Stock price reaction
Diamondback Energy (FANG) stock saw a massive correction following the announcement of the merger deal with Energen Corporation (EGN). FANG lost 12.0% in a single trading session following the announcement, eroding all its YTD (year-to-date) gains. It has recovered slightly since then.
Overall, FANG is down 8.3% since the deal announcement. In the same timeframe, the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) has lost 0.2%.
The market’s negative reaction to the deal could be attributed to the possible increase in the company’s leverage, near-term dilution, and pipeline constraints in the Permian region.
Increase in financial leverage
Diamondback Energy would assume $830.0 million of net debt as part of the merger deal. This is expected to drive the company’s leverage higher. An increase in leverage from this deal and high crude oil volatility could weigh on the company’s massive spending plans for the coming years.
The all-stock deal is expected to be dilutive in the near term to Diamondback Energy’s existing shareholders. The company expects the deal to be cash flow per share and EPS accretive from 2019. This might depend on the company’s realization of primary and secondary synergies, which we discussed in Part 3 of this series.
Widening of WTI spreads
The widening of the WTI Cushing–WTI Midland spreads was a concern for most Permian producers. The widening of the spread is due to the expected pipeline constraints amid strong production growth in the Permian region. The situation isn’t expected to improve until several major ongoing projects come online by the end of this year.
An organic expansion in the Permian region could be negative for the Diamondback region if the spreads don’t come down to their historical averages. Pioneer Natural Resources Company (PXD) and Concho Resources (CXO) are among the other Permian producers that are negatively impacted by the high price differential.
In the final article in this series, we’ll look into the analysts’ rating updates for Diamondback Energy following the deal announcement.