in at around 8.75% since the pro forma capital structure is slightly less levered

Good for the company in that the debt costs less compared to mezzanine PIK notes, bad in the sense that it ties down more cash flow for cash interest payments


CAPITAL STRUCTURE REASONING (CONT.)

Estimated required equity is at least 35% based on the middle-market size of the company and risk of energy price fluctuations

Higher equity requirements would show lenders that the sponsor has enough skin in the game but given the large amount of collateral and nature of the industry, a 36% equity contribution is likely sufficient to obtain commitments (especially since it was 22% previously)

5.2x total leverage is in range with leveraged lending guidelines for 1Q15 - 2Q15 Lead Left Capital Markets Review

TEV will come in at 8.1x which is high but not unreasonable given the competitive dynamics, current low energy prices, and potential for growth (see comps slide 19)


SOURCES & BACKUP DATA


Oil & Gas Exploration and Production Industry Definition

Industry firms engage in the exploration and extraction of crude petroleum and natural gas. The industry also consists of the recovery of butane, ethane and natural liquefied petroleum gases (LPG) recovered from oil and gas fields


Company Snapshot Warren Resources

Warren Resources primarily engages in:

Oil drilling and recovery in California Wilmington field

Raw natural gas extraction in Wyoming & Pennsylvania Marcellus Shale

Owns natural gas and oil leasehold interests in approximately 529 gross (366 net) producing wells and estimated net proved reserves of 71.3 MMBoe

Sources: Companies 10-K report

Recent Development

Expanding natural gas sales through acquisition of Natural gas assets from subsidiaries of Anadarko Petroleum in 2012 Marcellus (shale gas) assets from Citrus Energy in July

Revenue from oil and gas sales has grown at a 3 year CAGR of 13.4% and increased 17% during 2014, mainly driven by increases in gas production

Net income in 2014, 24 million, declined 20.9% from 2013 due to drop in oil and natural gas prices

63.83%

32.66%

3.52%

2014 Revenue Brteakdown by Segments

Oil Revenue Nat Gas Revenue Transportation Revenue

Business Overview


Warren Resources Share Price Performance to DateWRES Share Price Performance

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50

100

150

200

250

Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15

Re

bas

ed t

o 1

00

WRES S&P 500

Peak: $6.66

Acquisition of Marcellus Assets Announced ($313M)

$300 million 9% Senior Notes


Crude Oil Prices Outlook WTI Crude Oil Price (US$/Barrel)

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120

2004 2006 2008 2010 2012 2014 2016 2018

$ p

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bar

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Historic Price

Futures Prices

0%

1%

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5%

6%

7%

8%

9%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Cu

mu

lati

ve %

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Crude Oil Demand

Crude Oil Supply

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

WTI Crude Oil Prices have dropped to $51/bbl, Low oil for longer period of time will prompt E&P firms to cut spending (Capex)

Rig count in America in mid-February fell to its lowest since 2011, and was 35% below its peak in Oct, 2014

U.S. crude oil inventories rose to a record 425.6 million barrels and is expected to grow further in 2015

Domestic crude oil output will likely be resilient in 2015 U.S. volume may increase 8% to 9.3 million barrels this

year, based on EIA data

U.S Crude Oil Inventory Levels (MMBL)


Natural Gas Prices Outlook Natural gas prices declined 22% during 2014, but prices are expected to have a

positive outlook due to

Severely cold weather

Favorable demand & supply outlook

Obama plans to increase natural gas exports to drive job growth

Natural gas demand rose 13.0% yoy, mainly driven by industrial and power sector

Futures contract indicates that natural gas price will rise to $3.1/cf in 2015, slightly lower than the $3.3/cf consensus

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500

1,000

1,500

2,000

2,500

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4,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Bcf

U.S Natural Gas Inventory (Bcf)

-5.0%

0.0%

5.0%

10.0%

15.0%

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25.0%

30.0%

35.0%

40.0%

45.0%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Cu

mu

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ve %

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ange

Nat Gas Supply

Nat Gas Demand

Global Demand Vs. Supply (%change)

Natural Gas Prices (US$/Cf)

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2004 2006 2008 2010 2012 2014 2016 2018

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Historic Price

Futures Contract Price


WRES Proved Reserves

WRES is significantly cheaper than its peers based on Enterprise Value/Proved Developed BOE, given its large amount of proved reserves

Partially due to slower relative growth in reserves of its comparables


Comp Co & Comp M&AComp Co

CompanyMarket Cap

(12/31/2014)Sales Growth EBITDA Margin Net Margin (%) EV/EBITDA

US$m 3 Yr Avg (%) (%) (%) FY 2014A

Warren Resources 123 12.60% 63.24% 13.79% 7.55x

Northern Oil and Gas 344 91.57% 73.06% 13.66% 3.72x

Comstock Resources 317 7.41% 79.62% -0.18% 6.49x

Bill Barrett 552 -4.61% 59.27% -5.64% 5.15x

Penn Virginia 460 14.89% 63.83% -1.36% 5.11x

Swift Energy 177 11.71% 64.04% 0.70% 10.45x

Unit Corp 1,674 16.20% 48.83% 13.83% 6.98x

High 91.57% 79.62% 13.83% 10.45x

75th 15.87% 70.81% 10.42% 6.86x

Mean 22.86% 64.78% 3.50% 6.32x

Median 13.30% 63.94% 0.26% 5.82x

25th 8.48% 60.41% -1.07% 5.12x

Low -4.61% 48.83% -5.64% 3.72x

Comp M&A

Announcement Date Status Target Company Acquirer TV (US$ MM) TV/EBITDA

4/20/2015 Pending LRR Energy LPVanguard Natural Resources 251 9.37x


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