Reports of a potential acquisition of Concho Resources Inc. by ConocoPhillips spurred industry observer interest on Oct. 14, with Concho's stock jumping more than 13% and analysts seeing positives for both sides.
According to a report from Bloomberg News, Conoco is in talks with Concho about a potential deal but it could take several weeks to conclude. That was enough for analysts to start a discussion of the merits of a potential deal, with Stifel calling the potential transaction a "strength-on-strength merger."
"[ConocoPhillips] has been quite vocal about its desire to pursue M&A and [Concho's] position would address [Conoco's] reinvestment risk overhang," the firm said. "We would view the transaction as a strength-on-strength merger with the pro forma company resulting in a best-of-breed diversified Bellwether."
Stifel said a merger between Conoco and Concho was one of the few that makes sense in all aspects, adding that there may be "a degree of admiration between the two companies."
Considering Concho's lack of depth and its position in the Permian Basin, its interest in a potential merger could be considered a bit of a surprise. But that position also includes a considerable amount of acreage on federal lands, which could become off-limits to drilling in a Biden administration.
"They could see it as a get-out-of-jail free card," Morningstar analyst David Meats said, noting that some of the company's best acreage could be in jeopardy if a drilling ban on federal land were to be implemented. Meats said that Concho's interest in making a deal could be even more basic than that and could come down to a simple lack of faith in oil prices rebounding.
"If management has lost confidence in higher prices, and cannot see the market giving more credit after this multi-year sell-off, then exchanging undervalued [Concho] shares for undervalued [ConocoPhillips] shares that have less company specific risk could make sense," Meats said.
Siebert Williams Shank & Co. LLC Managing Director of Equity Research Gabriele Sorbara has been of the opinion that M&A activity in the upstream oil and gas sector will be limited due to the large debt burdens held by otherwise appealing targets, but he said a Conoco-Concho deal is one of the few that fits.
"It's a reasonable deal. From the aspect of combining a company with high cash flow and less leverage [in Concho], it becomes highly accretive [for ConocoPhillips]," he said. "The list isn't very long of who can be approached if you want a bigger Permian footprint [without heavy debt]. I like it; I think it will be applauded by investors."
Speculation surrounding the possible discussion between the two companies is that any deal will likely be an all-stock transaction. Sorbara said that, while most mergers in the present environment would come with little to no premium, Conoco may have to pay a premium of 10% or more to obtain Concho. With Conoco's stock up 1% at midday Oct. 14, Sorbara said it appeared investors were comfortable with that kind of deal.
"The market is willing to deal with a 10% premium. It'll be a good deal," he said. "[Concho] needs a good 10%-plus premium, and you're seeing that in the market today."