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Shares of PDC Energy Surge on Acquisition of SRC Energy Announcement

By Tyler Crowe - Aug 26, 2019 at 12:06PM

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The two Colorado-centric oil and gas producers benefit from consolidating their overlapping positions.

What happened

Shares of independent oil and gas producer PDC Energy ( PDCE -0.02% ) are up 16.8% as of 10:45 a.m. EDT today after the company announced it would acquire SRC Energy (NYSEMKT: SRCI) in a $1.7 billion, all-stock deal. Shares of SRC Energy are also up 11.8% as of the time of this writing.

So what

The shale oil and gas industry in North America has been long overdue for some serious consolidation, and today's announcement was a welcome sign for two struggling producers that have seen their shares decline more than 45% over the past year, even including today's surge.

Drilling rig with mountains in the background.

Image source: Getty Images.

Both PDC Energy's and SRC Energy's primary holdings are in the Wattenberg Field in the Denver-Julesburg Basin in Colorado. Both had lots of overlap in their acreage holdings, and the combined entity should be able to generate some cost savings from more coordinated drilling plans. Also, since it is an all-stock deal, it will help to keep the company's overall debt levels in check. According to management, the pro forma company would have a net debt-to-adjusted EBITDA ratio of just 1.0 times.

The thing that likely has Wall Street most excited about this deal is that management is projecting strong free cash flow as a result of the deal. Management claims that it will be able to generate about $800 million in free cash flow with commodity prices at $55 per barrel of oil and $2.70 per thousand cubic feet. If that were indeed the case, then this would be a great deal.

PDCE Chart

PDCE data by YCharts.

Now what

Over the past several years, the investor slide deck has been a siren song for many oil and gas investors; companies have been promising high rates of return on newly drilled wells and promising capital discipline, only to burn through cash at staggering rates. PDC Energy and SRC Energy aren't that different. Even though the combined company is promising high rates of free cash flow, both companies have been burning through cash for more than four years.

At this point, it's hard to take seriously the numbers that PDC's management projects. The company just doesn't have a track record of delivering what it says it will. If the combined company can deliver on these promises, then the stock may be worth reexploring. Until then, the onus is on management to deliver.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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