Zero-Premium Merger Applied: Pioneer Natural Resources & Parsley Energy

Recently, private equity firm Kimmeridge Energy has had success in the oil patch through exploration in the Delaware Basin and finding undervalued hydrocarbons in the stock market. Kimmeridge’s investment philosophy is to force consolidation, generate economies of scale and achieve capital market recognition.

On 10/19/2018, Kimmeridge pushed for a strategic initiative after acquiring 10% of the common shares of Resolute Energy (NYSE: REN) by a letter stating to management, “based on our belief that the Company's assets were materially undervalued in the market and that the Company had an opportunity to deliver significant value to shareholders by improving operational execution and engaging in appropriate strategic combinations or a sale of the Company.” Shortly thereafter, Resolute was acquired by Cimarex Energy (NYSE: XEC) for $1.6 billion. In response to the acquisition, Kimmeridge managing partner, Ben Dell stated, “we are pleased to see that Resolute’s management team has finally acted and believe consolidation is required in this industry. However, we feel that the proposed purchase price undervalues Resolute.” Would a zero-premium merger have created more shareholder value than the outright sale? On 06/12/18, Kimmeridge released a research paper titled “Zero-Premium Mergers: A Proposal for Public E&Ps” which explains how smaller E&Ps can create long term value through zero-premium mergers, in opposition to settling on the premium generated by an outright sale.

While hindsight is 20/20 regarding the Cimarex/Resolute transaction, to test this philosophy going forward, I applied it to two Permian pure play companies that have overlapping asset bases and deep roots in west Texas, Pioneer Natural Resources & Parsley Energy.

Although neither company is considered a small E&P, Pioneer Natural Resources (NYSE: PXD) & Parsley Energy (NYSE: PE) both appear to accomplish generous upside when merged without a premium.

Through a back of the envelope calculation (see Exhibit “A”), the combined company would have a dominant 890,000 net acre leasehold position and an enterprise value of $46.850 billion. By combining both companies and applying a EV/EBITA multiple based on the Diamondback Energy/Energen acquisition metrics, the shareholders of PXD receive a 26% uplift. Concurrently, the shareholders of PE receive a 45% uplift. The combination of these two E&Ps would create many synergies, namely, high grading asset bases through longer drilling lanes, less competition for land consolidation, more frac data, greater offset well communication control, optimal use of gathering systems, lower SG&A costs, pricing leverage with midstream and service organizations, to name a few.

The results of this exercise appear to be attractive, but if present, other capital structure instruments such as convertibles, preferred equities and debt could have a material impact on the final outcome. Moreover, as the industry drills longer laterals, completes larger fracs and requires more pipe to move larger product volumes, capital intensity has drastically increased from the days Parker & Parsley Inc. explored within this 890,000 acre block. In conclusion, zero-premium mergers appear to be a viable option for management teams to maximize long term shareholder value in a time when the Wall Street fails to do so.