Last Sunday, Whiting Petroleum (NYSE:WLL) announced that it will buy Kodiak Oil & Gas (NYSE: KOG) for $3.8 billion in stock plus the assumption of $2.2 billion in debt, in a deal that will create the dominant oil producer in the Bakken.
These types of mergers could become more common in the near future, according to a prominent hedge fund manager, as large companies with slowing growth seek out smaller, faster-growing firms. Of the few dozen or so publicly traded independent producers remaining in the Bakken, Oasis Petroleum (NYSE:OAS) looks like an attractive takeover candidate.
More consolidation likely
Few people understand the opportunities available in merger arbitrage better than hedge fund manager John Paulson, whose $23 billion New York-based investment firm, Paulson & Co., specializes in investing in merger situations. The recent merger of Kodiak with Whiting, companies that Paulson correctly identified as takeover candidates, reportedly netted his fund some $360 million.
Paulson thinks more such mergers are on the way and points to a few key factors to support that argument. The first is historically low interest rates, which make it cheaper to finance acquisitions. The second is high stock market valuations, which make it more attractive to use stock to carry out transactions.
Indeed, Whiting's acquisition of Kodiak was done in an all-stock transaction valued at around $6 billion including debt. The third main factor Paulson points to is slowing growth for large companies, which makes acquisitions particularly attractive because it allows them to grow faster than they could organically. In Whiting's case, its rate of production growth had been slowing in recent quarters, which made faster-growing Kodiak an ideal target.
Speaking at the recent CNBC Delivering Alpha conference, Paulson explained why leading independent producers in the Bakken are especially attractive acquisition targets: "They are too attractive to sit there at the current valuation. They are independent, they are in the U.S., they are growing very rapidly, they have enormous reserves, and the cost of harvesting the reserves continues to decline every year. So it should -- it's not likely they will remain -- they may remain as independents for a long period of time."
Is Oasis next?
One company that could be a prime target for a takeover is Oasis Petroleum (NYSE:OAS), a leading independent Bakken producer that possesses all the requisite qualities Paulson identifies. It boasts more than 500,000 high-quality net acres in the Bakken. Its production is growing rapidly; it surged more than 50% in 2013 to 33,904 barrels of oil equivalent per day and is expected to grow by 42% this year.
Its proven oil and gas reserves increased 59% year over year to 227.9 million barrels of oil equivalent at year-end 2013, giving it 3,590 remaining gross drilling locations representing nearly two decades of drilling inventory. And its drilling costs continue to fall, with well costs in the first quarter averaging just $7.2 million, as compared with $8.5 million in the fourth quarter of 2012.
Despite its attractiveness as a takeover candidate, Oasis looks relatively cheap right now. Shares trade at a forward P/E just north of 14 and an EV/EBITDA multiple of a little over 9 -- slightly cheaper than Kodiak's pre-acquisition multiples. Further, its enterprise value of $7.8 billion is only 30% greater than Kodiak's $6 billion, but its acreage size and drilling inventory are nearly three times as big.
Also, its EBITDAX -- a commonly used measure of profitability for natural-resource companies that adds exploration expenses to EBITDA -- is roughly $1 billion, about 43% more than Kodiak's $700 million, while its level of long-term debt is almost exactly the same as Kodiak's, despite its 30% larger enterprise value.
With further consolidation in the U.S. oil and gas E&P industry likely, Oasis Petroleum stands out as a potential takeover candidate. The company's vast drilling inventory, relatively low debt, and strong growth potential make it an attractive target for a large suitor and an intriguing play for investors looking to benefit from a merger situation.