What Concho bid means for ConocoPhillips
Houston oil giant faces risks, rewards as it eyes rival Midland shale driller
ConocoPhillips’ effort to acquire rival Concho Resources, reported Wednesday, reflects the oil industry’s growing appetite for consolidation despite the risk of alienating investors worried about company spending and declining returns during the ongoing downturn.
The Houston oil giant is in talks to buy the Midland shale driller and its assets in the Permian Basin, according to a Bloomberg report citing unnamed sources. ConocoPhillips said it doesn’t comment on “market rumors,” and Concho didn’t respond to a request for comment.
The acquisition would be one of the industry’s largest this year, as companies look to pool resources and cut redundancies to weather the oil market’s boom and bust cycles.
Chevron this month closed its $12 billion all-stock purchase of Houston-based Noble Energy. Devon Energy recently announced plans to acquire fellow Oklahoma rival WPX Energy for $2.56 billion, creating one of the nation’s largest shale producers in West Texas. Concho, as of Wednesday, is valued at $9.57 billion.
“With oil prices hovering around$40 a barrel, it’s making it easier for companies to be able to transact,” said Mike O’Leary, a
partner at law firm Hunton Andrews Kurth in Houston. “People are getting more confident in the market conditions, and everyone agrees that consolidation within the upstream industry needs to happen.”
This wave of mergers and acquisitions in the industry runs counter to promises by a growing number of energy companies to rein in spending and focus on boosting shareholder returns after years of disappointing results on Wall Street. Investors since 2018 have pulled out of the energy sector, abandoning shale drillers who require a constant stream of capital to drill new wells and replace rapidly depleted older wells. Energy is currently the worst performing sector of the S&P 500 stock index.
“That’s the challenge for the industry: how to attract investors back,” said Jennifer Rowland, a senior energy analyst with Edward Jones. “With a poor track record of mergers and acquisitions, it’s hard to spin that story forward.”
ConocoPhillips CEO Ryan Lance acknowledged this reality this year, saying in public interviews that oil and gas companies must learn to “live within their
means” and increase shareholder dividends to attract Wall Street investment.
“How do we get value investors and energy investors back into this business?” Lance said in an interview with market research firm IHS Markit in June. “That’s going to be a function of giving money back to investors and modifying your growth so there’s a heavy focus on returns and return on capital. That’s what’s going to get investors excited again about the (exploration and production) space.”
Yet ConocoPhillips didn’t close the door on growth. Lance in April told CNBC that ConocoPhillips was “on the lookout” to acquire smaller companies as their market values plummeted with the price of oil. The time is ripe to pick up valu
able assets on the cheap.
“It’s got to be accretive, it can’t destroy our financial framework,” Lance said April 30 on the network’s “Power Lunch.” “But we’re watching (acquisitions) closely.”
Publicly traded energy companies with strong balance sheets have a greater appetite for acquisitions, because they can structure all-stock deals that don't take cash out of the business. On the other hand, private-equity-backed-energy companies may be less likely to acquire competitors, because they would need to raise capital in a tight market.
Concho makes an attractive acquisition target because it has a relatively low amount of debt and desirable assets in the Permian Basin where scale is needed
to compete, Rowland said. Concho has drilling rights on about 800,000 acres in the Permian, which stretches from eastern New Mexico to West Texas, Conoco-Phillips said in an investor presentation last month.
“Conoco has a relatively smaller position in the Permian Basin than some of its peers,” Rowland said. “That’s kind of been an obvious hole. Having scale in the Permian would be a key driver.”
Large oil companies such as Exxon and Chevron moved to graba larger piece of Permian production in 2019, ramping up output until the oil bust this year forced some to cut back.
For ConocoPhillips, a deal with Concho to join the fray in the prolific shale field could come at a cost, however.
“Even though everyone is crying out for consolidation, the investment community has not been kind to companies that try to do this,” O’Leary said. “Their stock price is punished. That’s what makes some of these companies shy about pursuing acquisitions.”
Shares in ConocoPhillips fell by 1 percent Wednesday to $34.53 while Concho shares jumped by 10.2 percent to $48.66.