Merger and acquisition activity continues to sweep across the energy sector.

In the latest deal, Chesapeake Energy (CHK) agreed to acquire rival Southwestern Energy (SWN) for about $7.4 billion, in an all-stock transaction that will create the largest natural gas producer in the U.S. The enterprise value of the newly combined company will be around $24 billion.

This transaction marks the first big acquisition focused on natural gas since a deal frenzy kicked off in the U.S. energy sector at the end of last year. The deal is also the biggest natural gas-focused U.S. upstream deal in more than 10 years, reflecting confidence around the long-term outlook for U.S. liquified natural gas (LNG) exports.

Chesapeake will pay Southwestern shareholders $6.69 per share in Chesapeake stock, with Southwestern shareholder receiving 0.0867 a share of Chesapeake for each share of Southwestern they own. The combined company would be 60% owned by existing Chesapeake shareholders on a diluted basis, with the remaining 40% held by current Southwestern shareholders.

The transaction should close in the second quarter, subject to regulatory approvals. The combined firms will assume a new name after the closing.

Natural Gas Powerhouse

This deal should not come as a surprise.

While natural gas prices spiked in the year after Russia’s invasion of Ukraine, they were far lower in 2023, prompting explorers to be more conservative when it comes to spending.

Yet, U.S. LNG exports have grown in importance since the war in Ukraine began, as Europe seeks to replace gas shipped via pipeline from Russia. And with many of the best drilling locations already owned or leased, buying rivals with choice gas-producing sites has become increasingly important for companies to keep growing. As such, the logic behind the deal is pretty straightforward for Chesapeake: it seeks to feed the surging demand for liquefied natural gas exports along the U.S. Gulf coast.

The acquisition allows Chesapeake to blow past its largest domestic rival, EQT Corporation (EQT), and expands its holdings to 1.2 million acres in two key drilling regions: the Marcellus basin in Appalachia and the Haynesville basin, which straddles Louisiana and east Texas. The newly combined companies will produce about 7.4 billion cubic feet of natural gas a day, according to S&P Capital IQ, overtaking the current number-one producer EQT, which produces about 5.4 billion cubic feet per day.

The additional resources in the Haynesville are particularly important since it will allow Chesapeake to take greater advantage of the aforementioned growing U.S. exports of liquefied natural gas from the Gulf of Mexico.

Why Buy Chesapeake?

Chesapeake’s move to buying Southwestern cements its push to focus exclusively on natural gas. The merger marks the next stage in Chesapeake’s evolution, making it the largest natural gas exploration and production company in the U.S. by production, proved reserves, market capitalization, and enterprise value. The company’s decision to become more of a pure-play gas company sharpened last year when it exited South Texas and sold its remaining Eagle Ford oil assets to SilverBow Resources for $700 million.

I believe the merged company will be added to the S&P 500 soon after the deal is completed, but even if it is not, the new company will be a “must-own” stock as LNG exports from the U.S. to Asia and Europe in the coming years rise. The new company expects up to 20% of its future production will be tied to international pricing for gas.

That’s another reason for me to think this will be one of the few transactions where one plus one should turn out to be much greater than two.

And there is good news for income investors too: the combined group should see an improvement of some 20% to dividends per share over five years, the companies stated, under Chesapeake’s existing shareholder return framework. Chesapeake’s dividend yield is currently 4.7%. Southwestern doesn’t pay a dividend.

With the solid dividend background, and the booming LNG export industry giving it a strong tailwind, CHK is a buy up to $87 a share.