Cimarex Energy Co [NYSE: XEC] – Market Cap as of 01/12/2018 $7.84bn
Resolute Energy [NYSE: REN] – Market Cap as of 01/12/2018 $823.7m
Introduction
On November 19th 2018, Cimarex Energy announced that the company was planning to increase its acreage by 34% with precious shale-rich Permian Basin land through the definitive agreement to acquire Resolute Energy for a total purchase price of approximately $1.6bn in a cash and stock transaction. Resolute’s acreage in the Delaware part of the Permian Basin is located a stone’s throw away from Cimarex’s and is expected to add 35,000 Barrels of Oil Equivalent per Day (BOE/day) to Cimarex’s production base. The transaction was unanimously approved by both companies’ Boards of Directors and will include Resolute’s long term debt of $710m. The deal is expected to close by March 2019 and will offer Resolute shareholders a 14.8% premium on their shares, valuing them at $35.00 each.
About Cimarex Energy Co.
Cimarex Energy Company is an independent oil and gas exploration and production company that focuses on drilling, completing and operating wells. The company’s acreage spreads out through the Mid-Continent (namely Arkansas, Kansas, Louisiana, New Mexico, Oklahoma and Texas), however, the company is paying a special attention to the Permian Basin, situated in western Texas and New Mexico, with a 70% of its 2018 drilling and completion. The company, founded in February 2002 and headquartered in Colorado, has been presenting robust figures for the last years. Indeed, the firm has a $9.1bn enterprise value, a relatively low debt of 1.1x Debt/EBITDA and strong production growth expectations of 17%-18% for this year, before the acquisition. Moreover, Cimarex’s income statement presents an up-trend both in revenues and EBITDA as the former rose from $1.45bn in 2015 to $1.92bn last year and the latter increased from $753.73m in 2015 to $1.19bn last year.
The deal with Resolute does not come as a surprise for Cimarex’s shareholders as the company is betting on an acreage concentration to increase economies of scale and maximize full-cycle returns.
About Resolute Energy
Resolute is an independent oil and gas company solely focused on the acquisition and drilling of highly profitable oil wells and gas properties in the Delaware Basin portion of the Permian Basin of West Texas. The company, founded in 2004 and headquartered in Denver, registered last year revenues of $303.48m, approximately double that of 2016 and 2015 figures, $164.48m and $154.64m respectively, but significantly less than in 2014 and 2013, $349.78m and $329.37m respectively. However, Resolute still failed to present a positive Net Income in 2017, for its fifth year in a row. During 2013 and 2014 the company was showing signs of financial improvement that foreshadowed a positive Net Income in the following years, but in 2015 the price of oil dropped massively undervaluing the company’s exploration assets. Since then, as prices have gone up until October 2018, Resolute has been catching up to its 2014 levels by presenting better results such as a similar EBITDA of $136.11m in 2017 to the $139.48 in 2014. This low profitability is due to the fact that companies spend such large amounts of their cash on capex that even rising oil prices won’t necessarily offset the expenses. Moreover, as the U.S. is not part of the OPEC, if US oil companies tried to increase its production to capitalize on the oil price increase, they would generate a decrease in its price due to their increased supply.
Due to investors’ fear of non-delivery of shareholders’ value, the company has been pressured for more than a year to seek options to boost the shareholders’ value and have finally decided to sell in order to do so. However, Resolute’s largest shareholder, the private equity asset manager Kimmeridge Energy Management, believes that the proposed purchase price undervalues the company.
Industry Overview
The oil and gas industry comprises, by definition, all those companies involved in the exploration and development of oil and gas, their core activities being drilling and refining.
As of November 25th 2018, the volume of global oil reserves approaches 1.7tn barrels, 26% of which located in the US and Saudi Arabia alone. In terms of capitalization, the global market is dominated by ExxonMobil, Shell and Chevron. In terms of production amounts, instead, outstanding countries are, respectively, the US, Russia, Saudi Arabia, Iraq, Canada, China and Iran, altogether hitting 50 million barrels per day.
The industry is still expected to grow in the next few years, with a forecasted CAGR of 20% for the timespan 2018-2024. Anyhow, it is worth stressing that these estimates will be very likely subject to adjustments, provided the high volatility of oil prices.
Indeed, the sector is currently going through very hard times. The three major drivers of this distress are represented by oversupply, unsuitability of pipelines, and macroeconomic uncertainty. What is worth highlighting is that the facts are strongly correlated between themselves.
As for oversupply, its roots undoubtedly lie in the slowdown of consumption of crude oil throughout the world, in part due to the development of modern substitutes to the raw material at issue, and the slowdown of China and developing countries. Indeed, according to estimates from OPEC, “While growth in the major OECD economies remains well supported, decelerating trend have become visible in some emerging markets and developing countries”. These pessimistic forecasts, combined with the current rise in crude production and, above all, to the inadequacy of the infrastructures that delivers it countrywide, determine the oversupply.
This aforementioned unsuitability of pipelines constitutes the second driver of distress in the market. As a matter of fact, as time goes by, pipelines development is getting more and more expensive and fraught with regulatory risks, entangled with the debate over climate change (even though pipelines actually constitute the safest and cleanest way to move hydrocarbons).
Finally, as far as macroeconomic uncertainty is concerned, the possible scenarios are currently also counting all the potential outcomes of the Iranian case. Ever since early November, the US sanctions aimed at hurting Teheran’s economy have started shaping new precarious equilibria. Indeed, only eight countries have been allowed to import (limited) amounts of Iranian oil, the American target being driving Iranian export to zero. China, India, South Korea, Japan and Turkey are among those eight beneficiary entities.
Again, as of November 25th, Brent still lies below $60 per barrel, while WTI plummeted into the bear-market territory, hitting $50.39, the lowest figure ever since the 2014-2016 slump. It is worth stressing on the inconsistency of these figures, since Brent is expected to trade at a physiologic lower price, with respect to WTI. This discount is grounded in the fact that the latter is supposed to be “lighter and sweeter”, i.e. featured by low density and low sulfur concentration. The WTI is now trading at a speed discount, though, because of the oversupply in the North American market, where production has increased substantially over the past few years thanks to the shale boom, but the relative lack of infrastructure in Texas has prevented to oil from being exported abroad.
Deal structure
Based on 23.16 million Resolute shares at $35 per share, the equity value of shares is valued at $810.7 million, according to Reuter’s calculation. Including the long-term debt of $710 million, it sums up to approximately $1.6 billion.
The deal is structured in a way such that, post shareholder and customary approval, Cimarex Shareholders will hold 94.4% of the combined entity and Resolute shareholders 5.6%. Cimarex will acquire Resolute’s long-term debt of $710 million and will give shareholders three options to exercise with their equity holding. In exchange for one share of Resolute, they have the option to receive either 0.3943 shares of Cimarex common stock; or cash at $35/share, which is at a premium of 14.8% on $30.49/share, the closing price on Resolute’s stock on 16.Sept.; or a combination of cash and stock, i.e. $14/share in cash and 0.2366 shares of Cimarex common stock. This is subject to proration for total & cash mix of 60:40 respectively, which means that maximum available cash is capped at 40% of the equity value.
Deal Rationale
Despite holding highly productive assets in the region of the Permian basin, smaller firms face difficulty in returning optimum shareholder value in the face of crude price volatility and high capital cost. Thus, a consolidation wave is sweeping the Permian basin as companies seek to expand rapidly by buying smaller firms and deploy better drilling technology to boost production. Additionally, it allows bigger firms to negotiate better terms with services firms.
Resolute Energy has been struggling for a while and performed worse than market expectation even in its Q3 results, when high oil prices should have pumped up the figures. Investors are nervous, and it’s been already an year since they started claiming for better returns. The company was under pressure to sell itself as shareholders were worried that the company would be unable to deliver value as expected on its own.
Resolute Energy’s acreage in the Delaware, which is, part of the Permian basin, sits directly adjacent to Cimarex’s acreage. It adds 21,000 net acres (34% of Cimarex total acres) in Reeves County. It is expected to add 35,000 Barrels of Oil Equivalent per Day (BoE/day) to Cimarex’s production base. Cimarex also sees a significant growth in production every quarter and strong projected growth well into 2019. Moreover, the company has been looking to improve its ratio in oil. It currently averages around 30% whereas Resolute has an average of 45% oil.
For Cimarex Energy, they had a liquid and performing company next door with high oil ratio available at an undervalued price, largely due to Resolute’s inability to return optimum shareholder value because of net losses and crude oil price volatility. For this reason, the acquisition seems to be a good fit.
Cimarex is also looking to increase its production capacity as it wishes to take advantage of the new pipelines that will be ready by the end of 2019. It is however debatable whether it is a realistic scenario as many fear that an oil glut will drag down crude prices.
Market reaction
On November 19th, in the aftermath of the deal announcement, Resolute Energy’s shares saw their price rising by 14.4% up to $34.88 during the day, later closing with a 14% increase, at $34.71.
At the same time, Cimarex’s securities experienced a slightly decreasing trend during the day, loosing approximately 0.5%, and stabilizing at $88.28. Investors seemed rather concerned about the takeover target’s debt that Cimarex is absorbing, as well as about the extant issue of the sluggish growth of the sector this year.
As of November 25th 2018, Resolute Energy’s shares are traded at $33.53, while Cimarex’s at $79.95.
Everything considered, analysts have definitely optimistic outlooks for the deal at issue, pointing at the potential synergies the two involved companies will count on, from now onwards. The agreement has therefore been assessed as lucrative, on the basis of the potential benefits stemming from integration of assets and systems between the parties.
Financial Advisors
Evercore Inc. was be the sole financial advisor to Cimarex Energy, who was supported by Akin Gump Strauss Hauer & Feld LLP as legal advisor. For Resolute Energy, the firm was represented by Petrie Partners Securities, LLC., Goldman Sachs & Co. LLC. as financial advisors and Arnold & Porter; Wachtell, Lipton, Rosen & Katz as legal advisors.
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