One of the hot topics in the oil patch over the past couple of months has been the bidding war for control over Anadarko Petroleum (NYSE:APC). Chevron (NYSE:CVX) initially agreed to acquire the oil company for $33 billion, which was a stunning 38.9% premium. However, it walked away from that deal after Occidental Petroleum (NYSE:OXY) offered $5 billion more for Anadarko.
That epic takeover battle has fueled speculation that it could spur a wave of mergers and acquisitions in the oil patch. Oil CEOs, however, don't believe that will be the case. That was certainly clear by the comments of Scott Sheffield, the CEO of Pioneer Natural Resources (NYSE:PXD), on his company's recent first-quarter conference call. Here's what he had to say on that subject.
I don't see more large-scale M&A in the near term
Analysts didn't waste any time on Pioneer Natural Resources' first-quarter call getting to their burning question. The first one started the Q&A segment by saying: "I wanted to get your perspective on Shale M&A. ... In light of the situation with Oxy, Chevron, and Anadarko, just wondering to see if you [can] give us your thoughts on how the board thinks about M&A."
Sheffield responded in several ways. First, he made it clear that he didn't come out of retirement earlier this year "to sell the company." He returned to the CEO role because Pioneer's stock was cheap, and he wanted to lead a restructuring of the company to boost shareholder value. However, he noted that Pioneer wasn't the only oil company that traded at a cheap price, which is why "all the energy stocks went up when the Anadarko announcement" hit the wires.
Pioneer's CEO then commented that he "was surprised that Anadarko was the first company to be taken out." Though he did point out:
When you look at all the reports, they were probably cheap. They were trading at a very low EBITDA [multiple] and Chevron was able to go in and make a deal quickly. Now Oxy is paying up for it, obviously.
However, despite that bidding war, Sheffield said that he doesn't "think that there's going to be a lot of M&A over the next one to two years." While "things may happen," Sheffield said that he doesn't "think there'll be a wave of consolidation" in the near term.
What will drive future M&A
On the other hand, Pioneer's CEO did state that he believes that "over the next five years ... the majors will definitely start running out of inventory," which could spur more M&A activity. On top of that, smaller oil companies have two major issues that they need to address: general and administrative (G&A) costs and interest expenses. He stated that his rivals need to "get better balance sheets. They have to get a better cost structure, and that's what's going to be working and what's focused on." That's why he thinks that eventually "a lot of companies, smaller companies in the Permian, are going to have to consolidate" since they could then leverage their larger scale to reduce costs.
Earlier in the call, Sheffield referred to a report that analyzed the 76 publicly traded oil companies, looking specifically at G&A and interest expenses. Pioneer leads that pack as having the best balance sheet and peer-leading G&A costs. Because of that, it's in a strong position to create value for its investors in any oil market.
Its weaker peers, on the other hand, desperately need to address those two items. The report concludes that "over a half will either merge or go bankrupt over the next several years," said Sheffield. Thus, an M&A wave seems inevitable.
The calm before the big shakeout
Pioneer Natural Resources' CEO made some interesting comments on M&A during his company's first-quarter conference call. On the one hand, he doesn't see the bidding war for Anadarko fueling a consolidation wave in the near term. However, he does believe that one is eventually coming out of necessity. Not only will larger oil companies need to replenish their drilling inventory in the next five years, but smaller companies will need to merge to survive, given their weaker balance sheets and higher cost structure. Thus, it seems as if it's only a matter of time before an M&A wave hits the sector, likely in three to five years.
While it might be tempting for investors to look for potential acquisition candidates in hopes of scoring an Anadarko-like premium, that approach could yield lackluster returns. The most likely buyout candidates will be oil companies that can't create value for their investors due to their bloated cost structure and weaker balance sheets. That's why investors should instead focus their attention on top-tier producers since their stronger financials put them in a better position to outperform their weaker rivals in the coming years.