Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

It takes guts to be a buyer in the oil market these days.

Take Devon Energy. The $14 billion oil and gas explorer said Monday that it's paying $2.5 billion for Felix Energy's drilling rights in a shale region of Oklahoma and assets in the Powder River Basin in Wyoming. The properties are attractive enough and will help Devon continue its shift toward producing higher-margin oil and natural gas liquids. But these days, it's hard to convince investors that even the most sensible oil and gas deals are a good idea. So Devon's stock slumped 10 percent Monday, and fell another 4 percent early on Tuesday.

Downward Bound
Investors punished Devon for its dealmaking with the biggest drop since the financial crisis.
Source: Bloomberg

Devon's experience isn't an isolated incident: For the biggest exploration and production takeovers of 2015, acquirers' shares have dropped about 90 percent of the time on the day the deals were announced, according to data compiled by Bloomberg. While that's not totally unusual, the extent of the declines is noteworthy. Devon's slump was the biggest since 2008. WPX Energy initially rose after announcing it would acquire closely held RKI Exploration & Production for $2.75 billion in July, but then tumbled 18 percent over the next three days as it sweetened the terms on its bonds to finance the deal and cut the size of the offering. 

The rout in oil has investors on edge, and the last thing they want is for companies to be adding more debt, even if it's for a good cause. Even all-stock purchases, such as Noble Energy's takeover of Rosetta Resources, have gotten a cool reception. The biggest and most financially stable energy companies aren't getting a lot of love for dealmaking, either. Royal Dutch Shell -- whose $79 billion takeover of BG Group was dubbed possibly ``strategically brilliant'' by Matthew Beesley of Henderson Global Investors -- dropped on the day it announced the deal and has kept falling.

There are a variety of reasons to explain why investors may not have liked one deal or another, but the numbers paint a picture of a market that's generally not interested in rewarding acquisitions.

Biding Time
Exploration & production companies have announced the fewest takeovers in at least 12 years.
Source: Bloomberg

For one, after OPEC did nothing to support prices last week, crude's bottom could still be a while off. West Texas Intermediate and Brent crude both traded below $40 a barrel, and if prices continues to plunge, the logic of buying more production capacity could start to look suspect for some of these companies.

A continued slide in prices also means sellers will get more desperate -- and assets will get cheaper. Oil companies are due for another round of borrowing base redeterminations this spring and the outlook isn't great. There's not much incentive for a buyer to make a bid ahead of that. Which is why Devon's decision to strike a deal on Monday is so unusual.

Devon is valuing the shale and Powder River assets at about 17 times Ebitda on a combined basis -- versus its own valuation of about 8.4 times projected 2016 profit, according to Phillips Johnston of Capital One. Not only is the company paying a high price tag, it's taking on debt and issuing stock to cover the cost. As a result, Standard & Poor's put Devon's debt under review for a downgrade.    

Devon is planning on raising as much as $3 billion from asset sales of its own to help strengthen its financial position. But planning is the key word there. There are a lot of assets for sale as oil companies try to raise funds to stay afloat and prices aren't what they used to be.

The deal wasn't the only one Devon was involved with on Monday. EnLink Midstream -- which is controlled by Devon -- also agreed to acquire the gathering pipelines and natural gas processing plants associated with the Felix acreage in Oklahoma. Moody's called the price high for assets that may not carry as much oil and gas as expected, prompting the ratings agency to consider cutting EnLink Midstream Partners' debt to junk.

In the long run, these transactions may pay off. For now, they're not winning fans among investors. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net