After debt reductions and shareholder returns, energy companies are increasingly focusing on inorganic growth. The sector has started seeing an uptick in merger and acquisition activities of late. Canadian mid-cap energy producer Baytex Energy (TSX: BTE) announced its plans to acquire Ranger Oil (NASDAQ: ROCC) in February.
The total transaction value is US$2.5 billion, assuming debt and is expected to close in the current quarter. Ranger shareholders will receive 7.49 BTE shares along with US$13.3 in cash, valuing it for a total of US$44.36 apiece.
While Ranger Oil stock saw a surge after the announcement, Baytex has been trading subdued for a while now. It has lost 15% in the last 12 months but has returned a massive 2,000% since the pandemic.
Let’s see how the deal could benefit Baytex.
Baytex Energy-Ranger Oil acquisition: The positives
Baytex already has its presence in the U.S. Eagle Ford and pumps out almost 30% of its total oil production. Its expansion with Ranger increases the scale and offers proximity to the U.S. Gulf Coast. Baytex’s total production is expected to increase from 85,000 barrels now to close to 150,000 barrels of oil equivalent per day. A large portion of this will be light oil, which trades at a premium to West Texas Intermediate.
Moreover, the company’s free cash flows are expected to increase by 20% due to the acquisition. With the combination of Ranger, Baytex now expects to generate free cash flows of $3.6 billion through 2026, which would have been $1.9 billion had it been a standalone company.
Baytex Energy’s improved scale and asset quality will likely play well for its operational and financial growth. Higher light oil production should improve margins. The management expects its company-wide breakeven to improve, which should boost its operating netback.
However, there are some questions about the potential union.
The other side of the acquisition
First of all, the Baytex chair mentioned during the fourth-quarter (Q4) 2022 earnings call that debt repayment remains the company’s priority as against any inorganic growth opportunities. So, the acquisition in just a few months that increases the total debt raises questions about the company’s direction.
The acquisition is expected to increase its total debt beyond $2.6 billion. Even if the leverage ratio is expected to fall around one times later this year, it is still higher than the industry average of around 0.5. Baytex aims to allocate 50% of its free cash to debt repayments once the transaction is complete.
Moreover, Ranger Oil’s assets have a steep decline rate than Baytex’s total acreage. For example, Baytex’s Canadian assets see a decline rate of around higher single digits, while its to-be-acquired assets have a decline rate exceeding 35%. Oil and gas assets see a consistent decline in production over their lifetime, mainly due to a loss of reservoir pressure.
Valuation
BTE stock has been trading at a discount for long. Its pro forma financials for 2023 indicates that the stock is trading four times its free cash flows. That’s significantly discounted compared to the peers’ average at around seven to eight times.
While oil prices remain the crucial driver for Baytex stock, its upcoming quarterly earnings will also pave the way for it going forward.
