Wednesday, 05/25/2022 Published by: Housley Carr
The pace of multibillion-dollar M&A activity among oil and gas producers may have slowed a bit from 2020 and 2021, but big deals are still happening. Just last week, publicly held Centennial Resources Development and privately held Colgate Energy Partners III announced plans for a $7 billion “merger of equals” that will combine two midsize E&Ps in the Permian’s Delaware Basin to form one of the area’s larger producers. Each of the companies brings similar and complementary production assets to the deal, as well as corporate leaders very much in sync about the significance of scale in today’s increasingly concentrated upstream sector — and the importance of returning a big chunk of free cash flow to investors. Speaking of investors, an extraordinary 12% stake in the combined Centennial and Colgate will be held by the pro forma company’s management — that’s about 12x the norm among its peers. In today’s RBN blog, we discuss the Centennial/Colgate merger and what’s driving the ongoing consolidation in the U.S.’s most prolific hydrocarbon play.
Over the past two years, a combination of factors not only ushered in an era of unprecedented financial discipline among E&Ps, but it also spurred a boom in upstream consolidation the likes of which we haven’t seen since the turn of the century. As we said in Buy Buy Buy, most of the major deals announced since COVID arrived in early 2020 have involved one big, publicly traded E&P buying another, typically via all-stock transactions — these include ConocoPhillips’s $13.3 billion acquisition of Concho Resources, Chevron’s $13 billion purchase of Noble Energy, Cabot Oil & Gas’s $9.3 billion buy of Cimarex Energy (the combined company is now known as Coterra Energy), and Pioneer Natural Resources’ $7.6 billion acquisition of Parsley Energy. There also were a number of public-buys-private deals, however, exemplified by Pioneer’s agreement to buy DoublePoint Energy for $6.4 billion, as well as many mergers and acquisitions involving smaller producers, which we focused on in Baby I’m-A Want You. A commonality among much of the M&A activity — large, medium or small — has been that it involves assets and acreage in the hottest production areas, namely, the Permian and (to a much lesser extent) the Haynesville and the Marcellus/Utica. For example, Earthstone Energy, a publicly held independent oil and gas producer, has announced five acquisitions totaling more than $1.8 billion since December 2020, all involving acreage and production in the Permian’s Midland Basin. In announcement after announcement, buyers and sellers alike said they were looking to add scale, improve efficiency and boost the cash they return to shareholders.
Which brings us to the focus of today’s blog: the recently announced plan by Centennial Resource Development to combined with Colgate Energy Partners III to create what they say will be the largest pure-play E&P in the Permian’s Delaware Basin. Privately held Colgate, formed in 2015, had been considering an IPO (initial public offering) since late last year but ultimately chose a less-risky path to going public that also will funnel $525 million in cash to the company’s sponsors.
The $7 billion merger of equals announced May 19 values Colgate at about $3.9 billion and calls for the company’s equity holders to receive 269.3 million shares of Centennial stock as well as that $525 million in cash. Centennial also will be assuming Colgate’s $1.4 billion of outstanding debt. Set to close in the second half of this year, the Centennial/Colgate merger will result in a company with about 179,000 net leasehold acres, 40,000 net royalty acres and total current production of about 135,000 barrels of oil equivalent per day (135 Mboe/d), about half of it crude oil and the balance a combination of natural gas and NGLs. Sean Smith, currently Centennial’s CEO, will serve as executive chairman of the combined company (whose new name will be announced later), and Will Hickey and James Walter, currently Colgate’s co-CEOs, will maintain those roles when the companies close on the deal.
We’ll get to management’s rationale for the merger in a moment. First, we’ll look at what each of the E&Ps is bringing to the table. As shown in Figure 1, Centennial (orange areas) and Colgate (blue areas) each have substantial assets in both the Northern Delaware (southeastern New Mexico’s Eddy and Lea counties) and the Southern Delaware (West Texas’s Reeves, Ward and Winkler counties). Centennial’s 74,000 net acres (49,000 in West Texas and 25,000 in New Mexico) currently produce about 65 Mboe/d and Colgate’s 105,000 net acres (75,000 in West Texas and 30,000 in New Mexico) produce about 70 Mboe/d. The companies said during a conference call about the merger that they expect production at the pro forma company to increase to about 145 Mboe/d (from the current 135 Mboe/d) by the fourth quarter of 2022 and that they expect to drill and complete about 140 wells a year and to increase production by another 10% (to about 160 Mboe/d) by the fourth quarter of 2023. The E&Ps noted that the combined company will have more than 15 years of high-quality inventory at the current pace of drilling.
Figure 1. Centennial and Colgate Acreage in the Permian’s Delaware Basin. Sources: Centennial and Colgate
While none of the two companies’ Northern Delaware acreage is contiguous, quite a bit of their Southern Delaware acreage is, and management noted that both Centennial and Colgate have strong track records of acreage enhancement through swaps/trades, bolt-on acquisitions and the like. Particularly so for Colgate. Since its formation seven years ago, the E&P has executed five large acquisitions, more than 100 bolt-on additions, about 40 trades and more than 10 divestitures, primarily with the aim of high-grading and consolidating its holdings.
Each company will bring its own strengths to the combined entity. Centennial’s is operational efficiency, exemplified by its 14-day spud-to-spud stat (orange bar in left box in Figure 2) — spud-to-spud referring to the time between the start of drilling one well with a given rig and the start of drilling the next well with the same rig. (Colgate’s average spud-to-spud duration is about 20 days; blue bar in left box). Colgate, in turn, offers corporate efficiency in the form of much lower general and administrative (G&A) costs per boe: only $0.99/boe in the first quarter of 2022 (blue bar in right box), or less than half Centennial’s per-boe G&A costs in the same period.
Figure 2. Centennial and Colgate’s Spud-to-Spud Duration and G&A Expenses (per boe). Sources: Centennial and Colgate
The companies said that by improving the combined entity’s operational efficiency they expect to reduce its rig count while maintaining its production-growth rate, and that by increasing the scale of their operations they expect there will be more opportunities for the development of field-wide produced-water collection and recycling.
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Based on current strip prices, the Centennial/Colgate combo expects to generate more than $1 billion in free cash flow in 2023. While management declined to specify how much of free cash flow the pro forma E&P might return to shareholders, they said that Centennial’s recently announced $350 million, two-year stock-buyback program could be upsized. (Centennial does not yet pay a dividend, but Colgate earlier this year implemented a $25 million-per-quarter base dividend.) And, as we said in the introduction to today’s blog, the combined Centennial/Colgate will be a stand-out among its peers regarding the portion of shares held by management. As shown by the blue bar to the far left in Figure 3, about 12% –– or nearly one-eighth — of the pro forma E&P’s equity will be held by its executive team. That’s a lot of “skin in the game” –– well above the shares held by management at runners-up Hess Corp. (HES), Antero Resources (AR) and Matador Resources (MTDR), and a dozen times higher than the 1% peer average (dashed red line).
Figure 3. Percent of Pro Forma Equity Owned by Management Team. Sources: Centennial, Colgate, Capital IQ and public filings
The management of Centennial and Colgate indicated that while they are happy with the scale of the combined company, further acquisitions are possible, though there will be a “high bar” for any such deals. In our view, the Permian will likely continue to be a hotbed for corporate consolidation, with smaller players being gobbled up by larger ones; other midsized E&Ps like Centennial and Colgate combining to gain scale; and the region’s giants making deals to optimize their holdings in the all-important play by either adding or divesting acreage and production.
Interested in tracking crude oil and natural gas developments in the Permian? Read RBN’s Crude Oil Permian and NATGAS Permian reports.
“We Go Together” was written by Warren Casey and Jim Jacobs. Sung by John Travolta and Olivia Newton-John, it appears as the fifth song on side four of the double album: Grease: The Original Soundtrack from the Motion Picture. Although the album cover features Travolta and Newton-John, they only sing on seven of the 24 tracks of the LP. Sha Na performs many of the songs, and Stockard Channing sings on two tracks, Frankie Avalon on one, and Frankie Valli and Barry Gibb are featured on the title track.
Grease was recorded in 1977-78 and produced by Louis St. Louis, John Farrar, Barry Gibb, Albhy Galuten and Karl Richardson. Released in April 1978, the album went to #1 on the Billboard 200 Albums chart and has been certified 8x Platinum by the Recording Industry Association of America. Personnel on the record were: Olivia Newton-John, John Travolta, Stockard Channing, Frankie Valli, Barry Gibb, Frankie Avalon (featured vocalists), John Farrar, Tim May, Jay Graydon, Lee Ritenour, Dan Sawyer, Bob Rose, Dennis Budimir, Tommy Tedesco, Cliff Morris, Joey Murcia, Peter Frampton, George Terry (guitar), Mike Porcaro, David Hungate, Max Bennett, David Allen Ryan, William J. Bodine, Dean Cortez, Harold Cowart (bass), Louis St. Louis, Greg Mathieson, Michael Lang, Lincoln Mayorga, Thomas Garvin, Ben Lanzarone, George Bitzer (keyboards), Ollie E. Brown, Carlos Vega, Cubby O'Brien Ron Ziegler (drums), Ray Pizzi, Ernie Watts, Jerome Richardson (sax), Albert Aarons, Robert Bryant (trumpet), Lloyd Ulyate (trombone), Eddie "Bongo_ Brown, Larry Bunker, Victor Feldman, Antoine Dearborn (percussion), Dorothy Remsen, Gayle Levant (harp), and 29 backing vocalists.
Six singles were released from the LP, including the Billboard Hot 100 #1 hit singles “Grease” and “You're the One That I Want.”
Olivia Newton-John is a British-born Australian singer, songwriter, actress and entrepreneur. She has released 26 studio albums, six live albums, six soundtrack albums, 14 compilation albums and 70 singles. Newton-John has appeared in 15 motion pictures and 25 television shows. Due to health issues, she is semi-retired now.
John Travolta is an American actor and singer. He has appeared on 11 studio albums and released 30 singles. He has starred in 66 motion pictures and appeared in 16 television shows. Following the death of his wife, Kelly Preston, in July 2020, Travolta has stated that he is putting his career on hold for a while.
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