ConocoPhillips (NYSE:COP) announced Oct. 19 that it was buying Concho Resources (NYSE:CXO) for $9.7 billion in stock and the assumption of $2.3 billion in debt. This creates a force to be reckoned with in the Permian Basin. If you’re an Exxon Mobil (NYSE:XOM) shareholder, the fact your company didn’t buy Concho is excellent news for XOM stock.
The End is Near
Exxon Mobil stock isn’t having a good year in the markets — its year to date total return is -48.0% through Oct. 20 — nobody in the energy sector is doing okay.
However, had the company decided to go after Concho, I believe the deal would only have made things worse for America’s largest integrated oil and gas company.
Sure, ConocoPhillips is paying for the deal with 1.46 COP shares for every CXO share, so no cash is changing hands, but given oil demand could drop by 50% over the next 20 years, oil companies doubling down on the Permian Basin does not seem like a wise idea.
The novel coronavirus has made companies rethink making its employees make the long commute into work every day. BP’s (NYSE:BP) 2020 outlook for long-term energy demand actually mentioned people working from home post-pandemic as a big reason why future demand won’t meet the highs hit in 2019.
XOM stock’s loss is definitely not ConocoPhillips’ gain. Far from it.
Why Did COP Double Down?
ConocoPhillips trotted out the usual answers when a big deal is made.
The combined business will have 23 billion barrels of oil equivalent, an average cost of supply company-wide of $30 a barrel of West Texas Intermediate, and potential annual savings of $500 million by 2022.
What’s not to love?
“Concho is a tremendous fit with ConocoPhillips. Together, ConocoPhillips and Concho will have unmatched scale and quality across the important value drivers in our business: an enviable low cost of supply asset base, a strong balance sheet, a disciplined capital allocation approach, ESG excellence and great people,” stated chief executive officer Ryan Lance in the company’s press release announcing the deal.
“Importantly, the transaction meets our long-stated and clear criteria for mergers and acquisitions because it is completely consistent with our financial and operational framework.”
Translation: Forget the cost. We’re going to give XOM stock a run for its money. And analysts seem to like the deal.
Let’s Get Real
“Net/net, we like the deal and we see the premium as the sweet spot to both (i) justify the opportunistic nature of the transaction to COP shareholders (at first blush, transaction accretive to FCF metrics with low leverage maintained) and (ii) allow CXO shareholders to comfortably rotate into COP, a name which continues to hold favor with the investor community,” stated energy investment bank Tudor, Pickering, Holt & Co.
If you’re a CXO shareholder, you have to like a buyout because it gives you a better chance of survival in the long-term.
Another analyst suggests the transaction puts a favorable light on the long-term viability of the Permian Basin. I don’t see it that way. I see it purely as a move by COP to get bigger while putting a dent in XOM stock.
XOM Stock’s Future
Last September, I argued that Exxon Mobil shouldn’t make a big Permian M&A push. My comments came after the company’s CEO said it was looking for an acquisition in the Permian Basin.
However, the prices were too high.
On Sep. 27, the date of my article, CXO traded for $69. Conoco’s paying approximately $50.31 based on the fixed ratio of 1.46 shares and an Oct. 13 closing price. So, it’s getting Concho for 27% less than it would have paid a year ago.
Given the oil sector’s uncertainty heading into 2021, I’m not convinced a 27% discount would have been enough for Exxon Mobil to join the bidding. In my article from last September, I felt the debt of a large acquisition — I suggested Pioneer Natural Resources (NYSE:PXD), which has seen its enterprise value cut by 31% in the past year — would only make its debt situation that much worse.
With the pandemic in full bloom right now and a global recession is a real possibility due to more lockdowns, it’s going to take ConocoPhillips a long time to pay for the cost of its acquisition.
I’m no fan of XOM stock, but shareholders just dodged a real bullet from where I sit.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
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