A new merger between two midsize oil-and-gas companies seemed to touch all the bases that energy investors want to see: an all-stock deal, a low debt profile, a promising dividend, and that word “synergies” that Wall Street usually likes.
But the decision by Denver oil producer Cimarex Energy (ticker: XEC) and Cabot Oil & Gas (COG) to combine forces does not appear to be impressing investors or analysts much.
The deal, announced on Monday, is an all-stock transaction valued at $7.4 billion, or $17 billion after including debt. In Monday morning trading, Cimarex stock was dropping 7.9%, while Cabot was down 7.3%.
Cimarex shareholders will own 50.5% of the combined company after the deal, which values the companies without any significant premiums to recent prices. The new company will be based in Houston, and will take on a new as-yet-unreleased name.
After closing, shareholders will receive a special dividend of 50 cents. Going forward, the combined company is expected to pay out a fixed and a variable dividend each quarter amounting to at least 50% of its free cash flow. Variable dividend policies have already been put in place by Devon Energy (DVN) and will soon be instituted by Pioneer Resources ’ (PXD). Investors have mostly cheered the policies, because they allow companies to pay out big dividends when oil prices are high, but allow them to be more flexible when times are tough, instead of having to slash their base dividend, which companies like BP (BP) did last year. Cabot had previously announced a “base-plus-supplemental” dividend strategy that is similar to a variable dividend.
Right now, Cabot pays a dividend yield of 2.7% and Cimarex’s is 1.7%. After the deal, the “pro forma yield of total cash return is 5.6%, with first payment expected in the first quarter of 2022,” estimated Cowen analyst David Deckelbaum.
The expectations of a fatter yield, however, were not enough to impress Wall Street. What made the deal a head-scratcher for some analysts was the fact that the two companies are very different and drill in different areas. In other recent deals, such as Pioneer Resources’ acquisition of Parsley Energy, the two companies had overlapping acreage and more similar business models. And the “synergies,” or likely cost cuts, from the Cimarex deal amount to $100 million annually — not a huge number for a deal valued at over $15 billion on enterprise value.
Cabot is a natural gas producer focused entirely on the Marcellus Shale play in Pennsylvania. It is among the largest gas producers in the country and it has a particularly low debt load and steady operations. Barron’s has written favorably about Cabot, both this year and last, given its strong balance sheet and steady returns. Analyst Paul Sankey of Sankey Research has called it the “Saudi Arabia of natural gas.”
Cimarex, based in Denver, is more oil-weighted, and its operations are in Texas, New Mexico, and Oklahoma.
In a call with analysts, the chief executives of the two companies — Dan Dinges of Cabot and Tom Jorden of Cimarex– fielded pointed questions that indicated skepticism about the deal.
Bank of America analyst Doug Leggate said he had a “frank” question for the company, and mentioned the ages of the two CEOs (67 and 63).
“I just want to ask you, was this the best deal for both companies? What I mean is there’s no operational overlap,” the analyst said.
“Your balance sheets don’t get you a lower cost of capital,” he added, questioning whether there’s more of an explanation for the deal. “Clearly there’s better fits for both companies.”
“We’re entirely comfortable that this is the right combination for both of us,” said Dinges, the Cabot CEO, mentioning the companies’ sustainable free cash flow, dividend policy, and diversity of its assets. “It’s hard to shoot a lot of holes when you look at what the combination is as two companies coming together.”
Jorden of Cimarex, who will be CEO of the combined company, also responded, saying jokingly: “I want to disagree with your core premise. I am not too young to be leading this combined entity.”
Jorden noted that Cimarex’s executive bench was “deep” with “some very young people on our executive team and this company is built for the future.” He urged analysts and investors to look past the “noise.”
“You need to cover up the fact of geography and asset mix and look at the combined financial performance of this company,” Jorden said. “And when you look a that, it’s hard not to just say ‘Wow.’”
“Gas. Oil. Pennsylvania. Texas. That’s noise,” he continued. “The signal in this is they’re two of the best assets in our business, the best investment returns.”
He added later that the companies are building “an ark, not a party boat.”
But on Monday, it wasn’t an ark that investors wanted to climb aboard.