I've been up on the stage for 12 years. You've been here every year, and I can go back to a lot of conferences. It's nice to see you again.
It's great to be here.
Exciting times for SM. Big merger the last month between SM and Civitas. Obviously, a lot to talk about there. I'm going to turn it over to Wade to give a State of the Union intro, and then we'll jump into a fireside. I'll remind you, if you have questions later on, please feel free to raise your hand, and we'll call on you.
Thanks, Gregg. It is great to be here again. Thanks to B of A for this conference, and thanks for doing it in Boca Raton in December. Coming from Denver, Colorado, it's really nice to be here right now. Just anecdotally, just so you know how cold it is in Colorado, yesterday morning when I was leaving, I went to the Starbucks where I normally go to get my coffee, and I know the lady really well, and she said, "I always go into the walk-in freezer and get some stuff, get ready for the day." I walked in there this morning, and it felt really good. It's not a good sign. It's not a good sign. Thanks for having us in Florida. It is an exciting time for SM Energy, as you say.
We've been around, those of you that know us, we've been around for over 115 years. We've become very known for kind of brand recognition for being a premier operator, operation execution on top-tier assets, and having kind of a technical bent toward innovation. I think that really differentiates us from other, especially companies our size. We're really excited at the opportunity to add scale, to overdouble in size, in assets in four different basins that are top-tier basins. We're very excited to apply our operations expertise and technical innovation in those areas. We see significant synergies from the deal. We put out an announcement with some additional data a couple of weeks ago. I hope you've had a chance to look at that. I'll refer to some of it today.
It was really just in we were not pleased with the way that the stock responded to the deal, and we just wanted to kind of lean in and kind of quantify some of the areas and give some more meat to the bone on reasons we are so excited about this deal. I mentioned the synergies, $200 million-$300 million of kind of annual run rate synergies that we see being very achievable. That is mostly on the D&C, the drilling and completion side and LOE side, as you would expect. I will not read the slide for you. A lot of stuff in there you can look at on your own. Also, obviously, two public companies headquartered in Denver, Colorado. It is not hard to start immediately thinking about a lot of savings there on the overhead side.
On the cost of capital side, there's going to be significant savings there as well. Didn't really lean in too much on that as far as quantifying a number. You can easily see how I think we put $30 million-$40 million or $45 million of savings there. Just thinking about the synergies and the reducing debt from those, it's easy to start thinking about cost of capital savings. We talked about divestiture proceeds. I'll say something about that in a second. That would obviously drive savings there as well, but also just the average borrowing rate. You look at some of the coupons on some of the maturities, and you can see how as we refinance those and move along left to right, as a larger company, you can easily see a lot of cost of capital savings from this combined entity going forward.
Rating agencies were very favorable on the announcement. Two of them even said positive outlook. People love to ask, does this move you to investment grade? I'm always afraid to speak for the agencies. I think it definitely moves us that direction. Definitely checks a box on the scale side. The diversity side, sure, as well. Commodity mix, those kind of things are positive. The last point I'll make before I go to Q&A is we did also announce that we'd be targeting $1 billion plus in divestitures within the first year. We think that's very attainable. That would obviously be dedicated to strengthening the balance sheet, accelerating that deleveraging that we really want to do. You all know us really well. We try to run the balance sheet in that one times area. We consider that a strong balance sheet.
This pro forma moves us kind of up into that mid ones area. Not an uncomfortable area at all, but we like to move it back towards the one times area, and that's what we'll be focused on doing in the near term. Pro forma company generates a lot of free cash flow. I think if you just look at pro forma this year, it's something in the $1.5 billion area. That will be prioritized to debt reduction early on. Divestiture proceeds could accelerate that, and we look forward to getting back into that low ones area and kind of prioritizing the free cash flow more to return of capital, stock buybacks, et cetera. That's my summary.
That's a great start. I think we were talking about the originally you put out the announced the transaction a couple of weeks later, you announced an update. I think part of that was because the stock wasn't necessarily trading to reflect the M&A transaction. What's the ARB today on that? Do you see any challenges with the deal closing?
I don't see any challenges. I think I haven't looked at it today or too recently. I think it's gone, I think since that announcement, if I'm correct, I think it started going back the other direction as far as our stock versus their stock and what that implies for the exchange when we close. I don't think there's anything to be overly concerned about at this point.
Do you think you have to announce acquisitions, asset sales prior to the transaction close? Obviously, you can't announce Civitas sales, but.
Can't sell assets we don't own. That's not going to happen. There's no plans to do anything. We're ordinary course of business, looking at things all the time. That's all I can say on that.
The potential sales. There was a headline a couple of weeks ago about Eagle Ford possibly for sale. I'm curious what's on the table and what might not be.
As you would expect, I can't answer that too directly, too specifically. We love all of our assets. I start by saying that for different reasons. As far as when we think about divestiture candidates, there's a lot of factors that go into that that we would consider. It would be things like PDP component versus inventory upside, where you can imagine that being a consideration. Commodity mix is a consideration. Gas versus oil, where we are in the cycle, those kind of things, which probably led some to speculate on the Eagle Ford having that gas mix that we have there. Regulatory environment certainly is also a factor. Inventory upside is clearly a factor. Different things go into what we would consider divesting.
You mentioned regulatory. You entered the DJ Basin and obviously Colorado-based company. It makes sense, right? How do you feel about the regulatory environment there? Obviously, to have bought, Civitas had to have gotten comfortable with it. You mentioned regulatory is a consideration. Was that what you were alluding to?
Yeah. Now, you said it well. We know Colorado really well, being headquartered there, living there. I would say that looking at the Civitas team and how they manage the process, permits, et cetera, they do an exceptional job. Things have actually improved. There was a recent report from Enverus talking about how things have improved a lot this year as far as getting permits, time to get permits. It is looking better. The asset underground we really like. That asset generates a lot of free cash flow. It is something that we will be learning as we move along.
I guess it's fair to say you don't want to tell people what you're selling because you want to optimize value, right?
Sure.
There is a price for everything, right? That is fair to say. What is tricky for us is we see the cash flow generation of the combined company, and we understand that you have asked us to sell, but I am trying to figure out what does the pro forma company look like. One of the things that the agencies, you talked about the rating agencies, they care about scale and scope. Obviously, I think you are over 500,000 barrels per day. Do you feel there is a risk that you could, or do you think about this, that you could sell so much of the company that you remove the scale and scope that the agencies like to tell you to investment grade?
It's a great question. The short answer is yes, but the long answer is no. I think looking pro forma, looking at the possible divestiture scenarios leaves the company significantly larger than it is today, even after some divestitures.
Just remind us, the maintenance capital and the combined entity today, or the reinvestment ratio, how should we think about the right capital in the current pro forma business?
Yeah. I can't give you any dollars today. I mean, we're working that combined plan, and after closing, we'll announce something. You can imagine that we're working it the way we would work it in the past, and that is looking out at a two or three-year horizon, really maximizing, focusing on free cash flow generation, not necessarily production. I think I've already said it, so we can say it again, that you can imagine if the commodity price environment kind of stays in this area, $60 or below, I would imagine and I would predict an activity level that is reduced somewhat from what the pro forma, just putting the companies together right now, would look like.
This is more of an experiential question for you.
Can't wait.
We follow the rating agencies, what they write. And over the years, the timing of investment grade, every CFO knows the caveat. We want investment grade profile, but we leave it to the agencies' divine will to tell us.
That's what we have to say.
What I wonder is, it seems to me that in most cases, their holdup is always, well, you bought all these assets. We know how to operate it separately, but you need to show us organic growth. We need to see how you operate organically. I suspect that's what will happen here. I'm curious, do they tell you that? Do they say, "Look, you're there on the size and scale," or do they send you? What's the feedback that they give you to help you understand what that timeframe could be?
We have not closed yet, so the feedback's been fairly limited just on the announcement.
They haven't put out this note, they said, "Hey, Wade, this is what we're thinking right now. We'll follow up later."
Certainly nothing that specific, nothing that black and white. Scale, diversification, love it. There's always going to be, and I've heard a little of it already, that seeing some execution, seeing the deal close, seeing what the new actual guidance looks like, seeing what the actual return of capital plan looks like, things like that. Those are not long-range areas at all.
Their feedback is just as ambiguous as what they tell us?
Yeah. Yeah.
Okay. We share the same experience. There we go. It's my first experiential question in my career, by the way. Maybe coming back to the asset, you talked about probably a little bit less spending. There are some areas of the Permian that there's consideration that maybe you see more development because of higher gas prices, especially with the less oil development because of the lower oil price. Do you see that at all?
We're just now getting into those kind of questions on capital allocation and commodity mix. Nothing really to speak to yet.
Okay.
That would be getting specific into the plan.
Maybe getting to more fun stuff on SM, the operations today. You sit in a seat where you get to rerack your CapEx budgets and see how well people do on recognizing capital savings. Some of it is service costs, some of it is efficiencies. What's your observations about productivity gains in your portfolio, where you think they can go, and how that translates into potentially better CapEx or a more capital-efficient company?
Yeah. There are so many levers, I guess is what I would say, sitting here today and looking forward and trying to see what the opportunities are. We have listed a lot of those areas in those slides that I referred to from, I think it was November 17th. If you want to look back at those. It is going to be, first of all, the first question is just, are we in an overall deflationary environment on cost in our industry? That answer is, you have probably heard it from others. I assume you have heard it from others today. As CFO, it certainly feels like we are heading into that unless something changes on the commodity side. If oil stays in this $60 to below area, people are looking at their budgets for next year, hard for me to imagine that activity overall is not going to be slowing.
History says that has an impact on cost. We are not predicting anything yet, and I have not really seen anything material yet. That is certainly something we are trying to get our arms around before we see what we want to forecast for next year. From an SM standpoint, we talk about it every year. On the technical side, the team is just so diligent, the operations team is so diligent at trying new things, being innovative, whether it is completion design, spacing decisions on the drilling, the lateral lengths. That is going to continue. That is going to continue until we drill our last well, I am told. Not only will it continue, but now it is going to be applied a lot more on new areas. That is exciting. That will be exciting to see what can come out of that.
There's clearly going to be more just centralized, streamlined, combining supply chains between the companies. Purchasing power with the vendors is going to have a, there's going to be a positive impact from that. There's no doubt in my mind. Those are some examples.
Just a question. When do you expect the Civitas deal to close right now?
We're saying first quarter.
More likely, does that probably delay a capital budget from you guys?
Depends on when in the first quarter. Could, hopefully not.
You mentioned some of the, just coming back to some of those savings, cost of capital must be $30 million-$45 million. When you talk about the capital efficiency size in drilling, what is that number and help us understand that?
Yeah. I mean, again, I hate to keep going back. There's a slide that there's actually, we did an additional slide that just focuses on the D&C and the LOE and tries to break it down. It doesn't get that granular, but it breaks down the $100-$150 million by different areas.
Got it.
I want to mention again how big that is. That $200 million-$300 million, we tried to put that in context. First of all, it is incredibly achievable, right? If you look at half of that being D&C, that is only 2%-3% of the combined capital. In terms of valuation, if you think of $200 million-$300 million saved every year for, just pick a number, pick seven years and discount it back, that is $1 billion-$1.5 billion discounted back to today, which is 30% of our market caps combined. Big number, I guess, is what we wanted to make sure that investors understood.
Got it. It's just sort of interesting process. Obviously, you've been through it. As a CFO that has people put these numbers in front of you, and you're kind of like, how'd they come up with that, right? What's your sense of how do they figure out the amount of D&C costs they should fund? Is it a consultant? Is it your internal folks?
Yeah.
As you looked at those numbers and probably wanted to put a number in front of people that was achievable, how did you get comfortable with that?
It is very much driven by our internal folks, which is what you would expect. I mean, we pride ourselves on being experts in that area, work it really hard. And just based on looking at what we are doing, looking at what we could do, and looking at the data that we were provided on the new assets, the assumptions, again, seem very reasonable.
Is there some expectation that you can run the asset better than Civitas, or is it?
Yeah. I don't want to, I don't want to make a broad- brush statement. In certain areas, that is absolutely the case. There are some areas where we're going to see, wow, they're doing something really interesting there that, and we're not in the DJ, by the way, right? There are going to be things that we're going to learn from them. There's no doubt about it. We're excited, certainly about areas like, certainly about the Permian, where we've been for a very long time and doing things really well that we can apply some of the things we do well on their assets. There are going to be some things that they do well that we're going to learn from also.
You said you expected deflation in service costs. What type of indications do you have today?
For me, it's mostly anecdotal at this point. We're having conversations with vendors, and we're here, I'm not going to name anyone or anything like that, that when we're hearing numbers are starting to, when we bid this next, it's going to go down a little bit. There's some of that happening. It's really just mainly watching activity, watching the oil price. Just knowing that you look back, you look back when things line up this way, especially during a period where people are setting their budgets, you tend to get some deflation during these environments. That's really it. No guarantees, but it certainly feels like it.
Just the marketing side of things.
What's that?
On the marketing side of gas and oil, just any constraints right now, just the opportunities to reduce costs there, just in SM's business, but just maybe walk us through that a little bit.
Yeah. I don't see any constraints, any concerns about us being able to deliver what we're planning on in all the basins. That's my general response to that. There's always areas to work, and the team works those really hard.
You mentioned part of your synergies is the lowering of cost of capital. When you look at the debt stack, I think we have discussed, I think your plan is to guarantee, cost guarantee the structure. I do not know if you have contemplated how you are going to.
You can assume they're all SM bonds. Nothing's going to be stranded or anything like that.
How do you think about refining? When you think about, oh, there's some, when you look at what's a near-term event in terms of, maybe the better question is of the $30 million-$45 million of cost of capital savings, for what time period do you think you'll recognize that?
Yeah. I mean, we tried to put a number in there that was reasonable. And kind of the overall assumption for that $200 million-$300 million in total is all being actioned within 2026, with it all being realized, all of it on a run rate basis beginning in 2027 and beyond. Some of it in 2026, but all of it by 2027 and all of it actioned in 2026. As I said, we're pretty modest on the cost of capital assumption. We didn't want to put a big number in there that you could say, well, that's coming, but it's not coming that soon. That number is going to grow. That number is really, there's several different ways that can and will be achieved.
As I said, just starting with the synergies, the $200 million-$300 million, just apply an interest rate to that number, and you get a pretty big chunk of it. You take some out with divestiture proceeds and you blow through it. You start thinking about just your weighted average interest rate or cost of capital, that'll take a few more years, probably, maybe not, but probably as you start to refy some of the higher cost stacks, the first one of any size being in 2028. That will come. There are a lot of ways that that number is going to grow. We just wanted to be modest with the kind of the, we wanted to really focus people on this is a run rate that's going to happen pretty quick. That is why we were more modest on the cost of capital.
Got it. I know it's a little early to talk about the next deal, actually M&A. How long does this keep you, you're going to be in divestiture mode after this? It probably keeps you on the sideline for a little bit.
You know, as a general statement, that's a good assumption. Digesting is important. Integrating is important. Focusing everyone on those efforts is very important. It does not mean we will put blinders on and not continue to look for opportunities to improve the company and the value for shareholders and bondholders. The primary focus in the near term will be digesting this combination.
As you were involved in this process, obviously, and there were probably other people involved, and there's been just a lot of what's called SMID-cap M&A consolidation as of late. When you think about, do you think this trend is going to continue? And when you looked at who showed up in various data rooms, which you've probably been in, not just Civitas, I suspect, did you see that it was a lot of SMID-caps looking to get bigger, or were there also larger IG players or larger investment-grade names?
Yeah. I guess the first thing I'd say, and the lawyers will be proud of me, the proxy hasn't been filed yet. I look forward to reading it. You should too. There'll be a lot of that in there. Yeah, I can't really speak to who was there or any of that. Your first question, though, is I can theorize. It's hard to imagine an environment where that changes, where the desire to get larger. That's kind of the environment we're in. That's what investors want. Our industry is more mature. You get the drivers are cash flow generation, return of capital. That means you're not getting paid to grow up and to the right. That automatically makes you think, drives you to scale being important. Scale is important, size is important. It's hard for me to imagine the trend not continuing.
Another cut to the audience to see if there's any questions. I think I'll take one more here. If you think about buying the DJ Basin, which is something SM should know, and obviously you pointed to how the regulatory environment's improving, those equities have historically traded at a discount, right? When you thought about that, what got you over that hump?
You're just talking about one piece of the.
Obviously, there's a lot of.
It is an important piece.
It's an important piece. Obviously, I get the synergies argument, which, and perhaps that was the argument. I'm just curious.
That is a big part. That's a big part of the argument. All I can say is just from a value proposition, doing our own assessment of the NAV, we felt like it was a very compelling time. It's a good time. It feels like a good time in the cycle. It just felt like a good time to, and the moons had to line up, right? You don't just get to pick when M&A is going to happen. Things have to line up, and they lined up. We got very comfortable with the asset and the value.
Look, I'm looking around to see if there's any more questions. I think we drilled into the merger as well as much as we can get out of here. I just want to, Wade, we'll let you off the hook a little early. Just want to thank you for your time and making it here. Always enjoy our conversation.
My pleasure. Thank you.
I'll see you at the next one.
Absolutely. Thanks, everybody.
Thank you.