Late on Wednesday, the mystery surrounding the suspension of Premier Oil (LSE: PMO) shares was solved. The group is to pay $120m to acquire the North Sea oil and gas assets of energy giant E.ON.
Although this wont solve all of the problems facing Premier, I think it is a good deal as Ill explain below.
Why are the shares suspended?
Premiers shares were suspended before this deal was announced. As I write, they remain suspended.
The reason for this is that the collapse of Premiers share price has left the firm with a market capitalisation of less than 100m. Thats very close to the value of the E.ON assets being acquired, as Premier will have to pay a working capital adjustment on top of the $120m.
If a company acquires assets worth more than its current valuation, then the deal has to be classified as a reverse takeover and is subject to different rules. The stock market authorities are still trying to decide whether the Premier/E.ON deal should be treated as a reverse takeover or a regular acquisition.
How will the deal work?
Premier is paying $120m for E.ONs oil and gas production assets in the North Sea. The money seems likely to come from the $120m payment Premier received from the sale of its Norwegian business in December.
There is a sound logic to this, as the Norwegian assets were undeveloped oil fields which required further investment to bring to production. In contrast, the E.ON assets will add around 15,000 barrels of oil equivalent per day of oil and gas production to Premiers output and provide valuable cash flow.
The E.ON assets also benefit from attractive hedging. For example, 33% of this years expected oil production is hedged at $97 per barrel.
There are other attractions, too. Operating cash flow from the new assets will be untaxed for the foreseeable future, as Premier has $3.5bn of historic tax losses it can set against UK production.
The increase in earnings resulting from the deal will also strengthen Premiers position with its lenders, as it will improve the groups debt to earnings ratio. Premier says the E.ON deal should increase the groups borrowing limit by around $500m in 2016.
Is Premier a buy?
Alongside the details of the E.ON deal, Premier also published a regular trading update. The firms production and development projects are broadly on track and group production is expected to rise from 57,600 boepd to 65-70,000 boepd in 2016.
However, the elephant in the room is Premiers $2.2bn net debt. This is why the shares have fallen 86% over the last year. At current oil prices, Premier will struggle to repay any of this debt. The situation should be manageable in 2016, but sizeable repayments are due in late 2017.
In my view, Premiers deal to acquire the E.ON North Sea assets is smart and should deliver long-term returns. However, I think that the groups debt levels make the stock a very risky buy until we see some evidence that the oil market is starting to rebalance.
If you’re still unsure about oil stocks and are looking to diversify away from commodities, then you may want to consider the company chosen for “1 Top Small-Cap Stock From The Motley Fool“.
The company concerned is an innovative pharma business with a number of fast-growing products. The Fool’s experts believe that this stock may be significantly undervalued at present.
This exclusive small-cap report is FREE and carries no obligation.
To receive your copy today, click here now.
Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.