With rapid payout and strong cash flow, the Gulf of Mexico (GOM) has emerged as the "epicenter" of merger and acquisition (M&A) activity, accounting for half of the top 10 deals involving U.S.-based exploration and production (E&P) companies year-to-date, Raymond James analysts wrote in their latest "Stat of the Week." Overall, M&A activity within the oil and gas sector continues to heat up, with more than $18 billion in announcements involving U.S.-based E&Ps so far this year.
The GOM transaction that swayed deals toward the U.S. offshore was the September 2005 acquisition of Spinnaker Exploration by Norway's Norsk Hydro for $2.3 billion (see NGI, Sept. 26, 2005), "implying a record-setting valuation of $7.51/Mcfe of proved reserves, approximately double the average for offshore producers at the time, and even currently," said analysts J. Marshall Adkins, Wayne Andrews and Pavel Molchanov. The analysts reported an upswing in North American sales last December, but "even we are surprised by the magnitude of the M&A activity we have seen this year."
Since the Spinnaker announcement, five other GOM transactions, including two corporate and three asset deals, have been valued above the $1 billion mark this year.
In January 2006, Helix Energy Solutions (formerly Cal Dive International) bought Remington Oil & Gas in a deal valued at $1.4 billion, with an approximate valuation of $5.02/Mcfe (see NGI, Jan. 30). Also in January, W&T Offshore bought some Kerr-McGee Corp. GOM assets valued at $1.339 billion, or $3.70/Mcfe (see NGI, Jan. 30). Marubeni Corp. bought $1.3 billion worth ($6.50/Mcfe) of Pioneer Natural Resources assets in February (see NGI, Feb. 27). And in April, Apache Corp. bought $1.3 billion ($3.75/Mcfe) of BP plc assets (see NGI, April 24), and Plains Exploration & Production bought $1.94 billion ($3.34/Mcfe) of Stone Energy assets (see NGI, May 1).
"From a strategic standpoint, these transactions signal a shift in the kinds of E&P companies that are viewed as attractive takeover targets -- or, more precisely, an expansion in the universe of potential targets," said the analysts. "In 2004 and the first half of 2005, the E&P companies that were acquired -- for example, Westport, Tom Brown, Evergreen, Patina and Medicine Bow -- were mainly Rockies-focused with resource play opportunities and long-lived reserves. The Gulf of Mexico, on the other hand, represents a mature hydrocarbon province with short reserve lives (typically from six to 10 years). Given that Gulf of Mexico pure-plays tend to trade at very low [earnings before interest, tax, depreciation and amortization] and [earnings per share] multiples, they often represent highly attractive value opportunities for potential acquirers."
The GOM asset buyers don't all fit into the same category. For example, Norsk Hydro is an offshore-based Norwegian E&P, while Helix is an oil service/E&P hybrid. W&T is a mid-cap E&P that is offshore-focused, while Marubeni is a Japanese conglomerate. Apache is a diversified large-cap E&P; Plains is a mid-cap, onshore-focused E&P.
"An interesting observation is that almost all of the domestic E&P acquisitions made by international operators over the past year have been in the Gulf of Mexico," the analysts noted. "In addition to Marubeni and Norsk Hydro, Norway's Statoil and Japan's Nippon Oil and Mitsui & Co. have made sizable purchases in the Gulf of Mexico." And only a few GOM-weighted producers above the $1 billion market cap are left: ATP Oil & Gas, Bois d'Arc Energy, Energy Partners, Mariner Energy, and W&T.
Adkins and his colleagues noted there are only a few areas with "truly outstanding potential for long-term growth" left in North America: the Rocky Mountains, the Barnett Shale, Appalachia and East Texas.
"The rationale for Gulf of Mexico deals is typically different. The Gulf of Mexico, of course, is clearly a mature area that does not offer the same degree of long-term growth potential as the aforementioned onshore areas, but for many acquirers the rapid rate of cash flow generation more than compensates for the lower growth outlook. And, as commodity prices rise, the Gulf of Mexico's deepwater and deep shelf areas -- which are relatively risky from a drilling standpoint and often have a high cost structure -- are garnering more interest."
The latest M&A deals bode well for drilling, said the analysts. "Whatever the geographic area, a critical factor in making an acquisition succeed is for the acquirer to immediately boost drilling activity on the new properties. Unlike the integrated majors, who have long ago cut back on North American capital spending, E&Ps consistently reinvest 70%+ of their cash flows, primarily on their domestic properties. Our March 2006 capital spending survey for our coverage universe suggests that 2006 growth in drilling spending should be up 20-25% over 2005, even before mid-year budget increases that are likely to be announced over the next few months."
The analysts said that their "long-standing thesis -- that the equity markets are largely under-pricing E&P companies -- remains firmly intact. Accordingly, there is a very good probability of further consolidation in the E&P space. Producers are likely to continue seeking out growth potential by acquiring properties or smaller peers with deep inventories of attractive drilling prospects, as has been demonstrated by the surge in M&A activity that began in 2004, and, if anything, continues to accelerate.
The Rockies, Barnett Shale, Appalachia, and East Texas, as some of North America's premier areas for oil and gas exploration, should continue to be important components of the ongoing acquisition trend. In addition, given the tremendous cash flow generation of offshore properties, the Gulf of Mexico, which has led M&A activity year-to-date, is likely to remain a focal point. From the standpoint of the oil service space, ongoing M&A activity represents a clear opportunity to capitalize on further meaningful increases in domestic drilling activity. In short, it is the best of both worlds for E&P and oil service investors."
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