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Domestic oil and gas explorer Energy XXI (Bermuda) Ltd. (EXXI - Snapshot Report) has agreed to acquire smaller rival EPL Oil & Gas Inc. for about $2.3 billion in stock, cash and debt. Following the announcement, shares of EPL surged 30%, while those of Energy XXI fell about 6%.

Both companies, based in Houston, are upstream players engaged in the exploration and development of crude oil and natural gas resources in the U.S. Gulf of Mexico (GoM) shelf. The deal will create the largest publicly-owned independent oil producer in the region’s shallow water, with 10 oilfields, daily production of approximately 65,000 barrels of oil equivalent and an enterprise value of $6 billion.

The transaction has been okayed by the boards of both companies but awaits regulatory and shareholder approval. We expect the buyout to conclude by June 1 following which the current stockholders of Energy XXI will own approximately 77% of the combined company, with EPL shareholders owning the rest. The resulting entity – to be headquartered in Houston – will be led by Energy XXI Chairman and CEO John Schiller, while one EPL director will join the enlarged board.

Under the terms of the agreement, EPL shareholders will receive $25.35 in cash and 0.584 shares of Energy XXI for each share they hold. This combination of cash and stock values EPL shares at $39 apiece, a 34% premium to the pre-announcement closing price. The cash component of the deal is worth about $1 billion, while equity contribution will total around $500 million. Additionally, Energy XXI will assume $707 million in debt.

The acquisition – Energy XXI’s largest in more than three years – will allow the GoM pure play widen its presence in the central shallow water region, thereby lowering capital costs and improving operating efficiencies. In particular, as access to new energy resources in the GoM becomes more difficult, Energy XXI, like most of its peers, has been facing headwinds to replace its reserve base and grow production. The EPL buy will help Energy XXI to overcome this problem.

Both EPL and Energy XXI retain a Zacks Rank #3 (Hold), implying that they are expected perform in line with the broader U.S. equity market over the next one to three months.

Meanwhile, investors interested in the ‘Oil/Energy’ sector may consider stocks like Helmerich & Payne Inc. (HP - Analyst Report) and Patterson-UTI Energy Inc. (PTEN - Analyst Report). Both of them carry a Zacks Rank #1 (Strong Buy).

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