A new wave of oil-and-gas acquisitions is under way, but unlike in past eras, it isn’t resulting in a windfall for shareholders of the acquired companies.
Investors are being rewarded with the promise of steady cash flows and dividends over time, instead of the 10-gallon cowboy hats full of cash that they once received.
That matters to investors because it changes the calculus behind investing in the companies. Buying smaller oil-and-gas companies because they may be acquisition targets probably won’t pay off like it once did, at least in the short term.
It is clear that energy companies are now more interested in acquisitions. In the second quarter, oil-and-gas companies made $24 billion worth of deals, up from $13 billion in the same quarter last year, according to Enverus Intelligence Research.
In past eras of M&A, oil companies built empires by buying up their competitors, sometimes at large premiums. But in the latest wave, they are making more modest purchases, and they are only paying slight premiums to market prices. The deals are being done at an average of less than four times the acquired company’s earnings before interest, taxes, depreciation, and amortization. In 2018, the average was more than seven times, according to Enverus.
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The latest example came on Monday when
(PR) agreed to buy
(ESTE) for $4.5 billion, after including debt—valuing Earthstone at 2.9 times its expected 2024 Ebitda. The combined company will become the third-largest producer focused on the Permian Basin of Texas and New Mexico, the most productive oil-drilling region in the U.S. Permian is paying for the deal in stock at an 8% premium to the average exchange ratio between its shares and Earthstone’s stock price over the previous 20 days.
That isn’t exactly a rich premium in historical terms.
(OXY) deal to buy Anadarko in 2019 for cash and stock valued the company at a premium of more than 50% of its market price before a bidding war for that company.
(XOM) agreed to pay a 25% premium for XTO Energy in 2010.
The Permian deal comes after two other notable all-stock purchases this year. Exxon agreed to buy oil producer
(DEN), which also has a growing carbon-capture business, at a 2% premium. And
(CVX) agreed to acquire Colorado producer PDC Energy in a stock swap at an 11% premium.
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The lack of larger premiums now comes from several factors. For one, oil companies are no longer focused on getting bigger at any cost. Instead, shareholders have been demanding that they focus on becoming solidly profitable, and sending more cash back to shareholders. Buying another company just for production growth is no longer a viable strategy because previous deals have resulted in poor performance.
It is also becoming more difficult for small and mid-cap oil producers to attract investor attention—and stronger multiples. In general, energy is out of favor among most investors, making up less than 5% of the
versus twice that level a decade ago.
When investors do buy energy stocks, they gravitate to bigger names such as Exxon, Chevron or more famous shale players such as
(PXD), said Andrew Dittmar, an analyst at Enverus. “Small and mid-cap oil stocks are cheap, but the market just doesn’t care,” he said.
There is no easy way for the smaller companies to boost their equity values without hitching their wagons to larger players, who have lower costs of capital and better efficiency. Smaller companies are realizing “there’s more value in exchanging your equity into one of these [larger] companies, where the market does assign a higher multiple,” he said.
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In Earthstone’s case, the company was unlikely to fetch a better multiple from Permian Resources because Permian itself is a more efficient operator than Earthstone, said John Gerdes, an analyst at Gerdes Energy Research. Gerdes looks at “cost curves,” which show what oil price a company needs to break even on production. The lower on the cost curve that a company sits, the more efficient they are. “You cannot afford in this industry any…