(Reuters) – The latest business combination in the U.S. shale patch is signaling a path forward for the troubled sector.
In contrast to the bankruptcies of the past three months, Devon Energy DVN.N’s $2.56 billion all-stock, low premium deal for rival WPX Energy WPX.N brings together two companies with assets in a few oil-producing basins and relatively low debt levels.
Investors supported the idea with a rally in shares. WPX closed up 16.4% on Monday and Devon gained 11%, buoyed by the prospect of a combined company that analysts believe would be better positioned to pay dividends and reduce debt.
Shale has been hammered by the COVID-19 pandemic that has slashed global demand for oil and investors have shunned the sector’s poor returns.
“This deal represents the form of shale company consolidation that many across the industry have been looking for,” said Andrew Dittmar, a mergers and acquisitions analyst at Enverus.
He cited the complementary acreage in the top U.S. shale field, the all-stock swap and the little-to-no premium paid. The selling point for investors, he added, is that the combined company will have added scale and efficiencies to generate free cash flow for its investors at current low oil prices.
It is the second big shale deal with a similar profile. Chevron CVX.N earlier agreed to buy Noble Energy NBL.O for $13 billion including debt, in a low-premium, all-stock deal. Noble investors are due to vote on the offer on Friday.
Devon and WPX have similar profiles with substantial operations in the Permian Basin shale field in West Texas and southern New Mexico. The two have also been hit hard by the oil-price plunge.
The need for shale consolidation is clear. Whiting Petroleum Corp WLL.N recently emerged from Chapter 11 bankruptcy with less debt, while Oasis Petroleum Inc OAS.O entered into a grace period after failing to make interest payments on some bonds.
Devon-WPX combined will have a net debt-to-EBITDA ratio of 1.6 on a trailing 12-month basis, much lower than the 2.92 average of companies in the S&P 500 Energy index .SPNY, according to Refinitiv Eikon data.
The deal also signals that companies with higher debt-to-equity ratios could be left out in the cold as shale producers consolidate.
“It potentially leaves some over-levered companies without dance partners”, said Dan Pickering, founder and chief investment officer at asset manager Pickering Energy Partners.
“You certainly aren’t going to pay up to get riskier.”
Devon and WPX have committed to limiting future investments to 70% to 80% of operating cash flow and volume growth to a maximum of 5%.
“Shale didn’t work because folks threw too much money at it to grow too quickly,” Pickering said. “It feels like we now have the play book.”