Investors began returning to Rocky Mountain oil and gas driller Civitas Resources Inc. on June 21, reversing a retreat after the announcement of a $4.7 billion deal.
The planned merger would transform the company but would involve $2.7 billion of new debt and the issuance of new shares worth nearly $1 billion. By early afternoon on June 21, Civitas shares were up less than 1% to $65.60/share after losing 6% in the wake of the deal announcement on June 20. Both days saw heavier-than-normal trading volumes.
Civitas is buying two private Permian operators and moving away from being a pure-play Rockies natural gas producer, similar to the October 2021 combination of Marcellus Shale gas producer Cabot Oil & Gas Corp. and oil producer Cimarex Energy Co. to create Coterra Energy Inc. Like Cabot, Civitas is looking to grow from one commodity — gas — and from one basin — Colorado's Denver-Julesburg (DJ) — into a larger operator by adding oil and the Permian to its mix.
Permian is not cheap
"This looks mostly like a play for additional scale for Civitas and expands the company's operations beyond the DJ Basin into both sub-basins of the Permian," Andrew Dittmar, director of Enverus Intelligence Research, said in a June 20 note after the announcement. Civitas has few private operators to roll up in the DJ, and so it expanded into the Permian, Dittmar said. This echoes the reason Chevron Corp. decided to buy into the Rockies with a deal to purchase gas producer PDC Energy Inc., Dittmar said.
"While the Permian is a prime target for consolidation, assets there don't come cheap," Dittmar wrote. "Increasing pricing for core inventory has been a key theme of 2023's M&A market, and with two more chips off the table that trend doesn't look likely to reverse any time soon."
The big winners in Permian deals have been private equity investors, Dittmar said. "Private equity exits in the Permian have comfortably topped $10 billion in 2023 as sponsors stampede for the exits amid strong demand for their inventory from public buyers," he said.
Dittmar said he thinks the next wave of Permian M&A will be dominated by corporate consolidation, as "remaining private acquisition opportunities are scarce."
Debt reduction plan
John Wren, Civitas' director of finance, planning and investor relations, said in a June 21 email that Civitas plans to dedicate about half of its expected $1.1 billion in free cash flow in 2024 to pay down debt. The operator ended the fourth quarter with $393.7 million in long-term debt.
The company expects to cut its share-buyback plans in half to $500 million, but that option will be used as a backup to free cash flow, Wren said. "We do not have to successfully execute noncore asset sales to reduce leverage, it can be done organically. If we do share repurchases, then we'll likely do noncore asset sales as well," Wren said.
Announcing the deal June 20, Civitas said its $2.45 billion purchase of Delaware Basin driller Tap Rock Resources LLC and $2.25 billion purchase of Midland Basin operator Hibernia Energy III LLC will increase its existing production by 60% with the addition of 100,000 barrels of oil-equivalent per day, 54% oil, to current production.
In addition to the $2.7 billion in long-term notes Civitas is issuing, it is also will pay Tap Rock 13.5 million Civitas shares, equal to $950 million before the announcement. In addition, Civitas will draw $600 million from its credit revolver and use $400 million in cash it already has on hand to complete the deals.
Truist Securities Inc. analyst Neal Dingmann did not flag the debt as a concern.
"Importantly, the company's leverage only just breaches 1.0x [debt/EBITDA], which should drop quickly given debt reduction including noncore sales and a reduction in share repurchases" while opening a path to higher share values, Dingmann wrote in a note to clients. "We believe the deal should also disassociate [Civitas] from the lower-multiple DJ categorization, leading to multiple expansion."
Matt Portillo, director of research for energy investment bank Tudor Pickering Holt & Co., told clients June 21 that upstream consolidation is positive.
"We continue to view consolidation of private operators by public companies as a positive from a macro perspective for the upstream sector, as it will continue to reduce growth from the market (helping to tighten crude fundamentals over time) alongside lowering service demand going forward," Portillo wrote.
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