Chevron (CVX -0.91%) recently made a big splash. It agreed to acquire PDC Energy (PDCE) in a $7.6 billion deal. The highly strategic and accretive acquisition will provide Chevron with a meaningful boost.
The deal comes amid continued rumors that ExxonMobil (XOM -3.57%) is on the prowl for a mega-oil deal. While the company has said it plans to be patient, Chevron's deal could force Exxon to move faster.
An ideal deal
Investors weren't initially excited by Chevron's $7.6 billion deal to acquire PDC Energy, as the stock slid about 2% following the transaction announcement. Many thought Chevron would bulk up on its position in the oil-rich Permian Basin if it did a deal. While PDC Energy has land in the Permian (25,000 net acres), its primary focus area is Colorado's DJ Basin (275,000 net acres).
However, the more investors and analysts drilled down into the deal, the more they liked the acquisition. Shares of Chevron rallied more than 3% the following day, driven by favorable analysts' notes on the combination. For example, CFRA analyst Stewart Glickman upgraded Chevron's stock from hold to buy because the combination with PDC Energy will improve its costs in the DJ Basin, where it will become the top producer (up from third). HSBC analyst Gordon Gray also upgraded shares from hold to buy, while Morgan Stanley increased its price target from $192 to $198 per share.
Analysts also noted that Chevron got a great price for the assets. The company is paying a modest premium of 14% compared to PDC Energy's average trading price over the 10 days before the deal's announcement. Analysts thought the price was surprisingly low.
Chevron noted the low valuation it paid in its presentation on the transaction:
Image source: Chevron.
That bottom-of-the-barrel value of less than 3 times enterprise value to EBITDA enabled Chevron to significantly bulk up its resource base for a minimal cost. It will increase its oil equivalent proved reserves by 10% for less than $7 a barrel. That fantastic price will make the deal highly accretive for Chevron. It expects to add $1 billion to its annual free cash flow.
Chevron isn't just buying cheap oil; it's making a highly strategic acquisition. PDC Energy's land is adjacent to Chevron's in the DJ Basin. That should enable it to capture about $100 million of operational expense savings and $400 million of capital expense efficiency savings.
All eyes are on Exxon's next move
Chevron's deal news comes as rumors have swirled that Exxon is on the hunt for its next deal. There have been on-again, off-again reports that Exxon is interested in buying Denbury Resources (DEN). Meanwhile, The Wall Street Journal reported last month that Exxon had set its sights on Pioneer Natural Resources (PXD -3.09%). The report also noted that Exxon had discussed a merger with at least one other company.
Denbury and Pioneer would fit two different needs for Exxon. Denbury is a leader in using carbon dioxide for enhanced oil recovery. That would make it a great way for Exxon to bulk up its carbon dioxide business and further its lower-carbon ambitions. It believes carbon capture and storage could be a multibillion-dollar business for it in the future.
Meanwhile, Pioneer Natural Resources would enable Exxon to boost its position in the resource-rich Permian Basin. That's one of the company's four core areas of upstream investment focus, along with Guyana, liquefied natural gas, and Brazil. While Exxon's CEO Darren Woods stated on the first-quarter conference call that it's "always looking for an opportunity for an acquisition" and noted that "we're very active in the Permian" looking for deals, "that's down the road." Its current focus is on advancing its technology in the region to extract the most value from its existing resources and those of a future acquisition.
The big sticking point for Exxon is value. Woods stated on the call that a deal has "got to be value-accretive." While shares of Pioneer, for example, are currently 25% below their 52-week high even with the acquisition rumors, a deal might not be accretive enough for Exxon, given the takeover premium it would need to pay. That could cause it to continue to wait and see if a more value-accretive opportunity emerges.
Exxon can afford to wait
Chevron found a great deal in PDC Energy, which fits it perfectly. However, that likely won't push Exxon to make a deal because it already has a strong resource base in the Permian. While it would love to bulk up in the region, it can afford to wait until it finds an accretive deal. Given the cyclical nature of the oil market, Exxon's patience will likely pay off eventually.
