[Editor's note: A version of this story appears in the May 2018 edition of Oil and Gas Investor. Subscribe to the magazine here.]
In early 1999, eBay Inc.’s securities filings included typical risk factors—taxes, regulation—and a slightly more peculiar one: its dependence on the craze for plush stuffed animals called Beanie Babies.
In fourth-quarter 1998, about 7% of all EBay’s auction listings involved selling toys such as Stripes the Dark Tiger for $250—25 times its original value.
The question of value is of critical interest, particularly since Stripes is now essentially worthless, as Zac Bissonnette noted in his book, “The Great Beanie Baby Bubble.”
Permian Basin crude producers, by contrast, are neither whimsical nor cuddly. But their value—and that of their production—rests partly on market trends and perception.
At the end of March, Concho Resources Inc. (NYSE: CXO) gave us a look at what two would be worth. The company used its premium market value to acquire RSP Permian Inc. (NYSE: RSPP) in an all-stock merger worth $9.5 billion. Concho will add RSP’s 92,000-net acre position, which includes assets widely regarded as among the finest in the Permian Basin.
Typically unflappable analysts were agog at the corporate M&A, with initial reactions declaring “consolidation takes off” and “game on.”
The Permian, however, is an unpredictable, unwieldy place.
Despite investors consistently talking up “the merits of consolidation within a highly fragmented business,” Concho’s stock slid by about 8% following the March 28 merger announcement, David Kistler, senior analyst at Piper Jaffray & Co., said in a report. Nearly two weeks later, the stock was down 15%.
One factor: Concho sees $2 billion in corporate and operating synergies coming out of the deal, but the details are still somewhat murky.
Andy McConn, research analyst at Wood Mackenzie, said that those efficiencies are key for Concho.
“Realizing efficiencies to the extent that Concho estimates will be challenging” since both companies already run lean and efficient operations, he said in an email to Investor.
Concho also paid a lot for RSP. The deal puts a 29% premium on RSP’s stock, representing a leasehold value somewhere between $72,000 and $79,000 per acre, according to analyst estimates.
Despite its reputation, the Permian isn’t universally expensive. The mean acreage price since October is about $28,500, according to Raymond James. RSP itself bought acreage in the Delaware Basin in 2016 for roughly $47,000 per acre while next door Lilis Energy Inc. paid $11,000 per acre at roughly the same time.
As the economist Alfred Marshall wrote in 1890, “Value is relative, and expresses the relation between two things at a particular place and time.”
Concho’s own premium value created an opportunity that may be, for the short term, a one-off deal.
“The high market ratings of Permian pure plays are perhaps the main factor that has prevented corporate consolidation in the past,” McConn said. RSP cost Concho about 35% of its $26 billion enterprise value, said Richard Tullis, an analyst at Capital One Securities.
McConn is skeptical a rash of large-scale deals will take place. They could be a hard sell for investors in the face of rich valuations, anxious investors and the need of E&Ps to further demonstrate operational power.
“If this deal is to mark a second wave of ‘Permania’ in the oil M&A market, potential acquirers will have to be firmly confident in the Permian’s long-term potential,” he said.
Permian fantasy league M&A often involves picking up companies such as Lilis Energy Inc. (AMEX: LLEX), Halcón Resources Corp. (NYSE: HK) and Abraxas Petroleum Corp. (NASDAQ: AXAS). The least expensive, Lilis, is valued at about $210 million. Seaport Global Securities analysts argue Lilis gets short shrift despite peer-leading well results. The company’s value suggests its position is worth $12,000 per acre compared to competitors’ $32,000 per acre. A sale could double Lilis’ market cap.
Major oil companies may also lack interest. In an April report, Guy Baber, a Piper Jaffray analyst, said ExxonMobil Corp.’s (NYSE: XOM) footprint is already formidable; Chevron Corp. (NYSE: CVX) is high-grading through trades with 40 swaps in 2017; and Royal Dutch Shell Plc (NYSE: RDS.A) views U.S. unconventional as a growth-driver after 2020.
If Beanie Babies are a good cautionary tale for hype—some families went bankrupt collecting them—the underlying question is, how value is determined. Marshall, the economist, asked his students “Why does an egg cost more than a cup of tea?”
“It may be a small question,” the economist Joan Robinson wrote, “but it is a very difficult and complicated one.”
Darren Barbee can be reached at email@example.com.
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