Exxon/Pioneer: rising interest rates and nervous investors force shale consolidation

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Who will fund innovation in energy exploration and production? It’s a legitimate question this week after ExxonMobil confirmed its all-share acquisition of Pioneer Natural Resources. The transaction’s enterprise value totals $64.5 billion, representing a premium of 18%.

Pioneer (and other independent campers), best known for its acreage in Texas’ oil-rich Permian Basin, perfected the “fracking” technology to extract oil and natural gas in the United States. Cash flow never quite lived up to the hype. But fracking did make the country a leading global producer and exporter of fossil fuels.

Restless shareholders and rising interest rates have pushed shale drillers like Pioneer out of favor. ExxonMobil said its unique integrated model of oil extraction and refining gives it the scale to compress costs.

Pioneer and its exploration peers have cut capital spending in recent years, using cash flow to pay dividends and buybacks. Still, Wall Street analysts estimate that operating cash flow is expected to be $9 billion in 2024, half of which will be spent on capital expenditures. Exxon Mobil’s ratio should be below 40%.

Even though Pioneer has promised shareholders 75% post-capex cash flow, the stock price remains cheap. The acquisition price represents only 12 times the expected price-to-earnings ratio of Pioneer’s stock, which is at a relatively low historical level.

ExxonMobil will also be paying 12 times the price of its own stock, which is trading at 12 times. Its bonds maturing in 2030 trade at a yield of just over 5%. But considering the company’s A rating and only $40 billion in existing debt, using equity rather than cash makes a lot of sense.

ExxonMobil has calculated that giving up more than a tenth of its outstanding shares is worth it. This allows it to collect significant real estate in the Permian Basin, associated cash flow and an estimated $2 billion in annual synergies. Most will come from “improved resource recycling.”

It boasts of its ability to extract resources from the ground cheaply rather than any exploration revolution. Investors should approve.