E&P Consolidation Trends: Anticipating Gassy M&A

With several recent public transac­tions, the long-awaited E&P consolidation wave has finally arrived in the oil patch. Gas has been quieter (partially due to fewer public companies) with Southwestern Energy Co.’s acquisition of Montage Resources Corp. representing 2020’s primary announcement. Nevertheless, as the cost of capital and uncertainty surrounding the terminal value for conventional energy increase, the necessity for cost reductions via consolidation is magnified.

Accordingly, we believe combinations between gas companies are a matter of when, not if.

In late October, EQT Corp. paid $735 million to acquire Chevron Corp.’s Appalachian position including 125,000 core Marcellus acres adjacent to EQT, 70,000 undeveloped. But while the EQT/Chevron Appalachia announcement is significant, it primarily represents a large bolt-on transaction. Nevertheless, we see the potential for more meaningful consolidation in the Marcellus and Haynesville.

Within Appalachia, we see the merit of an EQT/CNX Resources Corp. merger but see meaningful hurdles which could push a potential transaction further into the future. Over the long (...long) term, we’d like to see CNX’s and Range Resources Corp.’s acreage positions in EQT’s hands with the company emerging as a gas titan.

We also believe the Haynesville Shale is well positioned for M&A and see Comstock Resources Inc. as the natural consolidator of private-equity-backed E&Ps within the region. We believe all-equity at-market transactions create value for all shareholders through reduced costs and production in the hands of fewer operators.

Consolidating southwestern Marcellus

Within the Marcellus, southwestern Pennsylvania—where CNX, EQT, and Range operate—represents the ideal target as we assume West Virginia players are digesting transactions (Southwestern) or fixing balance sheets (Antero Resources Corp.). EQT is the natural consolidator within southwestern Pennsylvania.

EQT and CNX: Based on our analysis, a potential zero-premium equity transaction between EQT and CNX, with EQT as consolidator, would be accretive to EQT.

In our analysis, we assume corporate synergies equivalent to 75% of CNX’s G&A. We also assume EQT can refinance CNX’s bonds at a 5.0% coupon (equivalent to EQT’s recent bond offering). Based on these assumptions, a potential transaction would be slightly accretive to cash flow per share, highly accretive to free cash flow per share and slightly accretive to leverage from EQTs perspective.

Notwithstanding the potential for value creation in an EQT/CNX merger, investors may want EQT to primarily focus on its organic deleveraging strategy and may not desire large-scale M&A until certain debt/leverage targets are met. Accordingly, we believe investors may be more amenable as we get closer to year-end 2021 and EQT achieves its net debt targets.

From CNX’s perspective, free-cash-flow yield would decline, but shareholders would retain similar levels of upside exposure toward the commodity and benefit from a lower cost of capital. The verdict is still out on inventory, but we believe investors are generally skeptical of CNX’s deep Utica position across southwestern and central Pennsylvania (in part due to midstream buildout costs and limited well results in CPA). Accordingly, investors may view the transaction as neutral or favorable to CNX based on Marcellus inventory.

Notably, CNX’s management believes it is on track to be the lowest cost gas player and has been vocal about its view that its stock is trading at a fraction of its intrinsic value. Accordingly, management highlighted on its third-quarter 2020 conference call that it is less willing to hand over the reins at current prices. Also, a 1.5x to 2.5x change of control may not be compelling if management believes it will generate copious amounts of free cash flow over seven years and believes it has the potential to drive its stock price higher via aggressive shareholder return initiatives.

Finally, CNX previously highlighted its desire to be a consolidator. These qualitative factors could push a potential transaction toward the right.

CNX and Range: A CNX/Range combination would be dilutive to CNX shareholders due to valuation and leverage. In our analysis, we assume corporate synergies equivalent to 75% of the lesser cash G&A between the two companies. We also assume the new entity will gain a lower cost of capital and would be able to refinance bonds at a 5.0% coupon. Based on these assumptions, a potential transaction would be dilutive to CNX before taking any operational synergies into consideration. Dilution is driven by Range’s elevated multiple relative to CNX.

EQT and Range: Similarly, an EQT/Range merger would be dilutive to EQT due to valuation and leverage. In our analysis, we assume corporate synergies equivalent to 75% of RRC’s G&A. We also assume EQT can refinance RRC’s bonds at a 5.0% coupon (equivalent to EQT’s long-dated bond yields). Based on these assumptions, a potential transaction would be dilutive to EQT before taking any potential operational synergies into consideration. Dilution is driven by Range’s elevated multiple relative to EQT.

Although a transaction is dilutive today, we see value in EQT eventually owning Range’s acreage once the multiple has significantly compressed and leverage is more under control.

While we believe EQT should consolidate the Southwest Marcellus over time, there are important impediments that may push this event further out into the future.

Consolidating the Haynesville

The Haynesville is ripe for consolidation as there are many private operators with large acreage positions. Since the potential targets are privates, information is fairly limited; however, some worth monitoring include: Indigo Natural Resources LLC, Rockcliff Ener­gy LLC, Vine Oil & Gas and Aethon Energy Management LLC.

Headwinds to potential transactions include debt burdens and existing midstream agreements while tailwinds include private-equity backers desiring an exit. Currently, the market views Comstock as the Haynesville’s natural consolidator, and we believe investors would prefer for the region to be in the hands of fewer public operators. Comstock and private E&Ps: The Haynesville map highlights various acreage positions of Comstock and various gas operators. The accompanying graph provides a sense of relative productive scale between the five operators.

On the whole, 12-month productivity between Indigo, Comstock and Aethon is fairly comparable based on 2019 production data. Vine led the group on productivity, while Rockcliff lagged the group. However, Rockcliff has experienced a 25% and high­er improvement in six-month lateral adjusted productivity during 2020, and we believe the improvement is in part due to the use of di­verter technology.

Key impediments to any potential arrangements would include midstream obligations and elevated debt levels (for example, Vine bonds trade at about >75c per dollar).

However, potential tailwinds include longer-dated private-equity investments, which may be getting close to the end of their fund lives. Vine made its first major acquisition in 2014; Rockcliff obtained capital from Quan­tum Energy Partners in 2015; and Indigo raised capital from Trilantic Capital Partners, Yorktown Energy Partners and Ridgemont Equity Partners and others in 2016.

At this juncture, we anticipate less consolidation within Northeast Appalachia. Southwestern recently acquired Montage’s assets but primar­ily for southwestern Appalachia. However, we don’t see Southwestern divesting the Northeast assets nearer-term as the assets generate a lot of free cash flow. Further, Southwestern’s legacy Northeast assets don’t compete for capital within Chesapeake Energy Corp.’s or Cabot Oil & Gas Corp.’s portfolios, the other major public operators in the region.

Chesapeake is currently in the middle of Chapter 11 proceedings, and while it is uncertain what reemergence resembles, the Marcellus was historically one of the stronger pieces of the former gas giant’s portfolio. Along with the fact that Chesapeake is running four rigs, that could make the asset less of a divestiture candidate.

Chief Oil & Gas LLC is one significant private operator within the Marcellus. CEO Trevor Rees-Jones is a multibillionaire with a history of selling assets. In the past two decades, Chief sold its Barnett position to Devon Energy Corp. ($2.2 billion); its Barnett midstream business to Crosstex Energy Inc. ($480 million); remaining Barnett assets to Quicksilver Resources ($330 million net/$1.3 billion gross); Marcellus acreage to Enerplus Corp. ($400 million); Marcellus acreage to Exco Resources Inc. ($460 million); Southwest Appalachia acres to Chevron ($1.8 bil­lion); and a pipeline network to Penn Virginia Corp. ($1 billion).

Currently, it is uncertain what the company’s forward objectives are given limited information, but it is worth highlighting that Chief’s 2019 well performance is commensurate with Chesapeake and Cabot on a lateral-adjusted basis. Nevertheless, Chesapeake remains in Chapter 11 proceedings and any Cabot transaction would possess exceptionally high hurdles as it would need to be leverage neutral/positive (Cabot 2021 net debt/EBITDA is 0.2x) and immediately accretive to free cash flow per share.

Conclusion

As stated earlier, the cost of capital and uncertainty surrounding the terminal value for conventional energy is increasing. This uncertainty increases the necessity for cost reductions, and consolidation represents one method of achieving that objective. There are important impediments that may push significant transactions toward the right, but ultimately we believe these companies will be stronger together. And we believe that it is only a matter of time until these combinations occur.

Kashy Harrison is a senior research analyst with Simmons Energy, a division of Piper Sandler.