Introduction:
Pioneer Natural Resources Co. will acquire rival Parsley Energy Inc. in an all-stock transaction marking the fourth large acquisition to be announced in the US shale patch since oil prices crashed earlier this year. At the time of the announcement, the equity of Parsley is valued at US$4.5 billion. Its total enterprise value (equity value and net debt) is about US$7.6 billion.
This deal suggests that industry consolidation is speeding up. Furthermore, the agreement brought a bust in the series of mergers that were reshaping the troubled US shale oil industry.
The extension of Pioneer’s production capacity in the Permian Basin will lead to gaining a central position in the world’s most prolific oilfield, which stretches across Texas and New Mexico, with daily production of 558,000 barrels of oil equivalent.
Companies overview:
Pioneer Natural Resources
Howard W. Parker and Joe M. Parsley founded Parker and Parsley in 1962. The company worked to purchase significant properties in the Permian Basin, and in the 1980s, the company moved from joint venture activities into drilling funds. In 1997, Parker & Parsley merged with MESA Inc. to form Pioneer Natural Resources.
Pioneer Natural Resources, headquartered in Texas, operates as an independent company engaged in the exploration and production of oil and gas. The firm conducts hydrocarbon exploration in the Cline Shale. It focuses operations on Permian Basin, Eagle Ford Shale, Rockies, and West Panhandle projects. Pioneer Natural became known for making smart choices, conservative hedges and shrewd deals as it assembled acreage and drilling plays.
Revenue for the quarter ending September 30, 2020 was $1.815B, a 21.94% decline YoY. Revenue for the twelve months ending September 30, 2020 was $7.574B, an 18.9% decline YoY. PE ratio and price to book ratio for Pioneer Natural Resources were respectively 32.76 and 1.55 as of November 30, 2020.
EPS for the quarter ending September 30, 2020 was $-0.12, a 108.7% decline YoY, while for the twelve months ending September 30, 2020, it was $1.03, a 76.16% decline YoY. These losses are explained by Covid-19 causing a huge drop in oil demand and a rise in countries developing sustainable energy alternatives.
Parsley Energy
Parsley Energy was established in 2008, and it is based in Texas. The company focuses on the acquisition, development, and exploitation of unconventional oil and natural gas reserves. Parsley acquired Jagged Peak Energy in January 2020. This transaction delivered complementary, high margin assets, and tangible synergies.
Parsley set a challenging goal to significantly decrease flaring volumes, it has a strong commitment to improving its environmental performance. The company has a broad operating history and footprint, a premier area position, great financial performance, an inviting growth profile, and a conservative financial strategy. They have transitioned from vertical drilling to horizontal drilling to more effectively capture all potential resources.
Revenue for the quarter ending September 30, 2020 was $0.447B, a 12.3% decline YoY. Revenue for the twelve months ending September 30, 2020 was $1.755B, a 7.21% decline YoY. PE ratio and price to book ratio for Parsley Energy as of November 30, 2020 are 16.77 and 1.38, respectively. EPS for the quarter ending September 30, 2020 was $0.06, an 86.05% decline YoY, while EPS for the twelve months ending September 30, 2020 was $-10.21, a 1197.85% decline YoY.
It is important to note that the two Texas shale companies share a father-son bond, with Scott Sheffield as chairman and Chief executive at Pioneer, and his son Bryan as the chairman of Parsley. Bryan started Parsley (now Parsley Energy) after some training at Pioneer.
Industry Overview:
The sector is in a full-on merger mode in response to weak crude prices after the Covid-19 pandemic hit global demand. Moreover, oil prices became negative for the first time due to very scarce storage facilities.
Oil prices have put pressure on energy companies around the world. The entire industry is weighed down by massive debt, the result of a dizzying expansion that has made America the largest oil producer but also disappointed investors with poor returns. Unsatisfactory returns increased the cost of capital, even for the best operators. As the pandemic continues, the cost of capital (both equity and debt) may increase even further. Investors’ patience with the sector has dropped, and some of them have called for consolidation to cut down operational and borrowing costs. Recently, energy plummeted to constitute less than 2% of the S&P 500 Index, down from more than 11% a decade ago, even as the broader market rose to record levels. Investors are now turning their attention to renewable energy, a more promising and innovative sector.
When we talk about the U.S. shale industry, size matters because of economies of scale. A larger company experiences lower overhead costs, increased bargaining power with suppliers, but also, crucially, easier and greater access to the debt market. Companies that do not have the financial resources to drill new wells face a situation of falling production, and this is happening in many firms. Thus, the bigger a firm is, the more debt it can take on, therefore, large firms won’t lack the large upfront fixed costs needed to produce/mine oil. The benefits of being a large oil company explain a major part of the reasoning behind Pioneer acquiring Parsley. Additionally, many oil producers are realizing the benefits of being large, and this is demonstrated in the M&A Energy sector’s deal flow ($30 billion worth of M&A transactions were completed or announced in the last few weeks). One consequence of the consolidation is that the top 10 oil producers will provide as much as half the shale industry’s total capex in the next five years, up from less than 30 percent during the past decade.
In the long run, the reduction of carbon emissions is a driving factor in the need for significant operational improvements. Investors are paying more attention to environmental issues; renewable energy prices are getting lower, and more and more countries are imposing carbon taxes on businesses. The covid-19 crisis is accelerating what was already shaping up to be one of the industry’s most transformative moments – the transition to sustainable energy. Without fundamental change, it will be difficult to return to the attractive oil industry performance that prevailed in the past. Innovation is the next chapter for the energy industry, as sustainable technologies are evolving fast. It has the potential to transform operations and deliver increased value.
Deal Structure:
The deal was an all-stock transaction with a total value of US$7.62 billion. The traditional enterprise value of the transaction is expected to be slightly lower given the premiums paid.
As of October 19, 2020, Pioneer Natural is expected to issue 0.1252 shares for every Parsley Energy common stock. During this period, Pioneer Natural was trading at $87.05 while Parsley Energy was $10.1, representing a 7.9% premium paid. Since the implied equity value of the deal is US$4.49 billion (including the premium paid), the remaining US$3.13 billion is net debt that was assumed by Pioneer Natural. This makes sense since the two companies have family ties – many of Parsley Energy’s lenders will allow Pioneer Natural to assume the debt rather than request refinancing, which would be an extra cost to Pioneer.
After the transaction, Pioneer shareholders are expected to own 76% of the combined company while Parsley shareholders will hold the remainder. Also, refer to the exit multiples and metrics in the figure below. Note that the Exit Multiples obviously represent the total transaction value (US$7.62 billion) as the numerator. Additionally, EBIT can be seen as a more accurate multiple since oil companies have large amounts of the depreciation associated with core business assets (capex should be accounted for in such an industry).
Deal Drivers:
The deal drivers are very clear and abundant:
- Cost synergies are expected to generate US$325 million in savings throughout the first year for Pioneer Natural. This is due to higher operational efficiency, reductions in G&A costs, and reductions in interest expenses. The present value of expected savings over the next 10 years is over US$2 billion. This expectation has determined that the deal is accretive to cash flow per share as well as earnings per share.
- Geographic synergies will clearly occur. Both companies have positions located in the high-margin Permian basin and mixed drilling efforts in an area with no other competition is beneficial.
- Environmentalism; Pioneer and Parsley have a shared vision regarding environmental stewardship, sustainability initiatives, and promoting a culture that works towards sustainable operations. As sustainability continues to trend, ESG activity will be an important selling point for non-renewable energy companies in the years to come.
- Economies of scale are extremely important for oil corporations as mentioned earlier, e.g. access to capital becomes cheaper. This deal will enable Pioneer Natural to gain the necessary corporation size to remain competitive.
Conclusion:
Overall, the deal seems like a clear win-win for both companies. However, Pioneer will remain in an industry that is struggling financially and structurally. The advent of shale, excessive supply, and declining demand for oil will make it hard for Pioneer to manage the entirety of the Covid-19 crisis. Although, after examining the deal and expected benefits, shareholders are not only hopeful but firmly believe that Pioneer’s acquisition will give it a competitive advantage in the long run.
Whether the price of oil goes up or down, only time will tell, but with Biden’s recent win, investors are skeptical about oil prices hitting former levels given his stance on sustainability. President Biden claims that his climate plans are the most ambitious of any president in US history. While this is bad for many oil producers, this may benefit the efficient oil producers since all inefficient producers will be eliminated from the market. As a result, firms that are able to produce oil at a low cost will gain market share from the companies that leave the market. Since the Permian basin is low-cost and offers relatively high profit margins, Pioneer is in a good position to manage this crisis regardless of whether the price of oil drops or increases.
The last point to mention is the momentum building behind Energy M&A. Since many firms see the benefit of being as large as possible, more and more companies look to merge or acquire competitors. The US Energy & Industrials M&A market is expected to grow over the next few quarters. Additionally, if this trend continues, we will likely see the US oil market tend toward an oligopoly. This could pose price-fixing issues in the long run, however, given that oil is such an international commodity, transparent market prices will likely prevent this from occurring.
Sources: Reuters, Bloomberg, Parsley Energy web site, Pioneer Natural Resources web site, Deloitte, Financial Times, Wall Street Journal, Offshore Technology, Macrotrends, McKinsey, CB Insights, BusinessWire, Marget.
Authors: Ethan Aspin, Silvia Maifrini
Bocconi Students M&A Circle 
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