I always find the oil industry interesting…
For instance, did you know that unconventional oil production – U.S. shale – was the only source of growth in global oil supply over the last 12 years?
The only growing non-OPEC basin is the Permian Basin in West Texas. Never before has global oil supply growth been so geographically concentrated. A mere six counties in West Texas are now 100% responsible for all non-OPEC global production growth.
This makes the oil service industry a key cog in the global energy machine. That’s why a recently announced merger in the sector got my attention.
Patterson-UTI/NexTier Merger
Patterson-UTI Energy (PTEN) provides land drilling and pressure pumping services, directional drilling, rental equipment, and technology to clients in the U.S. and western Canada. Its merger partner, NexTier Oilfield Solutions (NEX), is an oil field supplier and well completion company, and is one of the largest pure-play pressure pumpers in the U.S.
On June 15, the two companies agreed to merge in an all-stock deal to create a $5.4 billion oilfield services firm. NexTier shareholders will receive 0.752 shares of Patterson-UTI stock for each share of NexTier stock they own. The deal is expected to boost earnings per share and free cash flow per share in 2024, and generate annual savings of about $200 million within 18 months of closing.
This is part of a larger trend: oilfield services firms have been consolidating as they try to navigate both operational and pricing challenges, while catering to their oil company clients’ needs. Oil companies have cut spending on new wells – especially drilling for natural gas – in favor of shareholder returns.
Pricing is a challenge for these oil service firms at the moment. Prices for onshore U.S. drilling and completion services have decreased by almost 5% since the start of the year until the second quarter of 2023, according to Rystad Energy analysts.
Why I Like the Deal
I like this merger, which has clear strategic logic. The two firms complement each other nicely. Patterson is mainly an onshore driller, a provider of rigs and services. NexTier offers well-completion and production services, such as hydraulic fracturing.
According to Rystad Energy, NexTier and Patterson’s combined assets would account for roughly between 2.6 million and 2.7 million active hydraulic horsepower capacity (HPP). That will put the combined company ahead of the current leader, Halliburton (HAL), making it the largest frac provider in North America.
And like most mergers in the sector, management at both Patterson and NexTier believe the merged company will be more efficient at delivering integrated well site solutions at scale to the oil companies they serve. Both companies are trying to cope with labor shortages and increasing material costs for everything from steel to sand.
This combination means between 70% and 75% of the industry’s HHP will be consolidated in the hands of just five oil service firms, which also include SLB (SLB) and Baker Hughes (BKR). This should translate into better pricing power and profit margins for these five firms.
This deal looks like a winner over the longer term, with both companies’ stocks rallying after the merger announcement. Here’s why…
The deal would create one of the largest well-completion firms in the U.S., adding 33 active frac spreads (bringing Patterson’s total to 45). When combined with the second-largest U.S. super-spec rig fleet (172 rigs), this will further diversify the company’s operating segments, which will likely lead to cash flow improvements.
Super-spec rigs have more horsepower and have higher pressure, drilling better and faster than standard rigs. Super-spec rig utilization remains well above 90% in North America, which translates to a significant degree of pricing power. Patterson’s average rig day rates approached $35,000 in the second quarter of 2023, quarter, nearly $12,000 more per day than last year.
As a result, the deal price for NexTier–at just 2.4 times 2024 EBITDA – is a remarkable bargain.
In addition, Patterson’s relatively high exposure to longer-term drilling contracts (about one to two years) will ensure that it enjoys elevated contract pricing, even after the industry supply/demand imbalance evens out.
Add it all up, and – even though the oil service sector is out of favor on Wall Street – PTEN stock is a buy anywhere in the $10 to $13 range.
— Tony Daltorio
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Source: Investors Alley