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InsideArbitrage April 2023 Mid-Month Update: The Mother Fracker Is In Play

  • April 16, 2023

We started tracking pre-merger announcements or rumored deals in 2017 and called them “deals in the works” (DITW). One of the advantages of collecting data over multiple years is that you can check for patterns and revisit your analysis to see if any conclusions you came to, continued to persist with a larger data set.

I have been told that DITW is a potentially lucrative area that I am not paying enough attention to, but that couldn’t be farther from the truth. Not only have we looked for patterns in the data multiple times, we have run several experiments by writing code as well as by manually combing through SEC filings to look for nuggets of information to see if they could predict which DITW situation would turn into actual deals with a definitive merger agreement (DMA).

Before we discuss some of that analysis and what the latest iteration of that analysis turned up, I am going to borrow from our first mid-month update article from October 2021 discussing a potential deal to describe how we approach DITW.

Analysis of Deals-in-the-Works

We started tracking “potential” deals more than six years ago and built a tool for premium subscribers to see which of these rumored deals eventually came to fruition and which ones failed. To avoid speculative noise or baseless rumors, we restricted the types of deals we included in this DITW tool and described them in the disclaimer section of the tool as,

These potential deals are ones where i) the company has indicated that it is “seeking strategic alternatives”, ii) there has been an unsolicited bid for a company as mentioned in a press release by the company or iii) news about the deal has been published by a leading news organization like The Wall Street Journal, The New York Times, Bloomberg, Financial Times, The Washington Post, Reuters and The Associated Press.”

As best as possible we will try to avoid baseless rumors. There is a high probability that many of these potential deals may not materialize and if they do, the terms of the deal may be different from what was initially reported. Please do your own due diligence before buying or selling any securities mentioned on this website.”

The first time we analyzed this data in December 2018, we wrote the following:

With over 200 deals in this tool, a question by a recent premium subscriber about the types of deals that succeed and the ones that fail prompted me to analyze the data in more detail. Out of the 205 deals we analyzed, 80 succeeded (39% of total) and the successful ones generated returns of 11.96%. Confirmation of the deal usually followed in quick succession after the rumor came out and hence annualized returns were even more impressive at 149%. Unfortunately the 61% of the deals that did not materialize or that became inactive (we mark them as inactive if there is no deal within six months of the rumor) wiped out the gains from the successful ones.

We then decided to dig deeper and see if we could find any signals by looking at the type of potential deal, including news reports, unsolicited bids or the company announcing that they were seeking strategic alternatives. We did find some interesting patterns but nothing that looked particularly appealing and the numbers were so small that the results were probably not statistically significant. I shelved the post I had started writing about this little research project and figured I will revisit it when we had more data.

The second time we analyzed this data was in October 2021 when our data set had more than doubled and we wrote:

The number of deals in the DITW tool have more than doubled since we last analyzed the data and there are 477 deals in the database now. Interestingly, the success rate has improved to 43.4% and potential deals classified as “unsolicited bid” had the highest success rate with more than 51% of them ending up with a definitive merger agreement. Contrary to what I would have expected, “companies seeking strategic alternatives” had the worst track record with just 31% of them ending up with an acquirer.

Going deeper into the rabbit hole and looking at the potential returns for the three categories yielded even more interesting results. Successful deals that we tracked as a result of an unsolicited bid generated 11.38% returns after the news of the potential deal was out. Since these returns occurred in a relatively short period of time, the annualized returns worked out to 183.59%. The potential deals we tracked as a result of news reports also fared quite well with successful deals generating returns of 12.32% and annualized returns of 182.30%. Companies seeking strategic alternatives generated gains of only 1.11% and as discussed earlier, less than a third of them were successful.

Data Refresh

I wanted to feature a DITW opportunity for this mid-month update but instead of just focusing on that specific opportunity, I also wanted to refresh the data to see if our prior conclusions held with an expanded data set.

As of April 15, 2023 the data set now includes 750 pre-merger deals with 297 or nearly 40% of them resulting in a successful merger announcement. An additional 300 or exactly 40% were marked inactive by us as there was no further news about the situation six months later. A group of 88 or nearly 12% were flagged as failed because the company or the potential acquirer denied the rumor, and 65 or just below 9% are still active.

Some of our observations from prior analysis continued to hold and the numbers this time around were closer to the first time we dug into the data in 2018. Here are the updated conclusions:

  • Successful deals generated gains of 11.51% on average and given the short-time between the rumor and the actual merger announcement in many cases, the annualized returns worked out to 184.62%. This time around, given the larger data set and the fact that the number are remarkably similar to what we saw the last time, I did not comb through the data as closely as I did the last time to look for any discrepancies.
  • What was interesting this time was that the “inactive” category of deals also generated gains of 7.63%. Between these two groups (successful and inactive), you have nearly 80% of all DITW situations covered.
  • Once again, it was the situations classified as “unsolicited bid” that had the best track record with nearly 47% of them ending up with a DMA and generating healthy gains of 13.34%.
  • Companies seeking strategic alternatives weren’t very good at finding those alternatives and only 26% of them ended up with a DMA. Gains on those deals were also smaller at just 3.58%. It was fascinating that the overall returns for this group including successful, inactive, failed and active deals was very high. I am not publishing the exact number here because the results were unusually good and I want to comb through the data closely to make sure we didn’t make a mistake when capturing the performance information.
  • The third group classified as “news report” had the largest number of DITW situations at 358 and 40.5% of those were successful, generating gains of 12.23% after the rumor came out and a DMA was announced.

While this data is exciting, I wanted to see if we could improve on that 40% success rate by looking for signals that could improve the hit rate. I think we are getting closer to that goal and there are a couple of promising signals that we are currently testing. A recent deal, where the private equity firm Apollo (APO) decided to acquire the chemicals distributor Univar (UNVR) last month for $8.1 billion or $36.15 per share in cash was on my watchlist because of the new signals we are now tracking.

Unfortunately the deal was announced before I got a chance to write about it. The current spread on the deal is 2.41% with an annualized return of 3.38% if it closes by the end of this year. The rumor came out in late November 2022 speculating that a German chemicals company might be a potential acquirer. I liked Univar because it was reasonably priced with a single digit P/E, was expected to grow 9% in 2023 and had a history of generating consistent free cash flow. Missing this rumored deal turned out to be not so bad because the price at which the DMA was announced was actually close to the price post-rumor.

Pioneer Natural Resources (PXD) $230

Pioneer Natural Resources is a oil and gas fracking company that is the most active driller and largest oil producer in the state of Texas (as of 2/8/2023) with the largest amount of continuous acreage in the Permian Basin. The company was also the star of David Einhorn’s Sohn Conference presentation in 2015 called “Meet the Frackers”PXD Mother FrackerWe picked a fracking company, Continental Resources, as a spotlight idea for our August 2020 Special Situations Newsletter following insider purchases by its founder Harold Hamm. The position turned out the most profitable one in the model portfolio when we exited for a gain of nearly 330% when Harold Hamm took the company private in November 2022. The other fracker in our portfolio is Diamondback Energy (FANG), which we discussed in our October 2021 newsletter following a large $2 billion buyback announcement by the company and it is currently up 55% in the model portfolio.

We wrote the following about Diamondback Energy and frackers in general in that October 2021 newsletter:

What was remarkable about this buyback announcement was that it was coming from a fracking company. When I think of fracking companies, the first thing that comes to mind is the hilarious “meet the frackers” presentation by Einhorn at the Sohn Conference in 2015. I have a great deal of respect for Greenlight Capital’s David Einhorn and I enjoyed reading his book Fooling Some of the People All of the Time, A Long Short Story about his multi-year battle shorting Allied Capital. For a period of time, Einhorn was right about the frackers as they continued to consume ever increasing amounts of capital to drill holes, flood the energy market with excess supply and got hurt by an OPEC engineered price war.

However, this has changed in recent years with companies like Continental Resources and Diamondback Energy reigning in costs and being selective about CapEx. The huge rebound in the price of WTI has helped and instead of drilling more and increasing CapEx, companies like Diamondback are now focused on returning value to shareholders through buybacks and increasing dividends.

While crude oil prices have dropped a lot since June 2022 and the frackers have also seen their stocks pull back from the peak, they continue to generate record profits at oil prices over $80 and have been consistently returning capital to shareholders through regular dividends, special dividends and buybacks.

Pioneer Natural Resources pays a quarterly dividend of $1.10 per share, which works out to a modest dividend yield of 1.9%. However once you include variable dividends, the company ended up paying out $25.43 per share in total dividends in 2022. This is in addition to a 3.51% reduction in shares outstanding over the last four quarters through buybacks.
PXD Return of Capital
A combination of increasing cash flows and repayment of debt had left the company with very manageable net debt of $3.9 billion. Debt maturities are well staggered with $750 million in debt due in 2023, $962 million in 2025 and the rest beyond that at very low interest rates. The company generated $7.43 billion in free cash flow last year despite spending $3.92 billion on CapEx.

Production and Valuation

The company has a pretty good distribution between oil, natural gas and natural gas liquids (NGLs) where 54% of its production is oil and the rest is natural gas and NGLs. To provide a uniform scale of measurement and understand production, natural gas and NGL production is often reported as “oil equivalent barrels”. During 2022, the company produced 650 thousands barrels of oil equivalent per day (MBOEPD) and provided guidance for production to reach 670 to 700 MBOEPD in 2023. The company expects to generate about $9 billion in operating cash flow and over $4 billion in free cash flow in 2023.

Pioneer Natural Resources’s enterprise value is $58 billion, implying it is trading at about 6.44 times expected operating cash flow in 2023 or about 14.5 times free cash flow.

Electrification and Renewables

There are several concerns related to energy generated from fossil fuels including an increasing focus by governments on electrification of transportation and the use of renewable sources of energy. Before the fracking boom and discovery of vast offshore oil fields, peak oil was also a concern. We also have geopolitical issues including wars and the stability of governments in oil producing countries. There are also fracking specific issues such as the rapid drop-off in production for shale oil wells.

Starting with electrification and renewables, less than 6% of new vehicles sold in the U.S. were electric vehicles in 2022. While a small piece of the overall pie, this number is a big jump considering sales of electric vehicles in the U.S. was just 2.4% in 2020. Countries like China are seeing a significant jump in the sale of electric vehicles. Considering this increasing move towards electrification of transportation and improving fuel efficiency, why is the price of oil rising?

While there could be a gradual decline on the demand side of the equation, oil is a commodity that is controlled by a legal cartel that can and does constrain supply. With the frackers aligned with OPEC and showing restraint with capital expenses to increase production, the oil story still has several years to play out and explains why Warren Buffett continues to add to Berkshire Hathaway’s stake in Occidental Petroleum (OXY).

The shift towards renewables is not lost on Pioneer Natural Resources and the company has partnered with NextEra Energy on a 140 megawatt wind generation project.

Potential Acquisition by Exxon Mobil (XOM)

Pioneer Natural Resources was up earlier this month following a report by the Wall Street Journal that Exxon Mobil had held preliminary talks with Pioneer Natural Resources. While the size of the deal is going to be massive – a 20% premium to current prices would put the enterprise value at $70 billion – given Exxon Mobil’s current enterprise value of $496 billion and the whopping $58 billion in free cash flow Exxon Mobile generated last year, the deal makes sense.  Locking in sources of future production is just as important to an oil giant like Exxon as share buybacks and returning capital to shareholders during an up cycle.


When we analyzed the potential acquisition of Pioneer Natural Resources, it exhibited the signals we have been testing. More importantly it looks attractive on a stand alone basis as long as oil prices don’t suddenly crater. At $39 per barrel of oil, the company is at corporate breakeven. At $47/barrel, the company can pay its current regular dividend. Anything above $47/barrel allows the company to invest in growth and return a significant amount of capital to shareholders.

I am going to start a position in Pioneer Natural Resources (PXD) at our regular position size of $5,000 in the model portfolio. I will also be purchasing the stock for my personal portfolio after this mid-month update is published. Considering the model portfolio is fully invested, I am going to sell three positions that have not done well for us including Virtu Financial (VIRT), Magnachip Semiconductor (MX) and Jefferies Financial Group (JEF).