Devon Energy An Unlikely Merger Partner in 2010

About a month ago I wrote about Devon Energy's (DVN) plan to focus on North American on-shore energy exploration by disposing of its off-shore and international properties in 2010. Essentially the company has too many properties to drill for oil and natural gas and not enough capital resources to fund all of the potential projects. By selling off their international and off-shore properties Devon can reduce debt and focus its future exploration efforts on the very promising on-shore acreage they have, boosting shareholder value in the process.

Despite the restructuring plan announcement just last month, Devon's name is being thrown around as a possible M&A partner now that XTO Energy has been gobbled up by Exxon. I find it unlikely that in light of the deal announced this week that Devon would all of the sudden scrap its 2010 asset disposition plan and instead entertain buyout offers from larger energy players.

Judging from Devon's stated strategy it does seem that they share Exxon's bullish stance on North American on-shore shale properties. After all, they are selling other assets to focus their company on those plays going forward. As a result, it seems to me that Devon already owns enough attractive assets that it prefers to go it alone and build a leading North American energy producer.

Now surely a larger company with less attractive assets may covet a company like Devon, but I do not believe given the firm's recent strategy announcement that it feels like it needs to partner with a larger firm to create shareholder value from those assets. Of course the company would need to strongly consider any significant premium they may be offered for the entire company, but in terms of companies positioned to benefit from doing a larger M&A deal, Devon Energy does not seem to fit that mold.

Like Chesapeake, which I mentioned yesterday, Peridot Capital is also invested in Devon, but again not necessarily for the prospects of a takeover. Rather, the company already has plenty of assets (and after their asset disposition plan is complete, ample capital) to boost their stock price significantly long term. Unless a large energy company has both an interest in the assets that Devon is putting up for sale, as well as a desire to boost its on-shore shale exposure, I believe it is unlike that Devon agrees to a takeover anytime soon.

Full Disclosure: Peridot Capital was long both Chesapeake Energy and Devon Energy at the time of writing, but positions may change at any time.

Chesapeake Energy Unlikely Next Energy Merger Partner

On Monday I showed data on the mid-sized energy firms that could be next in line to be acquired on the heals of ExxonMobil's (XOM) $31 billion buyout of XTO Energy (XTO). Today I wanted share my personal view that I do not believe natural giant Chesapeake Energy (CHK) will be next in line to be gobbled up if indeed the XTO deal sets off a domino effect in the industry.

For those who do not follow Chesapeake, they are one of the largest independent natural gas producers in the United States and the most gas-heavy exploration and production firm on the short list of possible buyouts going forward (about 90% of the present value of CHK's reserves are natural gas).

A lot has changed for Chesapeake over the last 18 months. Back in July 2008 natural gas prices were a lot higher than today and Chesapeake, as the largest leaseholder of gas-producing acreage, was busy inking exploration partnerships for its massive shale properties. Big energy companies were eager to gain access to vast gas reserves and Chesapeake was interested in sharing some of the development costs to reduce their growth financing needs.

Shares of Chesapeake Energy peaked at $74 each in July 2008. The company's  co-founder and CEO, Aubrey McClendon, had been aggressively buying the stock on the way up, signaling his optimism over the company's future prospects. At the peak, McClendon owned 5.2% of the company and those 34 million shares were worth a whopping $2.5 billion. Things could not have looked better.

Amazingly, within 5 months the tide had completely shifted. Natural gas prices began to decline as the financial crisis and subsequent recession began to rear their ugly heads. As the economy weakened demand for natural gas would drop and Chesapeake's profits would take a hit. Then in December 2008 the stock started to drop a lot faster than its peer group. Rumors began to swirl that there was a large seller of the stock and that it might in fact be the company's CEO. Chesapeake shares hit rock bottom around $10 each in December, down about 85% in just 5 months.

As rumors continued to run rampant about what was happening the company issued a press release informing investors that in fact McClendon had been issued a margin call by his brokerage firm and was forced to sell 93% of his holdings in the company. It turned out that McClendon had been using margin (borrowed money) to build up his stake over the years.

If that seemed reckless, despite his optimism about Chesapeake's future, it turned out to be even more reckless given that he did not seem to hedge any of his massive margined stake even when the stock peaked and was worth billions of dollars.

Given the events that had transpired and how shocking they were, one can certainly understand why the stock began to lag the natural gas sector. After all, if McClendon could be so careless with his own money, who knew what he might do with shareholders' capital. The stock did rebound from a panicked low of $10 to the 20's in subsequent months, but it continued to lag behind its rivals; companies that carried a lot less baggage.

After such an embarrassment, McClendon vowed to slowly rebuild his stake over time, but he has yet to do so. He still owns 2.4 million shares of Chesapeake (a 0.4% stake) worth nearly $60 million but that has to feel like nothing compared to what he once had. And that is why I doubt Chesapeake will be the next natural gas company to be sold.

While it is pure speculation on my part, I do not believe that McClendon, who co-founded Chesapeake with Tom Ward (who now runs SandRidge Energy), would be extremely anxious to sell the company after he allowed $2.5 billion of equity to disappear within a matter of months. McClendon remains CEO and shows a lot of passion about continuing to grow the company himself.

In my view, the only motivation for him to sell at this point in the natural gas cycle would be to lessen his work load and cash out financially. While $60 million may seem like a lot to you and me, it may not be an attractive option for McClendon (or even $70 or $80 million if he accepted a premium) considering that he owned a 5%, $2.5 billion stake as recently as mid 2008. Furthermore, with natural gas prices in the tank lately it would be a reasonable argument to claim that it would not be in the best interests of shareholders to sell now either.

More likely I would bet that McClendon does in fact want to build up his stake again (maybe not back to 5% but somewhere above his current 0.4%), sell at a time when the natural gas market is a bit more favorable, and really cash in on the company he has built from nothing over the last two decades.

As a result, I really do not expect Chesapeake Energy to be sold in the near term (say the next 3-6 months at least). It just does not seem to be something McClendon would entertain given where we are right now in the natural gas cycle and what he has been through over the last couple of years.

McClendon is usually outspoken on quarterly conference calls, so perhaps he will even address the M&A landscape and his current thinking on the company's fourth quarter earnings call in early February. If he does, I will be sure to keep you all posted.

All of that said, Peridot Capital continues to invest in the company. I believe it has excellent leverage to the future of the natural gas market, which will likely turn around sometime in the not-too-distant future as currently low prices discourage gas production. I am just not banking on a blockbuster merger anytime soon.

Full Disclosure: Peridot Capital was long shares of CHK at the time of writing, but positions may change at any time

Will ExxonMobil-XTO Spark Energy M&A Boom Like 1998-2001?

I have decided this will be "energy week" on the blog. I have a total four posts in mind including yesterday's about Exxon's decision to buy XTO Energy. I have reiterated what many people have said, that Exxon may have started a chain reaction of rather large energy mergers. Is there a precedent for such a run on quality energy assets? Absolutely.

Consider the period from 1998 to 2001, the last large energy consolidation. Large energy companies have a history of "me-too" transactions in order to avoid falling behind the competition in terms of size and scope of energy producing properties. Take a look at how many mega mergers were announced between 1998 and 2001:

• Exxon buys Mobil

• Conoco buys Phillips

• BP buys Amoco

• Chevron buys Texaco

Many energy industry insiders are thinking we could see a repeat of this now that Exxon Mobil, a conservative deal maker (they have not done a large deal since Mobil), has gotten the ball rolling.

So which targets are most likely to be gobbled up first? Interestingly, I have more of a strong view on which firms likely will not be sold in the short term. More details on those later this week.

Exxon Buy of XTO Could Start Energy M&A Domino Effect

I love Monday mornings for the sole reason that they are often very exciting from a merger announcement prospective. Many have expected lots of merger and acquisition activity in the energy sector but until today there was very little going on there. With this morning's announcement that ExxonMobil (XOM) is buying XTO Energy (XTO) it appears that the long anticipated trend of consolidation in mid-sized North American energy companies (most notably the unconventional natural gas producers) may be under way.

Exxon is paying a 25% premium for XTO Energy, one of the five companies always rumored to be on the short list of possible major oil company targets. Exxon is a conservative dealmaker so the fact that they are shelling out $31 billion ($41 billion including debt assumption) for XTO shows that they not only liked what they saw and the price they got. Other leading oil giants (think the likes of BP and Shell) are likely scrambling to draft their own plans to follow suit to ensure they do not get stuck with inferior growth properties. The majors are lacking an excess of replacement fields for the huge amounts of energy they produce each year, so a large acquisition is really the best way to secure future growth opportunities in a very competitive energy market.

So who might be next? I have compiled a list of the obvious targets, including valuations, to show you exactly why Exxon likely chose XTO (it was the cheapest company in the group), what other firms are likely going to have their tires kicked in coming months, and which of the remaining independent firms may be most attractive from a price tag perspective. Exxon is paying 6.6x trailing cash flow for XTO, so we can expect that to be the yardstick off of which future deal negotiations will be based.

Full Disclosure: Peridot Capital was long Chesapeake and Devon at the time of writing (yeah, unfortunately no XTO) but positions may change at any time.

Tesla IPO Hopefully Can Boost New "Green" Economy

From Fox Business:

"Tesla Motors, maker of luxury-all-electric cars, is reportedly planning a stock offering. If the sale occurs, Tesla would be the first U.S. car company to issue shares since Ford Motor Co. in 1956."

This is very exciting news. Not necessarily from an investment standpoint (it will likely be a while before pure electric car companies can prove to investors they have a sustainably profitable business model), but from an innovation point of view. The United States needs to promote the future of a "green" economy, not just to reduce oil imports, but even more importantly to generate a new force that can produce job growth, much like the advent of the Internet has already done. I hope Tesla has a successful IPO, as it may provide a psychological boost for other entrepreneurs out there who would like to get the "green" ball rolling.

Devon Energy Asset Disposition Plan Should Bode Well For Shareholders

Devon Energy (DVN), a leading oil and gas exploration and production company, announced yesterday an asset disposition strategy for 2010 that appears to be very accretive for equity holders should it be completed as planned. Devon announced that it plans to sell its Gulf of Mexico and international operations next year in order to focus on North American onshore energy properties. The sales are expected to bring in between $4.5 and $7.5 billion on an after-tax basis.

Devon's stock rose $3 to $71 on the news as investors realized that Devon simply had too many properties to explore given its finite financial resources. By selling non-core assets and using the proceeds to focus on their strongest properties, Devon should be able to operate in the most efficient and shareholder friendly way.

A deeper look at the numbers shows a very attractive proposition for stockholders. Devon believes it can reap $6 billion from their gulf and international assets, which represents about 20% of the company's current equity market value of ~$30 billion. These same assets only represent 7% of the firm's energy reserves and 11% of current production. Since energy production companies are largely valued by investors based on reserves, selling these assets appears to be a very smart move for Devon. Clearly Wall Street is undervaluing these assets if indeed Devon can get $6 billion for only 7% of the company's reserve base.

In addition, Devon will see its exploration expenses drop meaningfully after shedding these non-core assets. These non-core assets currently account for 29% of Devon's annual capital expenditures. So, not only is Devon trying to unload assets that are undervaluing the company, but they are also the company's most expensive assets to develop.

To recap, Devon currently spends 29% of its capital budget to develop only 7% of their reserves and it believes it can sell those assets for 20% of its current equity market value. This looks like a no-brainer for Devon and its shareholders.

As previously mentioned, Wall Street applauded the move, sending Devon shares up $3 to $71 after this strategic announcement. Since I am not fan of buying stocks after a big move up, now might not be the best time to scoop up the stock, but if it drops back to $65 or lower I will likely take a hard look at it based on recent developments.

Full Disclosure: Peridot Capital had a position in Devon at the time of writing, but positions may change at any time

United Airlines: How Not To Run An Airline

I came across this article by John Battelle over on Business Insider and thought I would share it with everyone. I am a loyal Southwest customer so I have managed to avoid the crazy complicated (and irrational) dynamic pricing algorithms that many of the major carriers use. Hopefully there are not too many United shareholders out there reading this...

Thanks For Flying United. Please Give Us All Your Money

The Bull Market in Gold Looks Familiar

Here is a 35-year chart of gold prices. Based on what you see, would you want to jump onto the gold buying bandwagon? I am bearish on gold over $1,000 per ounce and this chart is a good reason to at least be careful with the current precious metal of choice. The latest trend looks very familiar...

Barrick Gold Pressured To Lift Hedges Despite Elevated Gold Price

Tuesday evening we learned that gold producing giant Barrick Gold (ABX) has decided to issue $3 billion in new common equity shares in order to buy back all of its remaining gold hedges, which are currently in the red to the tune of $5.6 billion.

In the company's press release Barrick explained that investors have expressed disappointment that the company has hedged 9.5 million ounces of production below market values. Barrick claims such a fact has put pressure on its share price, and therefore seems to have concluded that lifting their hedges is good for shareholders.

The press release also included reasons why the outlook for gold was positive (as would have to be your view if you decided to lift out-of-the-money hedges), but is this really the best time to be lifting hedges? I'm skeptical about the timing of this decision and therefore am glad that I am not a shareholder in Barrick.

As you may have seen, gold prices have risen sharply in recent weeks (chart below) and now trade near $1,000 an ounce for the third time over the last couple of years. The metal never seems to stay over $1,000 for long, even in the depths of the credit crisis. Barrick has decided, seemingly based entirely on pressure from shareholders, to go 100% long on gold just as the metal is nearing its all-time high. I thought we were supposed to buy low and sell high?

Barrick is going to pay $5.6 billion to lift its hedges, which is the mark to market loss it has on the books right now. On 9.5 million ounces, that means the company is underwater by $589 per ounce and must pay that much to get out of them. That means Barrick is partially hedged at $411 per ounce with gold at $1,000.

Now, I am not saying that hedging gold at $411 per ounce makes a lot of financial sense in current times. I certainly understand that investors want to see them lift those hedges. After all, if you are long ABX stock, you clearly think gold is going to rise in price, and therefore would want to benefit if that view proves correct. Still, from a financial management perspective, Barrick is essentially buying at the top of the market.

Why not wait for gold to drop to $800 or $900 before lifting the hedges? That would be a "buy low" type of move and even buying at $900 per ounce would save the company $1 billion in cash, versus making this move right now.

The converse argument would be that gold might not trade back down to $900 or lower, but that seems unlikely. The chart above shows us that gold prices couldn't even stay above $1,000 during the worst credit crisis we have ever faced. In fact, gold traded at $700 less than twelve months ago, at $800 earlier this year, and at $900 just a few months ago.

Gold is typically seen as an inflation hedge as well as a flight to safety when fear is the paramount emotion on Wall Street. We have clearly already lived through the scariest part of this recession. In addition, inflation is unlikely to rear its head anytime soon because firms have little or no pricing power with such a weak economic situation (consumers and corporations are cutting back whenever possible, and demanding low prices, thereby rendering near to intermediate term inflation risks mute).

This $5.6 billion long bet by Barrick Gold with the metal trading at $1,000 an ounce looks like a bad idea to me and I would not be buying gold investments right now. Unfortunately, it appears that the company was forced to act by its shareholders, who likely have a biased view of exactly where gold prices are going to go from here.

If I were running Barrick Gold I would tell my shareholders, "look, we understand where you are coming from, and will look to lift the hedges when it makes sense, but not when prices are approaching all-time highs. Maybe on a pullback we will take swift action."

Time will tell whether this move pays off for Barrick's investors or not. In the meantime I believe it is a good time to be cautious on gold.

Full Disclosure: No position in ABX at the time of writing, but positions may change at any time.

Chevy Volt Could Get 230 Miles Per Gallon

This seems like the kind of thing that could get more people into GM showrooms and help them recapture lost market share, even if most consumers do not purchase the new Chevy Volt, due out in late 2010.

According to an Associated Press story today GM announced that the Chevy Volt rechargeable electric car should get 230 miles per gallon in city driving, more than four times the mileage of the current mileage leader, the Toyota Prius.From the story:

"The Volt is powered by an electric motor and a battery pack with a 40-mile range. After that, a small internal combustion engine kicks in to generate electricity for a total range of 300 miles. The battery pack can be recharged from a standard home outlet."

Despite a hefty initial price tag (expectations are ~$40,000), the car could still be cost effective. Why? According to the story, "If a person drives the Volt less than 40 miles, in theory they could go without using gasoline."

If we want to reduce our use of foreign oil in a meaningful way, this is exactly the kind of innovation that could do it. Not only will less of our money go to the Middle East region, but we will be reducing pollution and Americans will be able to keep more money in their pockets by saving on the cost of gas. Count me as very much looking forward to the launch of more electric cars in the United States.