(Reuters) – The latest business combination in the U.S. shale patch signals a way forward for the struggling industry.
Unlike the bankruptcies of the past three months, Devon Energy DVN.NRival WPX Energy’s $ 2.56 billion low-premium stock deal WPX.N brings together two companies with assets in a few oil basins and relatively low debt.
Investors backed the idea with a rally in stocks. WPX closed 16.4% higher on Monday and Devon gained 11%, supported by the prospect of a combined company that analysts say would be in a better position to pay dividends and reduce debt.
The shale has been hit by the COVID-19 pandemic which has reduced global demand for oil and investors have avoided the sector’s low returns.
“This deal represents the form of shale business debt consolidation that many industry players are looking for,” said Andrew Dittmar, M&A analyst at Enverus.
He cited the additional acreage in the first US shale field, the share swap, and the premium paid little or no. The selling point for investors, he added, is that the combined company will have greater scale and efficiency to generate free cash flow for its investors at today’s low oil prices.
This is the second major shale transaction with a similar profile. Chevron CVX.N earlier agreed to buy Noble Energy NBL.O for $ 13 billion including debt, in a low-premium, all-equity deal. Noble investors are due to vote on the offer on Friday.
Devon and WPX have similar profiles with substantial operations in the Permian Basin shale field in West Texas and southern New Mexico. Both have also been hit hard by falling oil prices.
The need for shale consolidation is clear. Whiting Petroleum Corp. WLL.N recently emerged from Chapter 11 bankruptcy with less debt, while Oasis Petroleum Inc OASO entered into a grace period after failing to pay interest on certain bonds.
Devon-WPX combined will post a 12-month net debt to EBITDA ratio of 1.6, well below the company average of 2.92 in the S&P 500 Energy Index. .SPNY, according to data from Refinitiv Eikon.
The deal also signals that companies with higher debt ratios could be left out as shale producers consolidate.
“This potentially leaves some over-leveraged companies without dancing partners,” said Dan Pickering, founder and chief investment officer at asset manager Pickering Energy Partners.
“You are definitely not going to pay to get riskier.”
Devon and WPX have committed to limiting future investments to 70% to 80% of operating cash flow and volume growth to a maximum of 5%.
“The shale didn’t work because people put too much money into it to develop too quickly,” Pickering said. “It’s like we now have the playbook.”
Reporting by Shruti Sonal and Arathy S Nair in Bengaluru; Editing by Nick Zieminski