While the Tullow Oil and Capricorn Energy share prices remained fairly flat on the news of the merger, the deal is expected to have benefits for both parties, including forming an Africa-focused energy group, increased output and new resources.
Tullow Oil [TLW.L] and Capricorn Energy [CNE.L] have agreed to merge in an all-cash deal valued at £656.9m, which will see shareholders of Capricorn – known as Cairn Energy until the end of last year – receive 3.8068 new Tullow shares for each share held. Tullow shareholders will own a majority stake of 53% of the combined entity, which, as of 1 June, would have a market cap of £1.408bn.
On 7 June, Tullow Oil confirmed the merger has been agreed, with Tullow shareholders taking a 53% stake and Capricorn Energy holding the remaining 47%. Together, the companies will create an Africa-focused group. Production is expected to be 96,000 barrels of oil a day with resources spread across Côte d’Ivoire, Egypt, Ghana and Gabon. Output is forecast to reach 120,000 barrels a day by 2025.
Tullow CEO Rahul Dhir and Capricorn CEO Simon Thomson said in a joint statement that “the combination has compelling strategic, operational and financial rationale”. By creating “a leading African energy company, listed in London”, the companies will be able to “access and accelerate near-term organic growth, add new reserves and resources” as well as “generate significant future returns for shareholders”...
There was a lukewarm reaction to the merger from investors, though. The Tullow share price jumped 3% in the first 15 minutes of trading on 1 June following the announcement before the market opened, but ended up closing 2% lower. However, the stock is up 17.9% since the start of the year. The Capricorn share price was up 4% at one point, but closed 2% higher on the day of the news.
Tullow to benefit more
Debt has been a problem for Tullow in recent times. Last year, the company raised $1.8bn via a bond offering to help manage its debt pile and avoid defaulting. As of the end of fiscal 2021, debt had come down from around $2.4bn to $2.1bn. To alleviate some of the pressure on the balance sheet, the company sold off assets in West Africa to Panoro Energy [0N08.L] last year for $180bn.
In contrast, Capricorn is sitting on a reasonable-sized cash pile. The company ended a long-running dispute with India’s government in January and is set to receive a refund of 79bn rupees (£815m).
Its stronger balance sheet means Tullow will get deeper pockets, while Capricorn will benefit from Tullow’s broader portfolio. However, some analysts aren’t convinced that the deal makes sense for both parties. Stifel’s Chris Wheaton told Investors’ Chronicle that the “strategic rationale” behind the deal is questionable, especially as it doesn’t “solve a shared problem for both companies of ‘what to invest in next’”.
Capricorn’s valuation is based on its cash holdings, so the merger is likely to benefit Tullow more, he added.
The new group plans to have an annual $60m dividend, but Capricorn stressed in the merger announcement that this would unlikely be funded in Tullow’s current financial state. A capital restructuring of either Tullow or the combined entity shouldn’t be ruled out.
Caution is warranted
The merger should close in the fourth quarter of 2022. Until then, Hargreaves Lansdown analyst Sophie Lund-Yates believes “Tullow’s stand-alone story should remain the focus”.
Tullow’s successful debt refinancing is described in a research note as “a crucial milestone” that will give the company “a chance to regroup”. Prior to the closing of the bond offering, concerns about its ability to continue operating were clouding its future.
While Tullow has made progress on this front, the fact the company is “struggling to turn a profit in the most accommodative environment” of rising oil prices is concerning. Investors need to remain cautious, Lund-Yates added.
Tullow has received eight analyst ratings in the last 12 months, according to MarketBeat data: four ‘buy’ and four ‘hold’. The consensus price target of 72.88p implies an upside of 33.1% from the 6 June closing price of 54.75p.