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Diamondback Energy Follows ExxonMobil and Occidental Petroleum with a Permian Megadeal

Motley Fool - Tue Feb 13, 6:05AM CST

The consolidation wave in the oil patch has washed over another producer. Diamondback Energy(NASDAQ: FANG) has struck a deal to acquire privately held rival Endeavor Energy Resources for $26 billion. The acquisition will create a premier producer focused on the resource-rich Permian Basin.

The merger of Diamondback and Endeavor follows in the footsteps of recent deals by ExxonMobil(NYSE: XOM) and Occidental Petroleum(NYSE: OXY), which are bulking up their positions in the Permian Basin. Like those deals, the Diamondback-Endeavor tie-up will likely spark additional consolidation among oil companies.

Drilling down into the latest deal

Diamondback Energy is merging with Endeavor Energy Resources in a cash-and-stock deal valued at $26 billion, which includes the assumption of Endeavor's debt. The company will issue 117.3 million shares and pay $8 billion in cash. It plans to fund the cash portion of the deal with cash on hand, borrowings under its credit facility, and new debt.

The deal combines two leading producers in the Permian Basin to create a premier pure play in the region. The combined company will have 838,000 net acres and produce 816,000 barrels of oil equivalent per day (BOE/d). It will also boast best-in-class inventory depth and quality with about 6,100 remaining drilling locations with break-even levels of less than $40 per barrel (well under the current price level of more than $70 per barrel). "This is a combination of two strong, established companies merging to create a 'must own' North American independent oil company," commented Diamondback Energy CEO Travis Stice in the press release unveiling the deal. "With this combination, Diamondback not only gets bigger, it gets better," stated the CEO.

A slide showing an overview of the Diamondback merger with Endeavor.

Image source: Diamondback Energy.

Diamondback Energy expects to capture about $550 million in annual savings by combining with Endeavor. That drives its view that the company will generate substantial near- and long-term financial accretion, with at least 10% free-cash-flow-per-share accretion expected next year.

The company initially anticipates using the incremental free cash flow to boost its base dividend (which it's increasing by 7%) and rapidly repay the debt it's taking on to close the deal. Diamondback plans on reducing its capital return target from 75% of its free cash flow to 50% in the near term, and redirect that cash (which would have gone toward repurchasing shares or paying dividends) toward paying down its debt.

Getting bigger and better

This merger is the third major deal involving a Permian-focused producer in the past year. ExxonMobil kicked off the current consolidation wave by agreeing to buy Pioneer Natural Resources in a more than $60 billion deal. Occidental Petroleum followed with its acquisition of privately held CrownRock for $12 billion.

All three deals will enhance the acquirer's scale in the Midland Basin side of the Permian. Those larger-scale positions should increase their returns. For example, ExxonMobil expects to generate double-digit percentage returns from its Pioneer deal by recovering more resources more effectively than either company could have accomplished alone. Another scale advantage the buyers expect to capture is cost savings, which will increase the combined company's free cash flow. Occidental foresees its acquisition of CrownRock boosting its free cash flow by $1 billion in the first year. The mergers will also provide the buyers with a large inventory of future drilling locations to enhance and extend their growth profile. ExxonMobil expects to grow its combined output from 1.3 million BOE/d to 2 million BOE/d by 2027, while Occidental will add 1,700 low-cost future drilling locations to its inventory.

With rivals getting bigger and better, others in the oil patch are searching for consolidation partners. Devon Energy, which was looking at bidding for CrownRock, has reportedly shifted its focus from trying to boost its scale in the Permian to bulking up its position in the Bakken. Meanwhile, oil giant ConocoPhillips was reportedly interested in CrownRock and Endeavor before they agreed to deals with its rivals. That oil giant, too, might now also need to look outside the Permian for an acquisition, potentially following Chevron's strategy of finding deals that enhance its cash-flow growth profile regardless of region.

The premier Permian player

Diamondback Energy will become a much bigger and better oil company by acquiring Endeavor. The deal will significantly enhance its scale in the Permian Basin, reducing costs, improving returns, and boosting its free cash flow. That will ultimately enable the company to create more value for shareholders. Its needle-moving deal will also likely spur others in the oil patch because those that remain will want to capitalize on the same scale advantages their rivals will realize.

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Matthew DiLallo has positions in Chevron and ConocoPhillips. The Motley Fool has positions in and recommends Chevron. The Motley Fool recommends Occidental Petroleum and Pioneer Natural Resources. The Motley Fool has a disclosure policy.

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