Callon Petroleum Needs to Pull Out of This Deal

Callon Petroleum (NYSE: CPE) has been in a soup this year. Shares of the oil producer are down more than 30% this year despite a decent operating performance that has been hurt by weak oil prices. However, there’s one more reason why investors seem to be shunning the stock apart from lower oil prices.

Investors don’t want Callon to acquire Carrizo Oil and Gas

In July this year, Callon announced that it will acquire Eagle Ford and Permian Basin operator Carrizo Oil and Gas in an all-stock deal that valued the latter at $3.2 billion.

That valuation represented a 25% premium to Carrizo’s stock price at that time, but Callon investors were not impressed with the money the latter was going to pay. Callon tried to convince shareholders by stating that the acquisition will yield immediate benefits such as a jump in cash flow and earnings.

Callon also said that it expects to generate $100 million in free cash flow each year thanks to the acquisition starting in 2020. However, key investor Paulson & Co. that holds a 9.5% stake has raised objections to the deal, citing that Callon is paying a high premium for a company that doesn’t have great assets.

As reported by Reuters:

“Paulson, which has a 9.5% stake in Callon, in a letter to the company’s board said adding Carrizo’s “inferior Eagle Ford assets will permanently reduce the attractiveness of Callon to potential acquirers.”

The risk of moving into a new asset base in the Eagle Ford and weakness in the oil price scenario as a result of macroeconomic problems could pose a challenge for potential acquirers of Callon. As such, shares of Callon have remained under pressure this year and they could continue to be that way until and unless the overhang of the acquisition doesn’t go away.

Some more things to consider

Callon is doing well on its own, so it probably doesn’t need Carrizo. The company’s production increased 40% year over year in the second quarter of 2019. Its average daily production during the quarter came in at 40,516 barrels of oil equivalent per day, 77% of which was oil.

So, even though its average realized sales price dropped from $52.02 per BOE in the year ago period to $45.31 per BOE in the second quarter of 2019, its revenue increased nearly 22% year over year. Of course, weak oil prices did take a toll on Callon’s operating margin and the bottom line, but investors shouldn’t forget that the production increase was achieved at a lower capital expense.

Callon’s Q2 2019 capital expenditure came in at $166 million as compared to $187 million a year ago. This makes it evident that the company is already taking the right steps by increasing output in an efficient manner, which is why it doesn’t make sense for it to diversify and take on another company at a time when there is uncertainty in the oil price environment.