TTFNF - APA Corporation Buys Callon Petroleum: Joining Domestic Energy Consolidation

2024-01-04 15:27:47 ET

Summary

• APA Corporation has reached a $4.5 billion deal to acquire Callon Petroleum Company in an all-stock transaction.
• The deal will provide scale and balance in the Permian Basin and add 102,000 barrels of oil equivalent per day to APA's production.
• Shares of APA Corp. currently are down 7% as investors are cautious about the stock component of the deal, which really feels like an overreaction.

In March of last year, I outlined some thoughts on APA Corporation (APA) (to many investors still known as Apache) as the business was heading into 2023. The company saw peak profits in 2022 come under pressure amidst lower oil prices, as those profits were used to reduce debt, although APA committed itself to shareholder payouts in the form of share buybacks and dividends.

On top of the commodity price exposure, like any oil business, Apache had a few production wildcards in the pipeline as well. Later in 2023, consolidation efforts were taking place across the North American oil and gas production sector, involving many majors. As 2024 starts, APA itself is starting to play a role in this consolidation.

Adding Callon

APA has reached a $4.5 billion deal to acquire Callon Petroleum Company (CPE), a much-rumored acquisition target, in an all-stock transaction under which investors in Callon are set to receive 1.0425 shares in APA for every share they own in Callon.

The deal is set to provide scale and balance in the Permian, in which both firms are active, on top of Callon's strength in the Delaware Basin and APA's focus on the Midland Basin. This overlap is clearly seen in the projected synergies, as overhead, operating, and cost-of-capital synergies are pegged at $150 million per annum.

Following the deal, APA will issue about 70 million shares to investors in Callon, combined giving them a 19% ownership stake in APA, while APA will refinance the $2 billion in loans of Callon (at lower rates). The 19% ownership stake in APA is a bit misleading, as the enterprise value of Callon to the pro forma business comes in at 21%, as it carries relatively more leverage.

The deal will add about 102,000 barrels of oil equivalent per day to the APA, of which 57% is in the form of oil, with 145,000 net acres added, most of these in the Delaware Basin. This contribution looks pretty solid, as APA will furthermore grow production assets relative to non-production assets and growth production at home in the U.S. Moreover, synergies look quite substantial, all of which are clear positives.

The Market Does Not Like It

Shares of Apache are down about 6% in response to the news, as this move has reduced the value of the company (including the to be issued shares) by around three-quarters of a billion dollars. This is quite a big decline in response to a $4.5 billion deal, moreover, given the anticipated synergies which are substantial, many of which look to be attainable with a large degree of confidence as well.

For investors in Callon, this looks to be the end of their investment as a standalone entity. Shares of Callon have been trading public since the 1990s, having delivered very mixed and modest returns for investors over this period of time.

That mixed performance has also been seen by investors in APA, to a lesser degree, after its shares traded in the low single-digits in the 1980s. Shares broke the $100 mark in 2008, and re-tested these levels in 2014 amidst the peak of the U.S. shale revolution.

Shares were down to $30 ahead of the pandemic, and fell to single digits during the pandemic (when the world was introduced to negative oil prices), after which shares traded between $30 and $50 per share in the last two years.

On Apache

After a disastrous 2020, APA showed a meaningful recovery as product revenues recovered to $8.0 billion in 2021, with operating profits reported around $1.9 billion, all while net debt came down to $7.1 billion. Following the outbreak of the war between Russia and Ukraine, the company started 2022 on a very strong note as energy prices sharply rose higher.

In fact, first-quarter profits for the year 2022 topped a billion dollars, running at a run rate in excess of $10 per share, aided by oil prices trading around the $100 per barrel mark, rapidly deleveraging the balance sheet. After another strong second quarter, net profits fell below the half-a-billion mark in the third and fourth quarters of 2022.

With capital spending originally seen at $2.0-$2.1 billion in 2023, net capital investments were seen exceeding depreciation charges by as much as $800 million, although this could grow production by close to 5%. With shares trading at $40 in March of last year, I believed that a prevailing earnings run rate of around $5 per share might fall to $3 per share based on the recent oil price (CL1:COM) developments. Given that net capital spending requirements came in around $2 per share, that did not bode well for free cash flows.

That said, debt was low and most of the maturity was only due in 2037, there were some wild cards, including the company's assets in Suriname and Alpine High, being real wildcards to the upside.

Trading Flattish

Since March of last year, shares have been trading in a $30-$45 range, trading in the middle of this range ahead of the announcement of the Callon deal. Through the first three quarters of 2023, the company has seen relatively solid profit performance. This is certainly the case, as oil prices traded at relatively low levels during 2023.

Net earnings of $1.08 billion, as reported for the first nine months of the year, came in at $3.50 per share based on a reduced share count. With earnings power of $4.50-5.00 per share being stronger than originally anticipated, in a relatively lower price environment, that performance looked relatively good, certainly as net debt was pretty flat at $5.5 billion as of the third quarter.

On top of the stronger operating performance, the company announced that it would work together with TotalEnergies (TTE) in order to proceed with FEED work for 200,000 barrels of oil-equivalent per day FPSO in Suriname. Both companies believe that reserves for the relevant fields could total as much as 700 million barrels, providing a huge resource base for the future.

And Now?

The reality is that I have some mixed thoughts on the deal. The $4.5 billion deal for Callon Petroleum Company has some real advantages, bringing relatively a lot of production and bringing production at home, as synergies moreover are substantial and could justify a great deal of the purchase price.

On the other hand, it is the stock component that gives Callon's investors a near fifth stake in the business. This means that APA is sharing in the upside of the Alpine and Suriname assets, which likely are among the reasons why investors are acting a bit cautious in a knee-jerk reaction. That said, investors were not willing to attach great value to these on a standalone basis, and the overall appeal seems to have improved a bit following the deal announcement, making me inclined to get involved with APA Corporation shares here.

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