Activist Insight Vulnerability Report | June 28, 2021
A deal made in hell
This article was first published on Activist Insight Vulnerability on June 28, 2021. For more information about the module, click here.
The announced merger between Cabot Oil & Gas and Cimarex Energy has been received poorly by analysts and shareholders, exposing both companies to shareholder activism.
Cabot Oil sits in the 95th percentile of companies most likely to face activism over the next nine months, while Cimarex is much better positioned in the 53rd percentile, according to Activist Insight Vulnerability. Indeed, since the deal was announced on May 25, Cabot Oil shares are down 7.5%, while Cimarex’s have fallen 1.1%. The S&P Oil & Gas Exploration & Production Index is up nearly 12% over the same period.
No shareholder has expressed any concerns publicly as of yet. However, industry sources have told Activist Insight Vulnerability there is high discontent with the deal, primarily in the Cimarex camp as many shareholders view the current terms as unfair. The transaction values Cimarex lower than Cabot and investors that bought Cimarex because of its exposure to oil prices feel the deal “pulls the rug from underneath shareholders,” because Cabot is mostly a gas company, a person familiar with the matter, who declined to be named, said.
A shareholder vote on the deal is not expected until late August, giving plenty of time to potential activists to see how things evolve, including whether alternative deals are advanced for either company. Activist Insight Vulnerability understands that Cabot and Cimarex will file their S-4 Form by the end of June and this might give more information to a potential activist, including whether there were alternative offers on the table or issues with the process. The S-4 form filed with the Securities and Exchange Commission typically contains details about the terms, risk factors, and background to the merger.
In recent years, mergers in the embattled U.S. oil and gas sector have taken place between companies that drill in the same regions. This typically leads to economies of scale, lower capital expenditures, and improved profitability. There have been plenty of these types of deals over the past few years, including the all-stock merger between Devon Energy and WPX Energy, and ConocoPhillips’ buyout of Concho Resources. Even the merger between Occidental Petroleum and Anadarko, which was lambasted by Carl Icahn, promised lots of synergies.
The merger between Cabot and Cimarex is nothing like that. The companies operate in different regions (Cimarex in the Permian basin in the south, and Cabot in Marcellus basin in the north) and markets, and the promised annual synergies of $100 million annually are too small to be attractive for shareholders. Similarly sized deals, like Devon-WPX, have generated between three and five times more synergies.
As a result, most analysts are scratching their heads, with some calling the combination “surprising” and reckoning that it might be voted down by shareholders.
Raymond James analysts said in a note that they are “struggling to understand the rationale of the deal” given that Cimarex has a “heavily discounted valuation and was capable of delivering similar cash returns on a standalone basis.” Wolfe Research analysts questioned the lack of “strategic overlap and lack of premium for Cimarex.”
The combined company will generate 75% of its revenues from natural gas. With the rise in oil prices, Cimarex shareholders could be deprived of a potential boon, especially as many invested because of their bullish view on oil prices. The deal also values Cimarex at a lower enterprise value-to-Ebitda multiple. According to Goldman Sachs, Cimarex trades at a 2023-estimated enterprise value to Ebitda multiple of 3.5, and Cabot at 6.3. “The transaction is expected to be accretive on free cash flow to Cabot shareholders, but on our estimates will be dilutive … for Cimarex shareholders on 2021/22/23 free cash flow,” analyst Neil Mehta said in a May 24 note.
To gain shareholders’ blessing, management is likely to trumpet some of the immediate benefits of the deal. The combined company will have a fixed plus variable dividend structure, similar to other deals like Pioneer Natural Resources and Devon Energy which were cherished by investors. This means that the variable part of the dividend is linked to the company’s free cash flow in a given period, which largely depends on oil prices.
Management is asking shareholders to look through the “noise” and focus on the long-term benefits of the deal. The asset diversification of the combined company is expected to lower the risk of free cash flow generation, particularly through the commodity cycle, according to management.
“Unlike other big consolidating deals, this one will need more time to prove it was a good deal for both sides,” Wolfe Research analysts said in a note shortly after the deal was announced.
However, given the secular headwinds from the energy transition, investors might not be willing to wait.
Opposition to deals has been picking up over the past 12 months, as uncertainty stemming from the COVID-19 pandemic has made activists wary about the terms of transactions. According to Activist Insight Onlinedata, 32 companies have seen deals opposed by activists so far in 2021, outpacing campaigns favoring deals for the first time since records began in 2013.
Activism in the energy sector has also picked up slightly this year, partly thanks to rising oil prices. So far this year, 10 U.S. energy companies have been targeted by activists, versus three during the same period last year and 18 in 2019. Among the notable campaigns this year are Engine No. 1’s successful proxy contest at Exxon Mobil and Glazer Capital’s unsuccessful opposition to the sale of QEP Resources to Diamondback Energy.
DISCLAIMER: Activist Insight Vulnerability reports use proprietary data, along with third-party analyst reports and, in certain cases, interviews with industry sources to identify companies that might become activist targets. They represent an analytical attempt at predicting companies that may be engaged by an activist from a wide range of possible targets and are in no way intended to indicate that a speculated event is imminent or will take place. Insightia does not provide investment advice or accept responsibility for the result of trades based on Activist Insight Vulnerability reports or descriptions of Activist Insight Vulnerability reports by third-party media.