We all knew this was coming. At some point someone was going to lead the charge and acquire an overlevered U.S. shale producer. That someone came from a rather unlikely source as Noble Energy, (NYSE: NBL) is leading the charge as it has agreed to take out Rosetta Resources (NASDAQ: ROSE) in a $2.1 billion deal, including the assumption of $1.8 billion in debt. Noble Energy is offering a very generous 28% premium -- as it the deal is clocking in at an Enterprise Value-to-Proved Reserves of about $13.65 per barrel of oil equivalent for Rosetta's reserves -- in order to gain a foothold in two key Texas shale plays. Given the price that foothold is clearly the key to this deal, which now provides a baseline for future shale deals.
Interesting timing
For several months now investors have been waiting for the first big shale merger as the deep drop in oil prices has taken its toll on shale producers. This is due to the fact that many shale players used debt to significantly supercharge their growth, which is something we can see at Rosetta as its debt really ballooned over the past couple of years as it used debt to acquire assets and drill new wells so that it could take advantage of persistently high oil prices.
ROSE Net Total Long Term Debt (Annual) data by YCharts
That move backfired when oil prices plunged last year leaving the company with a pile of debt and an inability to grow at weaker oil prices. That was abundantly clear from the company's first-quarter report as just last week the company reported that its production had declined from 73,000 barrels of oil equivalent per day, or BOE/d, in the fourth quarter to just 66,000 BOE/d in the first quarter. The company was projecting additional declines as its full-year production average was expected to be 58,000-62,000 BOE/d, despite the fact it was spending $350 million on capex. Investors didn't like the lack of growth and voted by selling off their shares, which apparently sent a very clear message that Rosetta needed to change course as it could no longer grow on its own.
Taking advantage of the situation
Noble Energy saw Rosetta's stumble as a chance to pounce. Armed with an investment grade credit rating, strong financial position, and robust liquidity Noble Energy was able to acquire the indebted Rosetta with minimal impact to its own balance sheet. This is clearly seen on the slide below as Noble's Debt-to-EBITDAX and Net Debt-to-Book Capitalization are barely changed with the acquisition.
Source: Noble Energy Investor Presentation.
In fact, even after the deal Noble's balance sheet will still be much stronger than Rosetta's, which had a debt-to-cap ratio of 55% as of the end of last year after it ballooned from 34% as of the end of 2012. It was that weaker balance sheet that really tied Rosetta's hands as the company's plan had been to invest only within its cash flow of about $350 million per year to defend its production at around 60,000 BOE/d, instead of driving growth.
Given that debt isn't a problem at Noble it has the ability to accelerate growth while staying within its much more robust cash flow thanks to its diverse and stable asset base. In fact, its robust cash flow was expected to drive adjusted production growth of about 5% in 2015, which is much better than Rosetta's expected decline. However, the real key to this deal is the fact that the Eagle Ford and the Permian Basin are really the two premier U.S. shale plays due to their superior economics even at current oil prices. Because of this Noble really sees this acquisition providing it with a springboard for future growth as it is adding 1,800 wells from Rosetta's current inventory as well as the opportunity to expand its presence in both regions through bolt-on acquisitions. This could enable the company to boost its production growth rate in the years ahead, without having to lever up.
Investor takeaway
Rosetta Resources really got carried away over the past couple of years loading up on debt to grow. That move came back to bite the company as it was handcuffed when oil prices collapsed leaving the company with an inability to grow. That opened the door for Noble Energy to pounce as it had a much stronger balance sheet, and plenty of cash flow to drive future growth. Once the deal closes Noble will have a prime position in two of the best U.S. shale plays with ample liquidity to drive future growth as it tries to capitalize on the drop in oil prices. Further, the deal could lead to other mergers as the industry now has a baseline for a reasonable price for U.S. shale companies.
