Callon + Carrizo merger - Stifel's take on Sept 22

[dan_s]

Comments below are from a report from Stifel dated 9-22-2019

"We continue to believe M&A is one of the most impactful, non-price catalysts for our sector. To understand the attributes for successful M&A, we
analyzed nine transactions across Energy with a focus on the merits of the transaction and post-announcement stock performance. Based on our
analysis of the last seven E&P transactions and the last two OFS transactions, the three factors that most impact reception include value uplift,
strategic fit and transaction structure. Surprisingly, multiple accretion had a minimal impact. Using this insight, we identified the most appealing M&A
opportunities across our coverage with a focus on synergies and strategic fit."

"CPE-CRZO transaction provides “proof positive” example of the industry and macro conditions driving M&A. In our view, the CPE-CRZO transaction
(CPE: $4.53, Buy) (CRZO: $8.63, Buy) and associated filings substantiate our views on the driving forces of M&A and provide a glimpse into how pervasive
M&A discussions are across the sector. Specifically, we believe four of the five industry forces were at play in the CPE-CRZO transaction. Prior to the
transaction announcement, we note CRZO’s CEO’s compensation was limited to an averaged of ~57% of target compensation for the past three years
primarily due to the effect of share price performance metrics on realizable compensation. We believe this limiting metric on compensation and the adoption
of a change in control provision in 2019 (base salary, 3.0x annual bonus target and immediate vesting of equity-based awards) incentivized management to
pursue M&A. Following the transaction announcement, the “Callon Acquisition of Carrizo” presentation and S-4 filing highlight the importance of pro forma
FCF generation and large-scale development (Figure 3 and Figure 4) in management’s considerations. The S-4 filing indicates both management teams
were concerned with evolving industry and macro conditions (declining public interest in E&Ps, deteriorating access to capital markets, difficulty of attaining
additional cost savings as a stand-alone) and were focused on gaining scale in the Permian. The S-4 also indicates how pervasive M&A discussions are
across the sector as nine companies (at least seven publics) were involved in potential transaction discussions and five companies made competitive offers.
In our view, the interest level implied by the S-4 is greater than initially perceived by the markets."

[dan_s]

Further down in the report:

M&A investor reception is largely driven by synergy and strategic fit.

Based on our analysis of the last seven U.S. Onshore E&P transactions, the three factors that impact M&A reception include value uplift (synergy/premium), strategic fit (enhanced pro forma investment thesis) and transaction structure (zeroto-low premium preferred). In Figures 5 and 6, we outline relative stock performance for the stocks post the announcement and provide an assessment of the merits of the transactions based on announced synergies and strategic fit. In Figures 7 and 8, we illustrate the importance of synergy versus valuation in stock performance. While valuation matters, it is clear that multiple accretion has a low bearing on stock performance. We view the PDCE-SRCI transaction (PDCE: $30.40, Buy) (SRCI: $4.78, Buy) as the quintessential example of the type of M&A the market covets. As evidenced by recent PDCE-SRCI stock performance, the transaction checks all of the boxes including value uplift (highest), strategic fit (pro forma company is the most advantaged DJ mid-cap) and structure (zero premium). In contrast, the ECA-NFX transaction offers the lowest value uplift and strategic fit of the transactions we analyzed. While the ECANFX acquisition could prove to be the most successful transaction overtime, it highlights the importance of clearly defined synergies and strategic fit for short-term performance and reception. Longer-term, the ultimate end goal for broad rationalization is improved fundamentals, resulting from higher corporate level returns and lower aggregate supply. We believe all seven transactions will accomplish that overtime."
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MY TAKE: Last week I posted a Pro Forma forecast/valuation model for PDCE+SRCI. The merger is going to create a very strong mid-cap. I've also posted a Pro Forma forecast model for CPE+CRZO. It also looks good to me and I believe the pullback in CPE following the announcement was more a knee-jerk reaction at a time when Wall Street was more bearish on oil prices. CPE+CRZO is about half the size of PDCE+SRCI. Since a large CPE shareholder has announced they are opposed to the merger, there is a small risk that it may not close by year-end.

[dan_s]

More from Stifel below. Note that Stifel thinks SM might merge with CPE+CRZO. It makes some sense, but SM doesn't generate FCF and it has a lot of debt.

Appealing M&A concepts: ranking the best opportunities. In the spirit of our zero-premium M&A view,
we have ranked our Permian mid-cap stocks based on the perceived M&A opportunity with a focus on
overhead (G&A and interest) and operational (contiguous, block acreage positions) synergies. Regarding
overhead, we calculated the long-term value of this synergy, assuming 75% of 2019 G&A and interest
cost savings (interest rate spread) could be captured over the life of the opportunity. We expressed the
opportunity for this synergy as a ratio of implied value to enterprise value and rated the stocks with the
highest ratio as the best opportunities. Regarding operational synergies, we subjectively ranked our
coverage universe on the operational upside of their positions assuming contiguous (blocky positions
provide the highest Upstream and Midstream value capture potential). Our subjective acreage
assessment was based on Figure 9 and Figure 10. While this assessment is flawed in some respects
(does not address buyer considerations), it provides a starting point for the analysis with the view that the
potential acquirer list for blockier positions is advantaged relative to non-continuous positions. In our final
analysis, we ranked the stocks given equal weight to each consideration. Referencing Figure 11, we
summarize the output from this simplified M&A assessment and note the combination of WPX-OAS
(WPX: $11.01, Buy) (OAS: $3.96, Buy) and CPE-CRZO-SM (SM: $10.83, Buy) represent the best M&A
opportunities in mid-cap for zero-premium M&A. We caution investors to note this exercise is purely
focused on synergy potential.

 We believe the WPX-OAS pro forma entity is the most compelling M&A concept for the mid-caps. In
our view, the entity could generate a FCF yield of ~4.8% in 2020 and trade for at 1.5x turn discount to
FANG (FANG: $96.82, Buy). At FANG’s implied 5.6x multiple, the pro forma stock would trade at an
implied share price of ~$18.50 (+60% upside) and would still offer a FCF yield of ~3% in 2020 at that
elevated valuation.

 We believe CPE-CRZO is an ideal acquirer in a merger of equal scenario with SM. Based on our
estimates, we believe the pro forma entity could generate a FCF yield of ~0.5% and ~6.1% in 2020
and 2021, respectively, and trade for at ~1.7x turn discount to FANG. At FANG’s implied 5.6x
multiple, the pro forma entity would trade at an implied share price of ~$9.90 (+100% upside) and
would offer a FCF yield of ~0.2% in 2020 at that elevated valuation.