What happened

Shares of Baytex Energy (NYSE:BTE) slumped more than 10% by 10:15 a.m. EDT on Monday after the company agreed to a strategic combination with Canadian rival Raging River Exploration (TSX:RRX).

So what

Baytex Energy has agreed to merge with Raging River in an all-stock deal. The company will exchange 1.36 of its shares for each share of Raging River, valuing it at 2.8 billion Canadian dollars ($2.1 billion). The transaction will create a CA$5 billion Canadian oil company that will retain the Baytex name and produce more than 100,000 barrels of oil equivalent per day next year.

An oil pump in Canada.

Image source: Getty Images.

Aside from the increased scale, the deal will strengthen the combined company's financial profile and growth prospects. Baytex believes that it can generate CA$1 billion in fund flow next year, which is the Canadian equivalent of operating cash flow. That will provide the company with enough money to grow production 5% to 10% annually while generating significant free cash, which it can use to repay debt, pursue additional acquisitions, and possibly reinstate a dividend.

In addition to those financial benefits, the transaction will diversify Baytex Energy's portfolio into the Duvernay Shale in Western Canada, enhancing its growth prospects.

Now what

While this transaction has many benefits, it doesn't come without risk. One concern is the increased execution risk by expanding into the Duverney, which is an emerging shale play. That's because the rest of Baytex Energy's assets in the country are more-established, lower-risk conventional assets. Since the Duvernay is so early in its life cycle, there's increased potential that future wells could underperform expectations, which would hurt the company's returns and growth prospects. That elevated risk makes Baytex less suitable for most investors, who might want to consider one of these top-tier oil stocks instead.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.