Could Exxon-XTO deal be a precursor?

Jason Reimbold
The Rodman Energy Group

ExxonMobil's $41 billion acquisition of the shale-heavy XTO Energy could be a game-changing event for M&A in the coming year. It certainly has fueled speculation in the analyst and investment community.

The largest deal since Chevron acquired Texaco for $44.8 billion in 2000 is notable for more than its immense size. The mega acquisition could set two precedents for future transactions. First, the deal demonstrates a willingness to allocate value for upside, which is something we haven't seen in a while. Second, it helps validate the value of the resource plays that could lead to a frenzy of acquisition activity if other super majors decide they want in on the resource play action. However, is this one deal enough to accelerate the entry of other super majors into the resource plays?

For years, the super majors have been chasing bigger prizes around the world and largely leaving US reserves for the independents. This has enabled companies like XTO, Chesapeake, Southwestern, and Range Resources to thrive in the domestic E&P space.

These firms were happy to exploit the "left-over" reserves in the US as the super majors focused their efforts in the international arena. As the independents began to transform into much larger companies, a number of them began to expand internationally alongside the super majors. However, many continued to focus on development of domestic reserves, and it paid off—their efforts helped make unconventional resources work.

The shale plays are not new; we've been producing out of the Barnett for quite a while, but higher commodity prices and technological advances have made unconventional resources much more attractive in recent years. As a result, we witnessed a bit of role reversal as the super majors were absent in the shale plays while the independents figured out how to improve the economics. But it appears unconventional reserves have finally gotten their attention. Still, the super majors missed the land grab, and now, they will have to buy their way into the shales.

The acquisition of XTO is not the first entry of a super major into a resource play. They have tested the waters recently through JVs, but the Exxon-XTO transaction is the first time a super major has jumped in with both feet.

One hurdle the super majors have faced getting into the resource plays is the difference in how their companies are valued compared to the independents. Super majors are valued on earnings, and independents are valued on assets and cash flow. Thus, it has been challenging for a super major to allocate sufficient value for upside potential, and of course, there was no reason for an independent to sell without consideration for upside.

All the same, the XTO acquisition suggests a value for the resource play potential. Certainly there are several ways to calculate a metric for the transaction. Some analysts have suggested a benchmark of $2.22 paid per proved Mcfe and $10,456 paid per flowing Mcfe when adjusted for non-proved reserve value. However, this "non-proved" estimate is a bit of a black box—it's difficult to define, and different analysts will have different estimates. Therefore, if we disregard the adjustment, we arrive at a valuation of $2.96 per proved Mcfe and $13,900 per flowing Mcfe.

Obviously, there are arguments for both estimates, but nevertheless, we determine that the range is between current market value to what could be a meaningful premium (allocation for upside). Ultimately, the impact of this deal should help support the valuation of many public independents that have significant shale exposure.

Bottom line: The world's largest publicly traded company has made a tremendous entry into US resource plays through the acquisition of XTO, and it will probably increase the chances of additional deals. Furthermore, we could witness a trickle-down effect in increased M&A activity if large to mid-cap E&Ps begin acquiring the smaller caps in anticipation of selling themselves to one of the super majors. In any case, the M&A market starts the New Year at a dead sprint.

About the author

Jason Reimbold is a vice president in the Houston office of The Rodman Energy Group where his focus is on A&D advisory. Rodman & Renshaw LLC (Member FINRA, SIPC) is a full-service investment bank with offices in New York, Houston, and Calgary. He can be reached at [email protected].

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