Concho Buys RSP Permian: Winners And Losers

(Bloomberg Gadfly) -- Shale's hot spot finally got the hot deal everyone's been waiting for.

Concho Resources Inc. on Wednesday announced a $9.5 billion acquisition of the subtly named RSP Permian Inc. In some ways, it is a perfect deal. Being all stock, it lets RSP's shareholders stay in the game with a 25 percent stake in the combined company. The two companies' acreage in both the Midland and Delaware sub-basins match up elegantly. And both drill among the most productive wells to be found onshore of the U.S.

That goes a long way to explaining the price. The deal values RSP at just over $51 per share, a 29 percent premium to Tuesday's closing price and higher than it has ever traded.

Sanford C. Bernstein estimates the price implies about $75,000 per acre for RSP's land once you back out the value of production. That's well above the already elevated levels of $30,000-$50,000 per acre typically paid in recent Permian asset deals.

That Concho is paying such a price reflects, in part, the value of its currency. Prior to Wednesday, it was trading at a significant premium to RSP and other Permian-focused companies:

It also reflects the touted synergies. Concho claims these are worth more than $2 billion in today's money, although it did itself no favors by offering little in the way of detail behind that number. The roughly $1.5 billion of that figure that would notionally accrue to Concho's own shareholders coincidentally covers most of the $1.8 billion being paid to RSP's.

Taking Concho at its word and assuming a 10 percent discount rate, that net present value implies roughly $250 million of pre-tax synergies. Factor that into the pro-forma production cost and you can see why that could provide a compelling reason to pay up:

Cutting costs -- by reducing down time between drilling and completions, using longer wells and other productivity gains -- is the strategic priority for frackers in a $60-ish oil environment. On that front, the geographical fit of the businesses offers some encouragement.

Concho's stock reacted badly to the news anyway, falling about 9 percent by late Wednesday morning (wiping out the implied value of the synergies and then some). Even so, the stock is only back to where it traded roughly a month ago. 

It's worth noting, also, that Concho's bonds ticked up, no doubt because equity is taking the strain of building a bigger, diversified asset base with scope for cash savings. Plus, pro forma net debt is a manageable 1.24 times Ebitdax, assuming synergies, and still only 1.33 times factoring in none.

With this being the biggest deal yet in the Permian basin, potential ramifications abound. It's no surprise that shares in other potential targets such as Parsley Energy Inc., WPX Energy Inc. and Laredo Petroleum Inc. traded up on the news. As I wrote here last summer, the basin is a patchwork, and consolidation offers a natural path to better capital efficiency. Concho just offered proof of concept, at least in terms of corporate-sized deals getting done (the proof of the savings is yet to come, however).

Not everyone's necessarily a winner, though.

Concho's high multiple for RSP's land is encouraging on one hand. But this reflects the geographical alignment in the core of the basin, suggesting latecomers that have been gobbling up scattered plots, such as private equity buyers, may not share in any M&A bonanza.

Oilfield services companies, too, may not relish the deal. Consolidation among their E&P client base potentially makes for stronger, more stable contracts. On the other hand, it will also undoubtedly make for tougher negotiations on pricing. It's surely a coincidence that sand provider US Silica Holding Inc. announced a deal of its own in the past week for EP Minerals, LLC, that effectively lets it diversify away from oil and gas producers to industrial clients. But the rationale dovetails with Concho's move.

And then there's the oil market itself. Concho, as you might expect, is talking up the deal as a catalyst for the Permian's next phase of "intense development" with a "manufacturing" approach. This is also the intention of other large operators there, including other consolidators such as Exxon Mobil Corp. and Chevron Corp. Even if Concho ends up having overpaid with its stock, if a less-fragmented Permian yields a more efficient one, then it would take shale's competitive challenge to the likes of OPEC to another level.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

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