Oil-weighted Permian Basin producer Cimarex Energy and Marcellus Shale natural gas operator Cabot Oil & Gas agreed to merge in an all-stock merger Wall Street initially viewed May 24 as a $17 billion market-cap oddity, but which the company CEOs said would provide compelling economics and important asset diversity.
But investors and even analysts gave lackluster marks to the transaction, as both companies' shares sank 7% to 8% over the trading day, while analysts' post-conference call investor notes gave it mixed reviews.Cimarex shares closed down 7% or $5.05 to $66.14/share, while Cabot shares closed down 6.7% or $1.19 to $16.62/share.
Analysts, who seemed surprised by the lack of geographical and operations overlap, concluded the financial aspect played a larger role in the pairing than they were accustomed to seeing in a slew of recent deals that were driven primarily by acreage expansion aims primarily in the Permian Basin of West Texas and New Mexico.
Instead, "this deal is driven by financial-side metrics, primarily boosting the base dividend to be one of the more aggressive in the industry while also adding a variable payout to the mix," Andrew Dittmar, senior M&A analyst for energy consultants Enverus, said. "The increased dividend, combined with the stability of operating as a larger company, is targeted at attracting long term investors."
Cabot, based in Houston and with 100% gas production, has low debt of just under $1 billion of long-term debt at March 31 and strong current cash from operations of nearly $300 million generated in Q1 2021. Those factors streamline Cimarex's pro-forma balance sheet and will help fund dividend plans, Dittmar said.
Denver-based Cimarex as a stand-alone operator offers "one the best unadulterated outlooks in the sector with potential for rising free cash ... and the combination of modest growth, returns of and on capital, and low financial leverage," Evercore ISI analyst Stephen Richardson said. "Today's transaction does little to bolster this outlook."
VALUE CREATION 'OPAQUE'?"This is an E&P transaction where forward potential yield [and] cumulative free cash flow is bolstered but value creation is more opaque," Richardson said, adding he was "willing to look beyond the limited geographic overlap and limited deal synergies of $100 million for a company with combined $240 million 2021 general and administrative expenses."
Cimarex CEO Thomas Jorden, during a conference call to explain the deal, emphasized the combined "high-quality diversified assets" the two merged companies will have, and said that "will protect us" through the commodity cycles and support long-term value creation.
"We view, and always have, commodity, geography and asset diversification as competitive advantages that will drive more resilient free cash flow and long-term value creation," Jorden said. "Diversity pays in the long run ... Our asset mix and low-cost structure are core competitive advantages that will dampen the impact of price swings on any single commodity."
Characterizing the differing commodity output and operating arenas of Cimarex and Cabot as "noise," Jorden, who will serve as CEO of the new company, and Cabot have "two of the best assets in our business, the best investment returns."
When one looks at the financial performance through cycles, "you just say, wow, this is really a premier company," Jordan said.
The combined company, which Jorden will head as CEO, will have a new name and be based in Houston. It is targeted to generate around $4.7 billion in free cash flow from 2022 to 2024, representing more than a third of Cimarex and Cabot's combined market capitalization at a $55/b WTI oil price and $2.75/Mcf Henry Hub gas, he added.
Also, the combined entity is expected to have an annual base dividend of $0.50/share, representing a forward dividend yield of 2.8%, to be paid quarterly with plans to supplement the base dividend with a quarterly variable dividend to achieve a target capital return of 50% of quarterly free cash flow, said Jorden. The first payment is expected in Q1 2022.
"We think the strength of that initial ordinary dividend communicates our confidence in the core business model and rationale for the combination," Jorden said.
Offering a contrarian view to some analysts, Siebert Williams analyst Gabriel Sorbara said he was not surprised by the transaction since Cimarex has been long mentioned as a takeout candidate for its relatively cheap valuation, "tremendous" free cash flow potential, low leverage and solid asset quality.
PERMIAN 'LIKELY TARGET' FOR CABOTAlso, [we] believed Cabot required a deal to extend its inventory and thought the Permian Basin was a likely target," Sorbara said, characterizing the May 24 stock sell-offs as a "typical 'sell the deal' type reaction."
Besides the Permian, Cimarex also operates in the Anadarko Basin of Oklahoma and has a combined 560,000 net acres in both plays, while Cabot holds 173,000 net acres in the Marcellus Shale largely sited in Pennsylvania.
"Cabot's perceived weakness was its longer-term inventory runway," Dittmar said. "Adding Cimarex's Delaware Basin position addresses inventory concerns while adding the ability to shift capex between gas and oil," depending on commodity prices.
"Cimarex will be shifting its commodity mix substantially towards gas (79% pro-forma versus 42% currently), showing a bullish outlook for the commodity at this point," he added.
Under the deal terms, Cimarex shareholders will receive 4.0146 shares of Cabot common stock for each share of Cimarex common stock owned.
Historically Cimarex, formed in 2002 when driller Helmerich & Payne spun off its upstream assets, has not been a consolidator although it has been mentioned widely as a takeover candidate in recent years owing to its Permian Basin assets in West Texas/New Mexico.
Cabot CEO Dan Dinges, who has headed that company since 2002, will become the merged company's chairman after the transaction closes, while long-time Cabot Chief Financial Scott Schroeder will assume the CFO position.
Dinges said two significant achievements of the combination will be mitigation of some commodity price risk and underpinning a solid return to shareholders.
"We think with that, we can attract the long-term investors that we both look for and we think with a long-term investor, we'll share in the upside that this organization is going to build," he said.
