Some oil companies avoid mergers and acquisitions (M&A) because they're often costly and can destroy shareholder value. However, for Diamondback Energy (NASDAQ:FANG), "M&A activity is as fundamental ... as the air that we breathe," according to CEO Travis Stice. That's why the company has steadily gobbled up rivals, growing its scale in the Permian Basin.

Diamondback took in another deep breath this week, agreeing to acquire QEP Resources (NYSE:QEP) and the assets of privately held Guidon Energy for more than $3 billion. The deals enhance its position in the Permian, growing its scale so that it can reduce costs and generate more free cash flow in the currently uncertain operating environment.

The silutet of two people shaking hands with oil pumps in the background.

Image source: Getty Images.

Drilling down into the deals

Diamondback Energy is buying QEP Resources in an all-stock transaction valuing it at $2.2 billion, including the assumption of its $1.6 billion of net debt. The company is paying an implied value of $2.29 per share for QEP Resources, which is slightly less than its trading price before the deal's announcement last week. However, it's above where QEP Resources' stock traded earlier this month before reports surfaced of Diamondback's potential interest in buying the company. Still, the overall low premium deal lines up with other recent sales in the industry's current M&A wave

The primary draw is QEP's 49,000-net-acre position in the Midland Basin. Because they're near Diamondback's existing assets in the region, Diamondback believes it can leverage these operations to capture $60 million to $80 million of annual cost savings. Even without those savings, Diamondback estimates that the deal will be accretive to its cash flow per share, free cash flow per share, and leverage while also lowering its 2021 reinvestment ratio.

Diamondback will also pick up QEP's assets in the Willison Basin of North Dakota. The company intends on using them to generate free cash flow in the near term, with the potential to monetize them in the future, depending on market conditions.

In addition to QEP Resources, Diamondback Energy is also picking up the assets of Guidon Energy for $862 million. It's paying $375 million in cash and 10.63 million of its shares. That deal will provide it with another 32,500 net acres in the Midland Basin. The transaction is also accretive on all the same relevant metrics.  

Building an oil giant one deal at a time

These transactions continue Diamondback Energy's steady consolidation of smaller operators in the Permian Basin. In late 2018, the company acquired Energen for $9.2 billion in a deal that significantly increased its scale in the Permian Basin. That year the company also bought Ajax Resources for $1.25 billion and completed another smaller land acquisition for $312.5 million. Before that, it acquired Brigham Resources in a transformational $2.43 billion deal that gave it a foothold in the Delaware Basin side of the Permian. 

All this wheeling and dealing has transformed Diamondback into a leading player in the Permian Basin. Once it closes the QEP Resources and Guidon Energy deals, the company will control 429,000 acres across the Permian, 64% of which will be in the Midland Basin. It will also have a sizable production base of 228,000 barrels of oil equivalent per day (BOE/D) out of the Midland Basin alone. That enhances its scale as the second-largest operator on that side behind Pioneer Natural Resources (NYSE:PXD), which will soon control 930,000 acres across the Permian and produce 631,000 BOE/D out of the Midland once it closes its merger with Parsley Energy (NYSE:PE). While Diamondback remains a long way from catching up to Pioneer, it will extend its lead over ExxonMobil (NYSE:XOM) and others in the Midland.

Increasing its air supply

Diamondback Energy previously stated that it didn't need to join the current consolidation wave since it didn't have to get bigger to survive. However, it found two deals that check all its boxes, as they'll reduce costs and boost its cash flow, which will help it better navigate lower oil prices. That's why it couldn't resist the opportunity to inhale deeply and continue its buying binge in the Permian Basin.

However, there's still a lot of uncertainty about what the future holds for the oil market. While demand has started recovering, it could be choppy in the coming year with the resurgence of COVID-19 cases and the time it will take to roll out vaccines. Add that to the long-term uncertainty as the global economy pivots toward renewables, and it's unclear if these deals will pay big dividends for Diamondback Energy.