[Editor's note: A version of this story appears in the February 2019 edition of Oil and Gas Investor. Subscribe to the magazine here.]

The A&D market got whammied in December. Year-end is usually a tough stretch for deal-making, but even industry veterans were lamenting the state of the business. “I’m not sure we’re going to sell anything ever again,” one joked over the phone.

A combination of tumbling oil prices, prickly investors, financial battles with China and more laid waste to a year that started so strongly.

One of Earthstone Energy Inc.’s (NYSE: ESTE) last acts of the holiday season was to cede. On Dec. 21, it announced it would reimburse $3.1 million in transaction fees to Sabalo Holdings Inc. to make its two-month-old deal go away. Slow murder by the markets does that to a company.

Reflecting upon the initial reaction in October to Earthstone’s $950 million deal for Sabalo’s northern Midland Basin acreage seems slightly cruel. Seaport Global Securities LLC analysts declared themselves “fans of this deal” because of the inventory it added. Robert W. Baird & Co. Inc. analysts, with unknowing irony, wrote that “we think the market will view this transaction favorably.”

The punchline—delivered over two months—was a 51% vaporization of Earthstone’s market capitalization. Put another way, for the 65 days the deal was officially on the table, Earthstone lost an average $5.9 million a day apparently just for proposing it.

It’s convenient here to recall the interrogation scene in “The Dark Knight,” wherein the Joker is shadowed by Batman, who promptly rage-slams his foe’s head into a table.

“Never start with the head,” the Joker complains. “The victim gets all fuzzy.”

The deal’s collapse can be explained by the toll exacted by months of frenzied oil trading, despite an OPEC-Russo pact to cut supply in early December.

Yet a report by Seaport on Jan. 3 seemed to underscore the “weird” that has taken hold of the valuations underpinning E&Ps. The average E&P covered by Seaport dropped 48% in fourth-quarter 2018.

A highly informative Seaport chart breaks down those companies alongside their “upside-to-PDP value.” After decades of investors valuing reserves and projected internal rates of return, companies are now being judged on how well they trade compared with their value at $45, $50 and $55 per barrel of oil. Potential and inventory is apparently for suckers.

Top of the list, Eagle Ford-focused Sundance Energy Australia Ltd. (NASDAQ: SNDE) does well, while Permian-focused Diamondback Energy Inc. (NASDAQ: FANG) and Concho Resources Inc. (NYSE: CXO) limp along at the bottom.

This brings us to a joke. An activist investor—let’s call him Carl Icahn—kills a $746 million deal, saying it’s bad for investors and bemoaning “$8.2 million in wasted transaction costs.” Fourteen months later, the company has lost 54% of value. Its left-for-dead deal would now buy the $320 million-market-cap company twice over. End of joke.

December crawled into January, and, with it, activist investor Elliott Management Corp. came bearing a letter to QEP Resources Inc. (NYSE: QEP). Included was a takeout bid that paid a 44% premium on the company’s stock—or roughly $2 billion—in cash.

Elliott sees QEP as undervalued, which is likely true if the measure of a company is its PDP assets.

QEP dutifully reported receiving the letter and said it would “carefully consider the proposal.”

Following the Jan. 7 announcement, QEP shares rose 40%, “which signals to us that the market views the deal as a likely outcome,” Capital One analysts wrote.

If you’re wondering what Elliott knows about QEP, it’s that Elliott knows money. Elliott incidentally owns a 5% stake in QEP.

Capital One goes on to make a wild suggestion: The firm’s offer for QEP is “an opening volley that could draw other would-be acquirers into the negotiations.”

“The 44% premium in Elliott’s offer is substantial, but we would not be surprised if other bidders enter the fray before letting core, contiguous, HBP and high-working interest acreage be acquired at a price that still represents a significant discount to recent deal flow,” Capital One analyst Brian Velie wrote on Jan. 8.

Cowen & Co. LLC analysts similarly puzzled at the price, which equates to about $25,000 per acre in Martin and Andrews counties, Texas. “Some could argue [that price] is still too cheap relative to the opening of a Permian data room” that might pique the interest of a Diamondback or Concho, analysts wrote.

If all of this seems a tad by design, consider this capping, savage irony: Earthstone’s offer for Sabalo was about $24,000 per acre.

The market loves a good laugh, even if they don’t get the joke.

Now, back to Batman and the Joker in the interrogation room.

“You wanted me. Here I am,” Batman snarls.

“I wanted to see what you’d do,” his nemesis replies. “And you didn’t disappoint.”

Darren Barbee can be reached at dbarbee@hartenergy.com.

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