Nomura Explains Increase to Range Resources Price Target

When Range Resources Corp. (NYSE: RRC) announced Monday morning that it had agreed to acquire Memorial Resource Development Corp. (NASDAQ: MRD) for $4.4 billion in an all-stock transaction, Range’s stock opened down more than 3% at $40.70 before falling further to close at $37.69. By Friday’s opening bell, shares had recovered to $40.30.

It’s easy to see why the initial reaction was negative: both companies are primarily natural gas producers and natural gas prices haven’t gone anywhere but down over the past year or so. Range already produced about 1.4 billion cubic feet equivalent per day of natural gas, more than three times Memorial’s production.

Range’s CEO, Jeff Ventura, said on Monday that the acquisition gave the company a strategic position in the Gulf Coast area to add to its dominant position in the Marcellus shale play in Appalachia. He also noted cash flow growth, a better credit profile and an enhanced portfolio.

Nomura Securities analyst Lloyd Byrne weighed in Friday morning with a price target increase on Range’s stock from $29 to $45 a share while reiterating the firm’s Buy rating. Byrne’s rationale is instructive:

[W]e are increasingly believers in the attributes of scale going forward. We’ve written about it often, but the industry is in early stages of driving down sustainable marginal cost with scale being an important go forward component. Last cycle was about resource capture. This cycle is about resource productivity, with operators judged on returns and trajectory.

[nativounit]
Size matters if the goal is to increase margins and profits and keep shareholders happy during the current low-price environment. Wringing out costs is about the only arrow in management’s quiver and, at least in the case of energy producers, reducing expenses is easier for bigger players (up to a point).

Nomura still had some questions, though:

In particular: (1) Is RRC concerned about the duration of the basis differentials in the Northeast? As new pipes are delayed or cancelled for economic and regulatory concerns, is RRC worried about basis? (2) Why would MRD sell for a low premium, in a 100% stock deal? The initial stock reaction had to be anticipated. Both questions are nagging at investors.

Both are legitimate concerns, and it will take a while to get a better grip on the first. As to the second, Memorial’s acreage in northern Louisiana totals some 220,000 net acres, with a potential 5 trillion cubic feet equivalent of resource. But low gas prices and Memorial’s cash position likely combined to paint a picture of slow to no growth. Shareholders in Range at least get an annual dividend of eight cents. That’s half what it was a year ago, but better than no dividend at all, which is what Memorial offered.

Range’s stock traded at $39.81 in the mid-morning Friday, down about 0.4% for the day, and in a 52-week range of $19.21 to $59.47.