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Essential Energy Insights - May 14, 2020

Parsley Energy's justification for Jagged Peak merger ignored by investors

Parsley Energy Inc.'s executives believe that the company's $2.27 billion all-stock acquisition of Jagged Peak Energy Inc. will make the combined company a "preeminent" Permian Basin producer, but cost-conscious investors have hammered its stock since the deal was announced the morning of Oct. 14.

Austin-based Parsley and Jagged Peak have been neighbors in the Permian's Delaware Basin for a number of years, something CEO Matt Gallagher said made the deal attractive for his company. Upon the closing of the deal in the first quarter of 2020, Parsley will have about 267,000 net acres in the Permian, including 120,000 "highly contiguous" acres in the Delaware.

"Being in our backyard, we have been intimate with these assets for a number of years," Gallagher said during an Oct. 14 conference call. "We've turned it into a true Delaware franchise."

Parsley's CEO said the acquisition of Jagged Peak would not only expand the company's presence in the Permian but would increase its free cash flow. Gallagher said the new asset base would start generating free cash flow immediately, and the combined company would operate with the assumption that West Texas Intermediate crude oil prices would average $50 per barrel in 2020.

"This large asset base will assist our free cash flow profile and … a large portion of that will be going back to our shareholders," Gallagher said. "We will be deploying our projects to increase and enhance our free cash flow through 2020 and beyond."

Gallagher said Parsley's familiarity with Jagged Peak's assets would allow newly acquired holdings to be "competitive out of the gate" when it comes to obtaining capital for exploration and production. Parsley's CEO said there would be a "significant reduction" from the combined capital expenditures for 2019 of $1.6 billion when the two merge in 2020, adding that the combined rig count would drop from 16 to 15. Still, Gallagher said, the expanded version of Parsley would be capable of expanding both production and free cash flow.

"It really is a preeminent position," Gallagher said. "Plenty of scale."

Investors, who have responded to virtually every acquisition in the upstream oil and gas sector over the past two years with a selloff, stayed true to form despite Gallagher's promises. Shares of Parsley were down more than 10% to $15.18 per share on the New York Stock Exchange at the Oct. 14 market close. That was an improvement from the immediate reaction to the deal, which led to the stock bottoming out at $14.62 per share.

Jagged Peak shares did not benefit from the news of the deal either. Shares fell from $6.78 per share at the open of the NYSE to a low of $6.40 per share before recovering to $6.72 a the Oct. 14 close.