I wanted the Netflix documentary “Hank” last night.  It was a great reminder of the state of things in 2008, and viewed with the perspective of COVID, bailouts, politicians and stimulus, was eerily familiar  I recommend you watch it if you find yourself home with nothing to do some time this weekend.  One of the key moments in the film was when Hank Paulson called the CEO’s of the big banks together and basically said “You guys need to merge because you are too big to fail and the world economy will collapse within 24 hours if you do.”  Oil and gas in North America isn’t “too big to fail” as we are only 2% of the S&P, produce <15% of the world’s oil and natural gas is abundant enough that a few bankruptcies won’t change the country’s ability to produce it.  BUT… companies have seen the writing on the wall and are merging of their own volition, seeing debt and prolonged commodity price instability as a key risk.  That brings us to the rumored merger of EQT and CNX.

Toby Rice has been busy.  Since selling Rice Energy to EQT in 2017, underperformance led the family to become activists and last year, got back into the C-suite, implementing a whole bunch of organizational and technical changes.  When we talk about gas, I always refer to the Marcellus as the only basin that really matters.  From 2010 – 2020, Appalachia grew from effectively 0 bcf/d from horizontal shale wells to 35 bcf/d and has made U.S. energy independence on the natural gas side a reality.  What a stark change from 2001 when Senate hearings centered on a shortage of natural gas and the commodity ultimately peaked at $14/mcf before undergoing 14 years of extreme pain for pure play gas producers.

It makes sense to want to consolidate.  I’ve advocated for it for over 2 years, and each of the deals announced in the past few months, I have been supportive of.  Of note, the synergies are usually head count reductions, but I’d add a comment that Clay Gaspar, the President and COO of WPX Energy (and he will become the COO of the merged Devon-WPX company): the bigger you are with more diversity of assets and commodities, the less you need to hedge and can benefit from the changes in commodity price because your business is more resilient.  It’s true.  Historically, WPX was more heavily hedged to ensure cash flow for the development of their assets and companies like Exxon don’t hedge.  But Devon-WPX will be a much larger, multi basin, multi commodity company.  How does EQT-CNX meet that criteria, other than making EQT bigger.

A couple thoughts.

1. One of the challenges of SMOG is when companies don’t book the entire 5 years of inventory (part of this is the SEC rule meaning you have to write off reserves that have been on for more than 5 years and I suppose it’s possible that at $2.57/mcf last year, only the best of the best inventory was economic at PV-10 AT to book. but I digress).  Comparing SMOG values of EQT and CNX, EQT net of debt is $14.85/share with $2.6 billion of future development capital booked (approximately 1 year) while CNX is $2.72/share (with $1.1 billion of FDC, also about a year).  High level, it feels like EQT is using paper to buy a company whose underlying assets don’t support their current share price (not investment advice).
2. CNX produced $21 mm of free cash flow in Q2 2020, but have put a projection out there that they will produce $3.4 billion in free cash flow in the next 5 years (through 2026).  I love me some hockey…. but hockey sticks are for sports, not financial projections.  Clearly, EQT believes it and if so, that free cash flow would exceed their YE2019 SMOG ($3.070 billion) by more than $300 mm.  Looking at the production profile from September of 2018,, I don’t see it, but I’m also not sitting in their board room. 
3. CNX spent $55 mm in 2019 on unutilized firm transportation.  It’s not Antero large, but it’s not insignificant when they spend $46 mm/quarter on interest payments and another $23 mm/quarter on G&A.  Conversely, from their YE2019 disclosures, EQT sees it’s firm transport commitments fall off tremendously next year.  As their decline rates don’t match the fall off in firm, presumably this means that they are in a great place financially relative to peers in the “excess operating costs spent on firm” category.

To be sure, the combined company would do almost 7 bcf/d and COULD have greater pricing power.  BUT… 7 bcf/d out of ~94 bcf/d gross raw gas production in the U.S. isn’t exactly Coke or Pepsi in terms of market share.  And, EQT certainly believes they can drive D&C efficiencies, on top of the improved capital structure, reduced interest payments (through refinancing) and hedging out the current gas strip which is a lot closer to $3/mcf than $2/mcf, and reducing G&A.  And while there is a lot more to a valuation than SMOG (and I don’t have their WI, land, capital, or reserve database so I can only rely on public disclosures), I’m not in love with the relative valuation.  That said, if the deal goes forward, EQT will certainly be bigger, and time will tell if they are able to show the value proposition in the underlying assets, and much of that will come from the belief in the hockey stick.