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Premier Oil shares surge on merger news. Is Tullow Oil next?

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The Premier Oil (LSE: PMO) share price has surged higher after the company announced plans to merge with privately-owned North Sea operator Chrysaor. The deal should secure Premier’s future and create a larger, more secure business.

Here, I’ll explain why I think Premier Oil shareholders should probably sit tight. I’ll also look at whether Africa-focused producer Tullow Oil (LSE: TLW) could be the next crash casualty to attract a takeover bid.

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Premier Oil shares: a tight squeeze

In my last article on Premier Oil I warned that the group’s debt looked unsustainable. I suggested shareholders could face a total loss if the firm failed in its efforts to raise at least $325m by issuing new shares.

Fortunately, that risk has now been eliminated. Today’s merger news means the planned fundraising is no longer needed. Instead, Chrysaor will repay Premier’s $2.7bn debt mountain and refinance the business more sustainably.

What’s really happening is that Chrysaor is taking control of Premier by using a mix of cash and new shares to repay Premier’s lenders. The combined business will then trade under Premier’s existing stock market listing.

As part of the deal, Premier’s lenders will be given shares in the combined business. Owners of existing Premier Oil shares will end up owning just 5.5% of the new group.

Why I’d keep holding PMO

Despite the dilution faced by shareholders, I think this is probably a good deal. The combined business should have production of around 250,000 barrels per day, nearly four times Premier’s output.

Estimated operating costs of $10.50 per barrel are 23% lower than those reported by Premier during the first half of this year.

Shareholders should also enjoy a greater share of future returns too. Whereas Premier used all of its spare cash to repay debt, the new business is expected to pay dividends.

Chrysaor’s shareholders will own 77% of the combined group. I don’t think they’d support this deal if they didn’t think it would earn them a positive return. I’ve upgraded my rating on Premier Oil shares to hold.

Tullow Oil: the next takeover target?

Shares in Africa-focused Tullow Oil have fallen by more than 90% over the 12 months, as the firm has suffered technical and financial problems.

The firm now has a new CEO, Rahul Dhir, with plenty of relevant experience. But Tullow’s half-year results in September warned that the company could breach some of the terms and conditions on its lending next year if oil prices don’t improve.

Tullow’s net debt of $3bn remains far too high for comfort, in my view. I think it’s likely Dhir will be forced to sell key assets, or seek out a buyer for the whole company.

However, there’s also a risk the firm will struggle on for years, servicing its debts, but doing little more. In a situation like this, shareholders face a lot of risks.

I don’t see any good reason to buy Tullow shares. Indeed, right now, I’d say Premier Oil shares are probably the better buy.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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