A wave of consolidation has washed over the oil sector in the last month. The latest deal came on Tuesday as Pioneer Natural Resources (NYSE:PXD) reached an agreement to buy fellow Permian Basin producer Parsley Energy (NYSE:PE). That merger is the second this week -- ConocoPhillips (NYSE:COP) agreed to buy Concho Resources (NYSE:CXO) on Monday -- and the third in less than a month (Devon Energy (NYSE:DVN) sealed a merger-of-equals transaction with WPX Energy (NYSE:WPX) in late September). Meanwhile, it's the fourth notable deal in the oil patch following a crash in crude prices back in March, with Chevron's (NYSE:CVX) purchase of Noble Energy kicking things off in July.
These deals will likely drive additional consolidation in the sector, which has been hammered by oil price volatility and underperformance due to poor capital allocation decisions. Here's a look at the latest deal and ones that might follow.
A no-brainer combination
The Pioneer-Parsley merger has always seemed inevitable given their family connection (Pioneer CEO Scott Sheffield is the father of Parsley's founder and chairman Bryan Sheffield). While it brings up some conflict of interest since they both own sizable stakes in their respective companies and stand to benefit from the merger, that likely won't scuttle this deal since the industry needs to consolidate.
Further, the deal makes lots of strategic and financial sense because it follows the consolidation blueprint laid out by Chevron, Devon, and ConocoPhillips. Pioneer's all-stock deal values Parsley at $7.6 billion, including the assumption of debt, implying a modest 7.9% premium. Because of that, the transaction will be immediately accretive to all its key financial metrics, including earnings, cash flow, and free cash flow per share. Meanwhile, given their joint focus on the Permian Basin, there are lots of strategic and financial synergies. Overall, Pioneer expects to capture about $325 million in operational and financial cost savings, including $75 million in interest expenses, by leveraging Pioneer's stronger credit rating.
Pioneer Natural Resources expects to return the bulk of those savings to shareholders via dividends. It already pays an attractive base that yields 2.7%. Meanwhile, it expects to join Devon by layering in a variable dividend next year to return additional free cash flow to shareholders. ConocoPhillips hinted it might do the same, as it could pay supplemental dividends or repurchase shares with its excess cash.
A look at the potential next wave
Despite all the recent deals, the oil patch seems ripe for more consolidation. That's because the increased scale can help producers drive down costs, putting them in a better position to weather the sector's volatility. Analysts have thrown out several names as potential M&A targets, including smaller players like Cimarex Energy (NYSE:XEC) and Whiting Petroleum (NYSE:WLL), as well as industry behemoths such as EOG Resources (NYSE:EOG). No name seems to be off the table in the rumor mill.
Analysts have suggested that a combination of Cimarex with Diamondback Energy (NASDAQ:FANG) or Marathon Oil (NYSE:MRO) would make a lot of sense as either would benefit from having greater scale in the Permian Basin. Meanwhile, a merger between Whiting Petroleum -- which recently emerged from bankruptcy -- and Continental Resources (NYSE:CLR) makes strategic sense, as they'd create a larger scale producer in the Bakken. Similarly, oil majors like Chevron, ExxonMobil (NYSE:XOM), or Total (NYSE:TTE) could target EOG Resources, with one already rumored to be evaluating a bid. Conversely, EOG could consider going on the offensive and acquiring a company like Diamondback or Marathon to ward off a potential suitor. Finally, there's been some talk that Chevron could buy Exxon after recently dethroning the oil giant for the largest market cap by a U.S. oil producer.
The urge to merge is growing stronger
The recent wave of mergers will likely fuel additional deals over the coming quarters. They'll probably follow the same pattern of a low premium all-stock transaction or merger-of-equals. That's because those structures will bolster the combined company's per-share financial metrics without negatively impacting its balance sheet. That will allow more oil companies to get the scale they need to survive in an increasingly challenging market environment.