Daily GPI / M&A / NGI The Weekly Gas Market Report / NGI All News Access

Energy Sector M&A Options Increasing Move to Swaps, Share-Based Dealmaking

After 14 months of intransigence, doing nothing will become less of an option for cash-strapped oil and natural gas operators, with some unusual dealmaking expected for mergers and asset sales.

Last year was a low point in terms of merger and acquisition (M&A) activity, as uncertainty over oil prices drove a wedge between buyers and sellers that began in late 2014.

"How the M&A market recovers will depend on how oil prices perform in 2016," said Wood Mackenzie Ltd. researchers. "Whether oil prices move up, down or nowhere at all, pressure to act will build, on either buyers or sellers."

The longer prices are depressed, "the more companies will become financially stretched. Sellers will become less able to hold out for higher prices. The ameliorating effect of cost deflation will come too late for many."

A sharp uptick in prices could signal the time to make more deals, or not. When prices strengthened during 2015, a few deals were made. Buyers could return quickly, seeking to capture deals before competition increases, driving inflation, Wood Mackenzie researchers said. However, as last year showed, "sharp, directional changes in price and sentiment can quickly scuttle deals by swinging the pendulum against either party."

Even with the boost last year from Royal Dutch Shell plc's agreement to take over UK-based BG Group plc (see Daily GPI, April 8, 2015), total transaction value for global upstream M&A deals last year declined 22% year/year to $143 billion from $184 billion, according to IHS Inc. IHS used an $85 billion price for the Shell deal, including debt, but Shell last month reduced the takeover bid by $17 billion (see Daily GPIDec. 23, 2015). The reconciled number for the mega-merger, as well as the falling/failing transaction bids for other deals, could bring last year's values even lower.

In 2015, asset deal values fell to a 10-year low.

"Unstable oil prices caused outlook uncertainty in 2015, and this lack of stability, a key ingredient for buyers and sellers to reach consensus, caused fewer deals to be reached," said IHS's Christopher Sheehan, who directs energy M&A research. He was lead author of the IHS Energy Global Upstream M&A Review. "There continues to be a wide disconnect between potential acquirers and sellers regarding valuations of the huge supply of assets on the market that vary in quality. At the same time, corporate takeover targets that suffered severe share price declines are reluctant to sell at modest current premiums in a weak market."

Traditional funding avenues for E&Ps remained available for the most part last year, which reduced the pressure to consolidate. However, Sheehan said, "we believe the likelihood for wider consolidation in the oil and gas industry will increase in 2016 as producers face further financial pain and will have more constrained financing options" because of persistently weak prices.

According to IHS, worldwide deal count, including both asset/corporate deals, fell by almost half last year from 2014 to the lowest level since 2001. Asset deals represented 80% of all the transactions, but the number of asset and corporate transactions fell steeply. Corporate deal count plunged to a 20-year low.

Other than Shell's agreement to acquire BG, no global corporate takeovers within the upstream industry exceeded $5 billion, according to IHS. Fewer than 10 asset deals last year were valued at more than $1 billion following more than 30 in 2013 and 2014.

North America for the second year in a row accounted for more than half (60%) of worldwide upstream deal value last year, which excludes Shell/BG. If the Shell deal were included, and a big share of Shell's business is in North America, North America accounted for only 30% of global deal value, IHS said.

The United States had slightly more than half the number of total worldwide deals, above its historical average. However, only three of the top 10 largest transactions in 2015 were in the United States, versus five in 2014. Total U.S. transaction value declined by 60% to $35 billion from $90 billion in 2014. U.S. corporate transaction value fell by more than 55%, while asset deal value declined by 70% to the lowest total since 2009.

Canada's market share year/year fell slightly to 11% from 13%, with only one transaction valued above $1 billion.

"The continued weakness in commodity prices is having a dramatic impact on valuations in the asset transaction market," Sheehan said. "Deal pricing for U.S. oil and liquids proved reserve assets fell extremely sharply in 2015. U.S. gas asset deal pricing also declined steeply. Asset deal market pricing in the U.S. for both commodities plummeted to 10-year lows."

Producers with heavy debt burdens and hedges rolling off this year are going to be "increasingly vulnerable," he said. "They will either have to dispose of prized assets, face serious restructuring -- including the potential for bankruptcy -- or become takeover targets in 2016. The volume of global assets for sale and companies under financial duress are surging as oil prices continue to be subdued."

IHS is tracking "more than $200 billion of oil and gas property and corporate opportunities that have the potential to transform the portfolios of stronger players."

While the top-tier integrated oil companies may be able to ride out the downturn this year, "the next tier down may have fewer options," Wood Mackenzie said. "Some will simply not have the stomach for it. We are already more than 12 months into the downturn. The psychology of an ongoing struggle against low oil prices stretching into 2016 will play on the minds of some owners and investors. Some, particularly among downtrodden small caps, will look for an exit."

All options are on the table, with "unusual deal structures" likely to increase. "Expect more swap and share-based deals," Wood Mackenzie said. "Non-cash deals can mitigate oil price risk," but some assets/companies will be more leveraged to oil prices than others. Sharing in the upside of an acquirer "is not always enough to tempt sellers into accepting lower valuations." Other deals could be structured to close the bid-ask spread. To date, these have been limited, but researchers expect to see more.

"Hope is a strategy,” Wood Mackenzie said. There is “light at the end of the tunnel. Somewhere. For every buyer thinking 'now is the time to buy,' is a seller thinking 'this would be the worst time to sell.' While there is that hope, most will want to hold on to businesses and assets indefinitely, or at least until they can be sold into a stronger market."

ISSN © 2577-9877 | ISSN © 1532-1231 | ISSN © 1532-1266

Recent Articles by Carolyn Davis

Comments powered by Disqus