Devon Energy’s RimRock Acquisition Highlights Value Outside Permian Basin

News of a new Devon Energy Corp. acquisition might have had investors expecting an expansion in the Permian Basin.

Instead, Devon’s $865 million Bakken bolt-on of RimRock Oil and Gas LP, announced on June 8, highlights the strategic value of a diversified asset base, said David Deckelbaum, an analyst at Cowen. In addition to its Delaware Basin “franchise growth asset,” Devon holds positions in the Anadarko and Powder River basins and the Eagle Ford Shale.

RimRock’s acreage, which overlaps and is adjacent to Devon’s Bakken position, “makes logical sense and paints an interesting picture of FCF accretive bolt-ons that can be arbitraged by diversified E&Ps to more rapidly grow FCF distributions per share.”

Devon agreed to acquire more than 100 “highly economic drilling locations,” from RimRock, a Warbug Pincus portfolio company, Deckelbaum said. Rimrock’s wells produce more oil and a higher percentage of cash flow than Devon’s.

The RimRock transaction also addresses any potential runway concerns Devon may have had in the Williston Basin, Goldman Sachs analyst Neil Mehta said in a June 8 report.

“The transaction should enable the company to stem natural production declines and keep production flat in the basin over the next 4-5 years,” Mehta said. “Per management, RimRock’s assets produced 15 Mboe/d in 1Q22 and are expected to increase to 20 Mbeo/d over the course of the next year.”

Devon said that the acquisition is accretive enough that it will increase its fixed quarterly dividend to 13% when the transaction closes, likely in the third quarter.

“The company noted that the transaction implies ~2.2x cash flow at current 12-month strip prices (~$110/bbl WTI and ~$8/MMBtu Henry Hub) and that the acquisition will be accretive to earnings/cash flow per share metrics in the first year,” Mehta said. “Management forecasts FCF yield of greater than 25% at current strip pricing.”

Devon Energy’s fixed dividend increase raises its divvy to about $0.18/share, Mehta said. The company’s first-quarter dividend payout was a record $1.27 per share. The Devon board of directors has also approved, after expansion, a $2 billion share buyback.

The all-cash deal also means Devon will maintain its “top-tier” balance sheet with expected net debt-to-EBITDAX of 0.2x by year-end 2022.

Mizuho Americas analysts Vincent Lovaglio and Silvio Micheloto noted in a June 10 report that Devon’s balance sheet strength has enabled it to differentiate itself.

“This all-cash deal is another means of delivering value from a position of strength, enabling a 13% regular dividend increase while extending plateau production from a legacy position,” they said.

The RimRock bolt-on transaction adds a contiguous position of 38,000 net acres (88% working interest) directly offsetting and overlapping Devon’s existing position in the Williston Basin. Devon expects to increase its production to an average 20,000 boe/d over the next year.

Devon will add an additional $100 million to its capital budget following the transaction. The company’s estimated cash flow for 2022, prior to the deal’s announcement was $3 billion.

Tudor, Pickering, Holt & Co. (TPH) estimated that Devon will end the year with production averaging 316,000 bbl/d of oil, an increase of about 5%.

Pro-forma 2023, TPH said production could rise to 328,000 bbl/d of oil on $3.1 billion capex, generating $6.6 billion in pre-return free cash flow—up from $6.3 billion pre-deal. The estimates assume $91/bbl WTI and $5.98 per Mcf.

“Solid deal, accretive on all accounts on our pro-forma model,” TPH said.