Fitch Ratings has placed Callon Petroleum Company's 'B+' Long-Term Issuer Default Rating (IDR) and all issue-level ratings on Rating Watch Positive (RWP).

The RWP placement follows the announcement that APA Corporation (APA) has entered into a definitive agreement to acquire Callon in an all-stock acquisition valued at approximately $4.5 billion, including approximately $1.9 billion of net debt. As contemplated, Callon shareholders will receive 1.0425 shares of APA for each Callon share at close.

The combined company will produce over 500 thousand barrels of oil equivalent per day (Mboepd), will hold approximately 425 thousand net acres in the Permian basin, excluding Alpine High and certain Midland acreage, and cost synergies associated with the deal are estimated at approximately $150 million per annum. APA expects to refinance all of Callon's existing debt with pre-payable term loans on or shortly after close, which provides a path toward deleveraging in the near term.

Fitch expects to resolve the RWP at close which is currently expected in 2Q24. Although unlikely, the closing of the transaction and resolution of the RWP could take longer than six months.

Key Rating Drivers

Acquisition Enhances Footprint: The announced $4.5 billion acquisition of Permian pure-play Callon should improve APA Corp's business profile by adding scale to the company's Permian operations. Callon contributes 145 thousand net acres in the Permian, split between the Delaware (82%) and Midland basins (18%), with Delaware acreage primarily in Ward, Reeves, and Winkler counties.

The acquisition also adds 102 Mboepd, boosting APA's pro forma size by around one-quarter to over 500 Mboepd and increasing its portfolio tilt toward the U.S. The acquisition should also increase APA's 1P reserve life (6.1 years versus CPE's 12.6 at YE22), provide a modest boost to APA's liquids mix (79% of production for CPE versus 67% for APA at Q323) and the transaction is expected to be FCF accretive.

Modestly Leveraging: The Callon acquisition is moderately leveraging (44% debt funding), and will add $2 billion in new unsecured term loans, which will be used to refinance CPE's existing debt. Both APA and CPE had low leverage heading into the deal (1.1x and 1.4x respectively for the LTM period ending Q3 2023, as calculated by Fitch). Fitch expects APA's credit metrics will remain within bounds of the 'BBB-' rating under the agency's base case assumptions (WTI oil prices of $70/$65/$60/$57/bbl 2024-2027) but notes a sustained drop in oil prices could be a risk for debt repayment given the historical lack of hedges at APA.

Sub-2.0x Standalone Leverage: Fitch forecasts sub-2.0x standalone mid-cycle EBITDA leverage for Callon, which utilizes Fitch's $57/bbl WTI oil and $2.75/mcf gas price assumptions, at the company's 3Q23 gross debt balance of approximately $1.96 billion. Fitch projects mid-cycle leverage will improve toward 1.5x following continued debt reduction toward management's stated long-term target of less than $1.5 billion.

Derivation Summary

Callon's 3Q23 average daily production of 102 Mboepd (57% oil) is higher than Permian peers Moss Creek Resources Holdings, Inc. (B/Stable; 58 Mboepd in 1Q23), but less than than SM Energy Company (BB-/Stable; 154 Mboepd) and Matador Resources Company (BB-/Stable; 135 Mboepd). The company's oil mix of 57% is on the higher end of the Permian peer average and supports the FCF and margin profiles.

The company's Fitch-calculated unhedged cash netback of $33.1/boe in 3Q23 is similar to SM Energy ($32.1/boe), but lower than Matador ($40.3/boe) and Moss Creek primarily given differences in oil mix and in-basin realized oil prices.

Key Assumptions

Base Case WTI oil price of $75/bbl in 2024, $65/bbl in 2025, $60/bbl in 2026, and $57 in 2027;

Henry Hub natural gas prices of $3.25/mcf in 2024, $3.00 in 2025, and $2.75 in 2026 and 2027;

APA Acquisition closes as contemplated in 2Q24;

Average standalone annual production growth in the low single-digit percentage points;

Standalone growth-linked capital expenditures throughout the rating case.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch expects to resolve the RWP upon completion of the contemplated transaction under proposed terms and favorable treatment of Callon's debt.

Factors that could lead to a positive rating action for Callon independent of the transaction include:

FCF generation that leads to gross debt reduction approaching $1.5 billion;

Organic and/or M&A growth resulting in total production approaching 125 Mboepd;

Maintenance of economic drilling inventory, proved reserve life and unit costs;

Mid-cycle EBITDA leverage sustained below 2.0x.

Factors that could, individually or collectively, lead to negative rating action/downgrade

Inability to generate FCF leading to an erosion of the liquidity profile and/or RBL utilization sustained at or above 50%;

Inability to manage economic drilling inventory and/or expectations for weakened unit economics;

Mid-cycle EBITDA Leverage sustained above 2.5x.

Liquidity and Debt Structure

Adequate Standalone Liquidity: As of Sept. 30th, 2023, Callon had $3 million of cash and $396 million outstanding under its RBL credit facility. The credit facility matures in 2027 and supports a $2.0 billion borrowing base and $1.5 billion of elected commitments. Fitch does not expect any material borrowings under the RBL in the near term and believes the liquidity profile is further supported by the expectation for strong standalone FCF generation in 2024.

Fitch believes Callon's outstanding notes will be refinanced with new APA term loans and the credit facility will be fully repaid and terminated on or shortly after the transaction close.

Issuer Profile

Callon Petroleum Company is a public U.S. onshore-focused exploration and production (E&P) company focused in West Texas. The company's asset base consists of approximately 145,000 net acres split between the Delaware and Midland Basins.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

(C) 2024 Electronic News Publishing, source ENP Newswire