Chevron’s All-Stock Deal for Hess Is Surprising. Why Wall Street Isn’t Thrilled.

Chevron (ticker: CVX) said early Monday that it reached a deal to purchase Hess (HES), an independent oil-and-gas company, in an all-stock deal that initially values Hess at $171 a share. That is a roughly 5% premium to Hess’s closing price of $163.02 on Friday.

Despite that modest figure and the fact that Chevron will be returning more capital to shareholders, Wall Street doesn’t seem thrilled that Chevron will be issuing 317 million shares, about 17% of its outstanding stock, for a company that isn’t a must-have asset. 

Hess shares were down 0.2% to $162.66 Monday, while Chevron shares had fallen 2.4% to $162.83. Trust analyst Neal Dingmann cut his price target on Chevron to $169 a share from $175 while maintaining a Hold rating. He cited “near-term dilution” to Chevron from the transaction—a negative factor that is partly offset by the fact that the company also said it plans to increase its quarterly dividend by 8% to $1.63 a share in January.

That would result in a yield of about 4% at the current share price, more than the 3.3% current yield on Exxon. Chevron also said Monday it increased its target for stock repurchases by $2.5 billion to $20 billion annually, which should result in a total yield—dividends plus buybacks—of about 10% annually.

One reason for Chevron’s stock-price drop Monday is arbitrage pressure as arbitragers buy Hess and sell short Chevron to lock in a spread. 

The transaction, due to close in the first half of 2024, follows Exxon’s $59.5 billion deal earlier this month for Pioneer Natural Resources (PXD). The mergers show that the two biggest U.S. energy companies—Exxon and Chevron—are keen on the oil and gas business in a bet that fossil fuels will be a critical source of global energy for decades to come.

With a premium of 5%—10% above the Hess’s average stock price for the 20 days ended on Friday—Chevron appears to be paying up less generously than Exxon has agreed to in the Pioneer transaction. Exxon offered an 18% premium above Pioneer’s stock price about a week before the deal announcement.

One reason that Hess may have accepted the low premium is that the deal is all-stock and therefore tax efficient, which may have appealed to the Hess family, led by CEO John Hess. The family owns about 10% of Hess stock. They and other Hess shareholders effectively get to diversify their investment into the much larger and financially stronger Chevron, which has a much higher dividend yield than Hess’s 1%.

Both Chevron and Exxon are using all stock for their deals, reflecting financial conservatism among big oil companies.

“If you put cash in upfront, then you’re setting yourselves up where you might not have a stable deal,” Chevron CFO Pierre Breber told Barron’s on Monday morning. “If oil prices rise, obviously, the acquirer wins. If they fall, the seller would win. You’re trying to set a deal structure that works for both parties. And we’re in an industry where oil prices can move quite a bit up or down.”

Still, Chevron has a great balance sheet, with just $12 billion of net debt (debt less cash) against a market value of about $310 billion and projected earnings this year after taxes of over $25 billion. Chevron could easily have done a deal offering half cash and half stock that would dilute existing shareholders less and be more accretive to earnings. 

Chevron is using a currency—its stock—that trades for just 12 times this year’s estimated earnings, to buy a company that is valued at 35 times this year’s profits. 

Analysts were mildly surprised that Chevron decided to do a deal with a company without significant complementary assets, unlike Exxon’s merger with Pioneer, which combined two major Permian players. But Chevron’s view is that it has a big exposure to the Permian already and doesn’t need any more.

Hess’s crown jewel and the source of most of its value is a 30% stake in an offshore oil field in Guyana that holds the equivalent of more than 11 billion barrels of crude. That project is ramping up and now produces more than 300,000 barrels of oil equivalent a day. It could produce about 800,000 barrels by 2027, according to Exxon, which is the largest owner and the operator of the project

 The Guyana field is one of the best in the world due to its size and low cost of production. Like any international project, though, it carries the risk that the host country may seek to modify the terms of the deal to make it less favorable to international oil companies.

“Guyana has, to date, been an extraordinarily well-run exploration and development programme by the operator; it is difficult to see what Chevron can bring to the table to enhance the value further,” wrote Citi analyst Scott Gruber in a client note Monday.

Analysts said that with little overlap between the two companies, there likely won’t be any antitrust problems. Still, both the Chevron-Hess and Exxon-Pioneer deals are large, and Biden administration regulators, particularly Federal Trade Commission Chair Lina Khan, have been generally hostile to big mergers.

Write to Andrew Bary at [email protected]