When your sector goes from merely unloved to “hated,” you wonder how much worse sentiment can get. But the market mood in early April left more room for downside.

Could it have been the darkest hour before the dawn? One can only hope.

To set the stage, many E&P management teams had already professed their allegiance to capital discipline, generating free cash flow, returning cash to shareholders via dividend or stock buybacks and, over time, improving return on capital employed (ROCE). Growth as a goal per se was largely shunned.

The pushback from generalist investors: We first need to see several quarters of capital discipline.

This is understandable as energy has outperformed the broader market in only two of the last eight years. Hence the commonly asked question: “Why do I need to care about energy … the stocks never go anywhere,” according to a Tudor, Pickering, Holt & Co. note. Investors have to be “dragged kicking and screaming into the space,” it said. “That’s how hated upstream stocks feel at the moment.”

But rising on the horizon were two other potential catalysts. One was the prospect of M&A. Another was a possible strengthening of the back end of the commodity curve to narrow the gap between the near-month West Texas Intermediate contract ($62.06-per-barrel settle on April 6) and year-end 2019 and 2020 prices ($56.14 and $53.37, respectively).

While the latter has yet to play out, M&A materialized as Concho Resources Inc. agreed to acquire RSP Permian Inc. in an all-stock deal valued at $9.5 billion. The acquisition price, set at 0.320 shares of Concho stock for each share of RSP stock, represented a 29% acquisition premium. (Prior day closing prices: CXO $157.00; RSPP $38.92.)

Concho pointed to the transaction being immediately accretive on various metrics, including net asset value, cash flow and debt-adjusted growth. The acquisition “enhances scale advantages and leverages Concho’s execution strength to extract greater value from properties,” it said, adding that corporate and operational synergies were estimated to “exceed $2 billion.”

While some selloff in an acquirer’s stock is not unusual, Concho’s stock fell 8.7% on the day of the announcement. In addition, the news drew a tepid response that stumped some analysts’ expectations of gains for other Permian players viewed as possible consolidation candidates.

“All the valuation metrics are wildly supportive for the SMid-Cap Permian group, which should drive outperformance effectively across the board today,” said one research report. “We frankly expected the equity performance of the Permian pure plays to have ripped well beyond what we witnessed yesterday,” said another note the following morning.

To the contrary, the stocks in the deal, as well as in energy in general, have dropped sharply in value. From its pre-deal price, Concho’s stock was down 14.8% over the next seven trading days. Over the same period Diamondback Energy Inc., viewed by some as also being a potential consolidator, saw its stock slump 9.7%.

Simmons & Co. said the answer for Concho’s underperformance could simply be the lack of specific forward guidance related to the $2 billion in estimated synergies. Concho’s “consistent track record of accretive acquisitions and dependable execution” should have supported the premium valuation in the transaction, but the deal took place in “an energy market starved of investor sponsorship.”

With the currency value of their stocks in decline, energy companies are less inclined to pursue acquisitions. But this may be largely due to factors unrelated to the Concho-RSP deal.

Even if size and scale are increasingly important, as cited by Concho, current priorities are focused on free cash-flow generation and improving ROCE. In other words, many energy producers have a range of attractive alternatives. And even if organic growth opportunities were scarce—which certainly is not the case for many E&Ps—who would want to sell at valuations that have been crushed?

Outside the Permian—where Concho once traded at close to a three-turn premium to RSP in terms of Enterprise Value (EV)-to-EBITDA for 2020—some E&P stocks are themselves trading at multiples of only 3 to 5 times on EV-to-EBITDA.

“Valuations have collapsed,” commented one long-time, weary energy investor. The recent downdraft in energy equities reflects “just the latest excuse to de-rate the whole sector.”

After M&A’s recent disappointment, what’s the next potential catalyst to revive valuations, assuming oil fundamentals can only move at a moderate pace?

It’s geopolitics—the possible reimposition of U.S. sanctions on Iran—as seemingly a last resort when most everything else has left a dearth of investors in the space.

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