What happened
Shares of Denbury Resources Inc. (DNR) plunged 43.9% in October, according to data provided by S&P Global Market Intelligence. While a double-digit drop in oil prices ignited the sell-off, the main catalyst was the oil company's decision to buy Penn Virginia Corporation (ROCC) in a cash-and-stock deal valued at $1.7 billion.
So what
Denbury Resources is acquiring Penn Virginia for its position in the oil-rich Eagle Ford Shale. The company sees that acreage providing it with a near-term growth opportunity that will complement its long-term enhanced oil recovery (EOR) efforts in the Rockies and Gulf Coast to unlock more of the oil trapped in those legacy fields by flooding them with carbon dioxide. Further, the company sees future upside by applying its expertise in EOR to the Eagle Ford.
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In addition to that strategic rationale, the transaction will immediately boost Denbury's cash flow per share as well as many other key per-share metrics. Further, it will help reduce the company's leverage ratio, which should improve its overall credit profile.
However, while Denbury sees significant strategic and financial rationale for combining with Penn Virginia, analysts are a bit skeptical. The deal drove Imperial Capital to reduce its price target on Denbury from $6 to $4 per share. While the transaction will help reduce Denbury's leverage while providing it with more near-term growth opportunities, the shift toward the Eagle Ford adds significant execution risk, since Denbury has minimal experience developing shale resources, and it hasn't proven that it can apply EOR techniques to shale.
Now what
On the one hand, Denbury's decision to buy Penn Virginia could pay big dividends down the road if oil prices rise and it can successfully apply its EOR expertise to the Eagle Ford. However, there's heightened risk that it could run into trouble developing Penn Virginia's resources, which could cause this deal to come back to haunt the company. That's why investors appear as if they'd be better off watching this oil stock from the sidelines and waiting for signs that the transaction is paying off before they consider buying shares of this beaten-down oil producer.
