Chevron’s pending acquisition of Hess presents an attractive opportunity, despite inherent risks. Currently, Hess stock is trading at a discounted price, approximately 7% lower than Chevron’s all-stock offer for the energy company.
On October 23, Chevron announced its deal with Hess, initially valued at $60 billion. The agreement entails swapping 1.025 shares of Chevron for every Hess share. Initially, there was a tight arbitrage spread as Hess stock traded at a slight premium of $161 compared to Chevron’s $160.
However, the scenario has since changed. Currently, Hess trades at a $6 per share discount to Chevron, with Hess increasing by 0.7% to $141.50 and Chevron rising by 0.3% to $147.89 on Thursday. By applying calculations, the current value of the deal amounts to approximately $151.50 per Hess share (1.025 times $147.89). According to estimates, holders of Hess shares could potentially earn around $10 per share, resulting in a 7% gross return if the deal successfully concludes and both stock prices remain steady. Arbitragers can take advantage of this situation by buying Hess and short-selling Chevron to capture the spread.
Assuming the deal closes around June 30, the annualized return on this arbitrage trade is significantly higher than 7%, as investors can earn the return within a span of less than six months. Chevron aims to complete the transaction within the first half of this year, as stated during the announcement of the deal.
In comparison to another major oil merger happening during the same period, Exxon Mobil’s deal for Pioneer Natural Resources, the Hess/Chevron arbitrage spread is wider. Pioneer stock, which experienced a minor decline of 0.6% to $228.55 on Thursday, is trading at approximately a 4% discount to the value of Exxon’s all-stock offer. Exxon’s stock also observed a slight decrease of 0.4% to $102.42.
The widening of the Hess/Chevron arbitrage spread can be attributed in part to threats made by Nicolás Maduro, Venezuela’s leader, against Guyana. Hess’s most valuable asset is a 30% interest in an offshore oil field managed by Exxon Mobil, located in Guyana.
Overall, the Chevron-Hess deal appears to be a promising opportunity for potential investors seeking favorable returns within a relatively short period.
Implied Odds of Hess/Chevron Merger Completion
The Merger fund’s co-manager, Roy Behren, believes that the current market price of Hess indicates a lower probability of the deal with Chevron being completed than he thinks is realistic. According to Behren, the market is pricing in a roughly 65% chance of completion, but he believes the actual chances are higher than that.
Determining the implied odds of merger completion is more of an art than a science because it requires estimating where Hess’s stock price would be if the deal were to fall through. Behren assumes a price of about $116 per share, significantly lower than Hess’s pre-deal price of approximately $163 per share. However, if the deal doesn’t happen, Behren suggests that the “break” price for Hess could be higher, perhaps around $130 per share. This would shift the risk/reward dynamic more in favor of investors.
The market reaction to Chevron’s deal for Hess has been lukewarm, with concerns about the high price for a company heavily reliant on a single asset, particularly after Venezuela’s resolution in December asserting sovereignty over oil-rich Guyana. The Merger fund has consulted with international experts who believe Venezuela is unlikely to take military action against Guyana despite the resolution. Following the resolution, leaders from both countries met and committed to maintaining peaceful relations. Behren does not anticipate any antitrust issues with the deal.
Chevron, in its announcement of the merger last October, described the Guyana oil field as an “extraordinary asset” with strong cash margins and low carbon intensity, expected to contribute to production growth well into the next decade. Exxon Mobil estimates that the Guyana field holds over 8 billion barrels of crude equivalent, making it one of the largest in the world.
Investors will be closely watching Chevron’s fourth-quarter results, set to be reported this Friday, and CEO Mike Wirth may provide further insights on the merger during the company’s conference call.