Catalyst:
Concho Resources will be acquired by ConocoPhillips in an all stock transaction for about $9.7 billion, whereby, each share of Concho Resources will be converted into 1.46 shares of ConocoPhillips common stock, representing a 15 percent premium to closing share prices on October 13. The combined company will have a proforma enterprise value of about $60 billion.
At current stock prices, the spread on the deal is only about 1%. If we’re looking at the possibility of making money by arbitrage, then we should be bullish on ConocoPhillips and like any other oil company, the stock price is highly correlated with oil prices.
My investment in Concho Resources dates back to May 2019 and since then, the stock is down 53% underperforming both the S&P 500 and S&P 500 Energy indices.
My cost basis on Concho Resources is $56.16 and it represents 1.2% of my portfolio, meaning that we will need for the stock price to rise by 18.8% in order for us to break even on the investment. Whether this is possible or not depends on oil prices until the deal is done and the movements of ConocoPhillips stocks. The deal is expected to close in the first quarter of 2021.
I am not going to speculate on short term oil prices. For the time being, I’ll just hold on the stock. If we do have higher oil prices, then, we may make some better returns, otherwise, we will have to accept the loss and move on. Since it is only 1.2% of our portfolio, it won’t be such a big blow.
In case, the deal doesn’t go though, I’ll still hold Concho Resources for the long-term as they are a financially strong upstream oil company.
The probability of the deal going through is quite high as ConocoPhillips is among one of the best performing upstream oil companies right now. They were able to maintain a positive free cash flow, despite the low oil prices. ConocoPhillips is also one of the big oil companies and for them to keep growing, acquisitions are a necessity. This deal will give them higher exposure to the Permian Basin.
As far as regulators are concerned, I don’t think that there will be any issue since there has been a lot of consolidation in the oil industry in recent years. For example, Occidental Petroleum acquiring Anadarko Petroleum. With the multitude of struggling oil companies, more consolidation is to be expected.
Financial Analysis:
In recent years, Concho Resources had undergone massive cost reductions. In 2019, the Controllable costs per Boe was at $9.44 and now it stands at $7.49, a reduction of 21% in costs. Concho Resources also lowered well costs from $1200 a year ago to $800 today in the Delaware Basin and from $830 to $650 in the Midland Basin. The reduction in cost was helped by them selling some of their least profitable assets last year. This sale also considerably improved the balance sheet of the company. The sale of these assets enabled them to initiate a share buyback program and to pay dividends.
The company currently has $3.6 billion in debt with no maturities before 2027 (down from $4.3 billion a year prior). The current liabilities of the company are $760 million with $4.860 in total liabilities. As for the assets, they have a total of $12.780 billion, including $10.9 billion in PP&E and $1.37 in current assets. The tangible book value of the company is $7.92 billion.
Valuation:
The long-term valuation of the company will depend on oil prices and right now, because of this deal, we should be focusing on the short-term. Unfortunately, it becomes a little harder to value oil companies based only on the short-term. With a tangible book value of roughly $8 billion, this should be a good approximate of current value. In 2019, the company had a PV-10 of $10.5 billion.
Risks & Mitigation:
There are two scenarios: The deal goes through or the deal doesn’t go through. In the first scenario, it really depends on short-term oil prices, which can be affected by the state of the world economy in this pandemic and politics. In the second scenario, we should expect higher oil in the long-term as the recession ends. The main risk, however, in both scenarios is that oil prices remain low.
Conclusion:
Concho Resources is a company I was hoping to hold for the long-term, the pandemic happened and caused a massive drop in stock price. With this deal coming, we may not be profitable on it but if the deal doesn’t go through, then I’ll still hold.
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