Major Energy Deal Hits The Trade Block

In my previous article, I weighed in on the drought of M&As during the Covid-19 outbreak – and how deal activity was coming back with a vengeance.

As I explained, the drought was understandable. After all, many businesses were forced to adapt on the fly and change to accommodate workers and regular business activity in the middle of a lockdown. That left little time to think about deals. And then, of course, you have the uncertainty. It was just too risky to predict what things were going to look like in order to have the confidence to go out and acquire a rival.

But that’s quickly changing now. As things return to what looks like something akin to “normal,” cash-rich companies are back out on the prowl.

I also mentioned some sectors that are likely to be hotspots of deal-making activity in the coming months. But I didn’t spend too much time talking about one sector I know a lot of investors are wondering about: energy.

So let’s get into that today by focusing on one recent deal in the energy patch that I think is worth your attention…

A Big Deal In The Oil Patch

M&A activity in the Permian Basin went on a brief hiatus during the spring Covid oil crash. But it’s alive and well again, with Conoco (NYSE: COP) just making a bold $9.7 billion offer for Concho Resources (NYSE: CXO).

According to the terms of the stock-swap offer, CXO shareholders will be getting 1.46 shares of COP for each share of CXO. That values Concho at $49.30, a fair premium of 15%.

The resulting giant will be the nation’s largest independent energy producer, trailing only the integrated super-majors. With a post-merger enterprise value of $60 billion, the company is set to produce over 1.5 million barrels of crude per day – with a whopping low-cost resource base estimated at 23 billion barrels.

This deal will give Conoco a larger footprint in proven hotspots such as the Bakken and Eagle Ford shales. But Concho’s crown jewel is its 800,000 acres of prime territory in the Permian Basin – the world’s most prolific oil patch. Permian producers are currently bringing a staggering 4.5 million barrels per day to the surface.

Management expects to wring out half a billion in annual cost savings synergies from the merger, $100 million alone each year simply by streamlining board positions and eliminating administrative overlap. Those savings will drop straight to the bottom line.

With a stronger credit rating (and thus cheaper borrowing costs), Conoco will be able to more efficiently attack Concho’s most promising drilling targets in the years ahead. For now, even without incurring expensive drilling costs, it simply has to wait for a modest improvement in prices to crank up the production spigot by whittling down the hefty backlog of drilled but uncompleted wells (DUC).

Action to Take

Conoco’s disciplined spending and flexible balance sheet paved the way for this bold acquisition, which will convey meaningful advantages of scale and cost savings synergies. It will help further improve the firm’s already-low breakeven cost and be accretive to operating cash flows.

And management has pledged to reinvest no more than 70% of that cash right back into the business – while returning 30% to stockholders each year in the form of rising dividends.

I know most investors would prefer to be on the other side of the table when a deal like this happens. (Meaning you own shares of the company being acquired, thus enjoying a nice big pop.)

But COP is a quality name that’s likely to reward shareholders well over the long-term. In fact, if you had bought COP near the lows in March, you’d be sitting on a nice return already. And with a yield of more than 5%, it remains undervalued today.

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