The deal that Devon Energy (DVN) announced on Wednesday, November 20, isn’t a bad deal, but I think it’s big value for investors is what it says about where the profits are or aren’t in the U.S. natural gas and oil from shale boom.
Since 2009 Devon has transformed itself from an oil producer with a big presence in deep water and international discoveries into a producer with a major onshore natural gas and oil shale position in the United States and Canada through $9 billion in asset sales—and through acquisitions like that it announced last week. The company will acquire privately held GeoSouthern Energy for $6 billion in cash. GeoSouthern’s assets include 82,000 net acres in the very hot Eagle Ford geology. Those acres produce 53,000 barrels of oil equivalent a day and contain an estimated 400 million barrels of oil equivalent in recoverable reserves.
In terms of rounding out Devon’s production profile this is a smart deal—Devon has acquired low risk drilling opportunities—an inventory of about 6 years of drilling inventory—that, according to company projections will show a 25% compound annual production growth rate through 2017.
But the take away lesson here for investors is how efficient the market has become at pricing in acquisitions in the U.S. natural gas and oil shale boom. Credit Suisse calculated on November 21, the day after the deal was reported, that the acquisition would add about $3 a share to Devon’s market value. By the close on November 22, Devon’s shares had tacked on $2.78 from the November 18 closing price.
In other words the market had priced in the deal, according to Credit Suisse’s calculations at least, within days of its public announcement.
This doesn’t mean that the Devon acquisition doesn’t make solid sense or that Devon isn’t a good stock—Credit Suisse calculated a one-year target price of $77 a share.
It does say that the U.S. natural gas and shale boom isn’t undiscovered territory anymore. Acquirers today aren’t getting big steals on their deals that will pop stocks in the short-term. Investor skepticism about oil and natural gas shales is largely a thing of the past and these productive assets are priced so that acquisitions are taking place at something like full value—when they’re not taking place at more than full value as international majors that were late to the party overpay to get an invite.
What this suggests to me is that the biggest profits for investors from this boom will, going forward, come from investments in the best operators—those companies that can bring down drilling costs most quickly—from investments in companies with the biggest acreage position—but where there are doubts about a company’s ability to exploit all that acreage—and from investments in companies that are providing infrastructure to get more of the oil and natural gas from this boom to market—and in the process to raise prices for the oil and natural gas produced in this boom.
I think the holdings in my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ of Chesapeake Energy (CHK) and Cheniere Energy (LNG) fit that profile.
The Devon Energy acquisition last week, I’d argue, supports the logic of owning those stocks at this stage of the U.S. shale boom.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did own shares of Cheniere Energy and Chesapeake Energy as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/.
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