Private Equity Sees Shale Escape Route by Building Cash Flow
(Bloomberg) -- Private-equity firms that bet big on shale for more than a decade finally are seeing glimmers of hope that their investments will bear fruit.
Pioneer Natural Resources Co. took analysts and investors by surprise with its $6.4 billion deal to buy DoublePoint Energy LLC, a Permian shale powerhouse backed by Apollo Global Management Inc., Quantum Energy Partners, Magnetar Capital and Blackstone Credit. It’s the largest acquisition of a closely held oil company since 2011.
Big funds were among the most-acquisitive suitors in North American shale fields such as the Permian Basin, planning to flip their holdings to giant public companies for quick profits. But the strategy collapsed as debt-fueled drillers contributed to a global crude glut, oil markets shuddered and would-be buyers of PE-backed explorers turned their backs.
Deals like Pioneer’s takeover of DoublePoint have been few and far between. Over the past year, transactions have been dominated by public companies merging with each other in all-stock deals, rather than snapping up private equity-backed entities. But DoublePoint offered something different from its peers, co-CEO Cody Campbell said in an interview.
“The bar has gotten so high because the market has got so disciplined that a deal needs to add cash flow on Day One,” Campbell said in an interview. “It can’t just be the right prospect, can’t just have the right acreage, it has to be something that can fold into a larger company and provide accretion. We had a very tall task to get there.”
Pioneer made the case that the deal would improve key financial metrics and increase dividend prospects without adding much debt. Crucially, CEO Scott Sheffield pledged to slow DoublePoint’s rapid growth in order to harvest more cash, cutting the number of rigs active across its assets to five from seven.
Analysts have been mixed on the deal. Credit Suisse Group AG and Cowen & Co. raised target prices for Pioneer’s stock, noting expectations for improved cash flow. Meanwhile, KeyBanc Capital Markets Inc. and Scotiabank questioned the price to be paid and whether Pioneer even needed to bulk up its portfolio.
Pioneer fell along with its peers on Monday, declining 7.6% to $152.18 at 4:15 p.m. in New York, as international and U.S. crude prices slumped.
The transaction will “represent something of a litmus test of a healthy company with ample inventory pursuing an acquisition for prices that are off the bottom,” Scott Gruber at Citigroup Inc. wrote in a note.
Even if similar deals don’t come to immediate fruition, it’s clear that many smaller, private companies are as focused on pursuing the cash flow model as their public counterparts. The problem for the industry is that many private companies need to first build production to a point at which they can begin earning money. That means a lot more oil supply at a time when demand is still weak due to the pandemic.
“We have to get to free cash flow positive before a public company can buy one of our private companies,” Wil Vanloh, co-founder of Quantum, said before the DoublePoint deal was announced. Therefore “we’re willing to run a higher rig cadence than we’re used to. That is something that a lot of private equity funds are realizing.”
Other closely held Permian explorers that may be attractive to buyers include Mewbourne Oil Co., Endeavor Energy Resources and Crownquest Operating LLC, according to William Janela, a New York-based analyst at Credit Suisse. The trio is running a combined 22 rigs in the Permian, more than Exxon Mobil Corp. and Chevron Corp. combined.
“Any next wave of consolidation will need to include ‘roll-up’ of larger” closely held outfits, he said.
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