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E&Ps Now Look for Assets, Not Takeovers, Says Raymond James

Upstream merger and acquisition (M&A) activity isn't as slow as some believe, but now it's about asset transactions, rather than mega corporate takeovers, a Raymond James & Co. Inc. analyst said in a note Monday.

Investors often ask where all of the energy M&A activity is, especially with the backdrop of record-setting transactions in other industries, robust oil prices and supportive capital markets, said Pavel Molchanov. But there is a lot of activity, he said, particularly within the exploration and production sector, he noted. 2012 set an all-time global record in dollar terms and 2013 is "at the third largest level ever."

Today, it's all about the assets, not the corporate structure, said the analyst. For example, on Monday onshore operator EnerVest Ltd. agreed to sell Permian Basin properties to a subsidiary of QEP Resources Inc. for $950 million.

The move to asset buys rather than corporate purchases is a huge shift from 2005-2009 when blockbuster deals were done. It was during that period, for instance, that ExxonMobil Corp. snapped up XTO Energy Inc. for close to $40 billion, giving it the No. 1 natural gas position in the country.

Over the last four years, however, the downward trend in corporate takeovers and the sustained growth in asset purchases has been visible, said Molchanov.

"Corporate M&A's slice of the total pie has plunged from 82% in 2005 to 21% in 2013, and there have been only five $15 billion-plus corporate transactions in the past four years," he said. Why?

  • More focused strategy by buyers, which are targeting specific assets to fill portfolio gaps;
  • Economic nationalism and other regulatory hurdles to corporate M&A; and
  • Industrywide trend toward more capital discipline.

"Across the board, asset M&A facilitates skillset specialization by producers, avoiding the problem of 'being spread too thin,'" said the analyst. "If anything, the proliferation of 'breakup value' strategies in recent years, sometimes spurred on by activist shareholders, illustrates the value of an individualized, asset-centric approach to managing upstream companies."

Raymond James conducted its analysis of upstream M&A transactions using IHS Herold data for deals with a value of $1 billion or more, anywhere in the world, beginning in 2005. The dates referred to when the deal was announced, not closed. Corporate M&A represents an enterprise buyout or a partial equity stake in an enterprise. Asset M&A pertains to individual properties, producing or nonproducing; a package of properties or a volumetric production payment.

There was an uptick in corporate activity in 2012, when its percentage was 63%, Molchanov said. However, this year the percentage has been 21%, a historical low.

"Given the year-to-year choppiness, we wouldn't read too much into any given year's numbers, and we certainly wouldn't ascribe any predictive qualities to this data." In general, though, "there have been only five truly major ($15 billion-plus) corporate transactions in the four years since the all-time record set in late 2009, Exxon's $40.5 billion acquisition of XTO. One of these -- state-controlled Rosneft's acquisition of the TNK-BP joint venture (in two separate chunks) -- was a special situation."

The other three were China's CNOOC Ltd.'s $15 billion takeover of Nexen Inc. (see Daily GPI,July 24, 2012); BHP Billiton Ltd.'s purchase of Petrohawk Energy Corp. for $12.1 billion (see Daily GPI,July 18, 2011); and Freeport-McMoRan Copper & Gold Inc.'s $6.6 billion purchase of Plains Exploration & Production Co. (see Daily GPI,Dec. 6, 2012).

Buyers have become choosier and less inclined to pay a lot for a corporate buyout to acquire one or two desirable assets, Molchanov said.

"Insofar as there has been corporate M&A, it has centered on smaller operators with concentrated assets, which fill in a particular gap in the buyer's portfolio: unconventional resources, deepwater exploration, liquefied natural gas (LNG), etc." Devon Energy Corp.'s recent agreement to buy GeoSouthern Energy Corp. for $6 billion to gain a position in the Eagle Ford Shale, he said, is a case in point (see Daily GPI,Nov. 20).

Producers have become more capital-disciplined and therefore more reluctant to shell out a lot of cash or stock for M&A.

"There is certainly no shortage of historical case studies of deals that have been ill-timed," said Molchanov, citing ExxonMobil's bet on XTO just before gas markets began a steady descent, or ConocoPhillips' 2006 takeover of gassy Burlington Resources Inc., which pressured its bottom line for years (see Daily GPI,Oct. 9, 2006).

The historical tendency of North American E&P companies to outspend cash flow "has been diminishing, as management teams respond to shareholder (including activist) pressure for greater capital spending discipline and more dividends or share repurchases," said Molchanov. "Against this backdrop, corporate M&A would not 'screen' particularly well."

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