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Is Callon Petroleum's Carrizo Buyout Plan a Boon or Bane?

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Callon Petroleum Company (CPE - Free Report) is currently under the microscope as investors are closely watching the stock and monitoring its move regarding the acquisition of Carrizo Oil & Gas, Inc. . While the company recently announced that the acquisition will have significant positive impact on its portfolio, key shareholder Paulson & Co. — a private investment management firm — is wary of the deal.

Callon Petroleum Aims Economies of Scale

The all-stock deal — valued at around $3.2 billion — is expected to create large-scale development opportunities, and accelerate operational and capital efficiencies. The acquisition synergies are expected to make the company’s portfolio more competitive. This move can trigger economies of scale, which will likely lead to significant cost reduction, which is much needed for the company. Last year, its total operating expenses had increased nearly 46% year over year to $328.1 million. For full-year 2019, lease operating expenses per barrel of oil equivalent is expected in the range of $5.50-$6.50, the upper limit of which is much higher than the 2018 level of $5.76. Rising expenses can keep hurting the company’s profit margin in the coming quarters as well, in case proper measures are not adopted.

Moreover, the deal can improve Callon Petroleum’s cash flow situation. Notably, it has been reporting negative free cash flow for eight consecutive years. Callon Petroleum’s CEO Joe Gatto expects the addition of mature Eagle Ford production to the acquirer’s portfolio, through the Carrizo acquisition, to provide it with steady cash flow. The combined company is expected to have around 200,000 net acres in the Permian Basin and Eagle Ford shale.

Callon Petroleum to Lose Permian Pure Play Tag

The addition of Eagle Ford acreages to Callon Petroleum’s portfolio denotes that it will lose the pure-play Permian status. Some investors like Paulson & Co., which owns 9.5% of the outstanding shares of the company, are sceptical about this change in status quo. On the contrary, Paulson & Co. has advised Callon Petroleum’s board to sell itself than acquiring Carrizo. The buyout can reduce the company’s attractiveness to potential acquirers.

Moreover, Paulson & Co. stated that the deal requires Callon Petroleum to pay 25% premium to Carrizo, which is “unjustifiable”. The manager of funds views the assets to be added to Callon Petroleum’s portfolio, through the acquisition, as inferior in nature. This will likely affect the value of the company.

Notably, upstream companies are currently under pressure from investors, who are no longer supporting drilling programs and expansions in the absence of strong cash flows. Investors want these companies to reduce costs, improve internal efficiencies, raise share repurchases and increase returns. As such, the stock plunged 30.4% since the announcement of the acquisition compared with the industry’s 15.7% fall.

Zacks Rank & Stocks to Consider

Currently, Callon Petroleum has a Zacks Rank #3 (Hold). Some better-ranked players in the energy space are National Oilwell Varco, Inc. (NOV - Free Report) and Pembina Pipeline Corp. (PBA - Free Report) . Both the companies hold a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

National Oilwell’s 2019 earnings per share are expected to rise 137.5% year over year.

Pembina’s 2019 earnings per share are expected to rise 21.5% year over year.

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