Devon swoops on shale rival WPX, but will limit US oil, gas output growth

London — Merger partners Devon Energy and WPX Energy said Sept. 28 their combined company can better restrain oil and gas output growth in a low-price environment than either could separately.

The all-stock transaction announced Sept. 28, which values WPX at $2.56 billion, promises significant cost savings from reduced operational expenses, including job cuts, thanks to complementary though not necessarily overlapping footprints.

Devon and WPX are predominantly focused on the Permian Basin in Texas and New Mexico. They are also stretched across Oklahoma's Anadarko Basin, North Dakota's Williston Basin, South Texas' Eagle Ford Shale and Wyoming's Powder River Basin. But instead of looking for substantial growth opportunities, as with most mergers, they plan to actively limit growth. Their ceiling is 5%, with a bias to the status quo if US crude prices remain near current levels.

"We are absolutely going to prioritize the growth of free cash flow over adding incremental drilling projects," WPX CEO Richard Muncrief, who will head the combined company, said during an investor conference call. "By prioritizing free cash flow growth, we are establishing a much needed margin of safety should price volatility continue, and this discipline provides us with an avenue to accelerate cash to shareholders."

The new company, which will be called Devon and will be based in Oklahoma City, Oklahoma, will not even consider adding select high-return growth projects until, among other things, there is a high degree of certainty that $45/b WTI or higher is sustainable. WTI was trading at around $40/b Sept. 28.

In a memo to WPX staff that warned of likely job cuts as the combination is completed, Muncrief said lower for longer was the expectation for commodity prices, adding that the takeover by Devon was about "finding our place in a new era."

The deal, expected to be completed in the first quarter of 2021, will create one of the largest US unconventional oil producers, with 277,000 b/d of output. Their combined 400,000 net acres in the Permian's Delaware Basin will account for 60% of their total oil production. Associated gas production, particularly in the Permian, will continue to be part of the market equation.

On their own over the last few years, both companies have been trying to overhaul their portfolios to reduce costs and leverage better returns from their remaining assets. Devon has been especially aggressive, significantly downsizing its gas drilling operations by selling its acreage in North Texas' Barnett shale. WPX began bringing shut-in production back online in June as prices started recovering.

Those efforts have led to uneven financial results, with investors pushing shares of Devon and WPX lower in recent months. The steep drop in demand earlier this year due to the coronavirus exacerbated the situation and added pressure on independent producers to consolidate. Shares of both companies surged after the deal was announced.

PRODUCTION OUTLOOK

The new Devon should be able to keep production flat in 2021 with capital spending of $1.7 billion, achievable at WTI crude prices of $33/b and Henry Hub has prices of $2.75/MMBtu, according to a company presentation about the merger.

WPX shareholders will receive 0.5165 shares of Devon common stock for each share of WPX common stock they own at the time of closing.

The $2.56 billion price tag amounts to a 2.8% premium to WPX's market cap at close on the last trading day before the announcement. The companies estimate a combined enterprise value, a measure that also includes net debt, of approximately $12 billion. Devon CEO David Hager will become executive chairman of the combined company.

"At first glance, Devon's free-cash flow focus improves modestly while gaining scale, and WPX's Permian diversifies away from federal lands," Cowen & Co. said in a note to clients.

CLOSING CONDITIONS

The transaction is subject to certain conditions, with closing targeted for the first quarter of 2021. According to Cowen, that may be complicated by shareholder approvals on both sides, given the similar market caps and the small premium for WPX.

A Devon combination with Cimarex Energy "might have made more sense" given the large acreage overlap in the Mid-Continent region, Cowen said.

Funds managed by EnCap Investments, which own approximately 27% of the outstanding shares of WPX, have agreed to vote in favor of the transaction, Devon said.

Asked during the investor call whether there were better acquisition targets for Devon or better suitors for WPX, executives for both companies said they believe this deal is the best solution for them in the current market environment.

"A lot of times, egos could get in the way or that sort of thing," Muncrief said. "We were able to sit down and work out a solution with not only between Dave and I but our management teams as well. So, I think that's what makes this deal unique, and I think it's also what's prevented a lot of deals in the past from being able to get across the line."