Energy Business

Did ConocoPhillips Just Overpay for Concho Resources?

In a deal first rumored last week, ConocoPhillips (NYSE: COP) and Concho Resources Inc. (NYSE: CXO) on Monday announced a definitive agreement for an all-stock transaction valued at $9.7 billion under which Conoco will pay 1.46 shares of common stock for each share of Concho stock. The deal represents a premium of 15% to Concho’s share price at last Wednesday’s close before Bloomberg reported rumors of the deal.

The deal is expected to close in the first quarter of 2021 following approval of shareholders in both companies, regulatory approvals and other customary closing conditions.

Including roughly $4 billion in Concho long-term debt, the total enterprise value of the deal is around $13 billion, and Conoco said it is paying less than $30 a barrel for Concho’s resource base on a cost-of-supply basis, which the company defines as the “WTI equivalent price that generates a 10 percent after-tax return on a point forward and fully burdened basis.” Fully burdened includes “capital infrastructure, foreign exchange, price related inflation, and G&A [general and administrative].”

On the basis of proved reserves that could be extracted profitably at current prices, Concho reported 1 billion barrels at the end of 2019. The $9.7 billion acquisition price (paid in Conoco shares) represents a price of $9.70 per proved barrel. Earlier this year, Chevron paid about $5 per proved barrel for Noble Energy and Devon paid about the same for WPX’s 527 million barrels of proved reserves.

When Chevron announced its $5 billion acquisition of Noble Energy in July, the premium to Noble’s share price at the time of the announcement was 7.6%. Late last month, Devon paid a 2.6% premium for its $2.6 billion acquisition of WPX Energy. Conoco is paying a premium of about 12.8% for Concho.

For investors, the combination of Conoco and Concho “will offer a compelling ordinary dividend supplemented by additional distributions as needed to meet its target distribution of greater than 30 percent cash from operations.” In the second quarter, Conoco’s operating cash flow totaled $7.58 billion and Concho’s totaled $689 million, for a pro forma total of $8.27 billion, implying a payout of $2.48 billion to shareholders. Concho paid $129 million in second-quarter dividends, and Conoco paid $1.72 billion for a combined total of just over $2 billion. The shortfall will presumably be comprised of cost and capital savings of $500 million annually by 2022.

In Monday’s announcement, Conoco and Concho focused on the total resource base of 23.4 billion barrels of oil equivalent that the combined company will have at a cost of supply below $30 a barrel. Conoco CEO Ryan Lance commented, “[T]he transaction meets our long-stated and clear criteria for mergers and acquisitions because it is completely consistent with our financial and operational framework.” That framework includes a low cost of supply, a strong balance sheet and a “disciplined capital allocation approach,” among other things.

The announcement did not trigger a big share price move in either stock. That all happened last week. Concho shares jumped more than 10% following the Bloomberg report to close the day at $48.66, right at the stock’s trading price early Monday morning and up about 0.4% from Friday’s closing price. Concho’s dividend yield is 1.61%.

Conoco shares closed down slightly after last week’s report and traded flat early Monday at $33.72. Conoco’s 52-week range is $20.84 to $67.13, and the consensus price target is $48.60. The dividend yield here is 5.09%.

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