Farmers often pray for rain. These days at least some who farm the oil and gas patch are praying for M&A — mergers and acquisitions, that is — the thunderclouds from which oil and gas properties fall.
When companies combine they almost always have unwanted holdings that they sell to others, which keeps the acquisition and divestiture (A&D) market moving.
“M&A is the divestiture market’s best friend. Fortunately, we’re starting to see a little bit of it,” said Scott Richardson, principal, Richardson Barr & Co. “When a corporate transaction closes, six months after it closes they typically hit the street with divestitures.
“Right now, we think there’s about $50 billion of E&P capital chasing about $25 billion in deals, clearly a 2:1 ratio. You have to go back to the late ’80s when the high-yield market was open when you saw the capital available that we have today.”
Richardson was one of about a dozen upstream deal-makers who spoke at Hart Energy Publishing’s A&D Strategies & Opportunities Conference on Aug. 30 in Dallas. Despite the hot market and relatively few properties to be had, he said there still are opportunities, particularly on the lower end for players doing smaller deals.
“2006 has probably been one of the most interesting years in A&D in recent history,” Richardson said. “I think if you were to have polled a lot of people in 2005 they thought that valuations would have pinnacled in the fourth quarter last year when gas prices were $14. I think people would have thought that we had a lot of deal flow and that valuations might have come down a bit.”
Not so, and for several reasons. First, the market doesn’t have the supply of properties it had last year. Last year there was $10 billion worth of selling done by the private equity market, Richardson said. “I think the private equity guys were very nervous on gas prices going into the new year. A lot of them sold in the fourth quarter, and I think you’ll see a lot of these guys come to the market in ’07.”
Additionally, there have been “very, very few onshore divestitures from the public companies… The only thing they’re really selling right now is the Gulf of Mexico and Canada.”
The continuing strength of the Nymex strip is another reason for the high valuations, as is the amount of money flowing into the industry. “There’s capital for private producers; there’s capital for public producers, and it is a bit overcapitalized. We probably will not be able to sustain this kind of capitalization going forward, but in the near-term it’s really propping up asset values,” Richardson said.
On the demand side, public companies are asset-hungry.
“The big sea change is that in the late ’90s all the sellers were public companies,” said Richardson. “Today, all the sellers are private companies. This is a structural event that’s occurred in A&D and it’s not going to change dramatically. The biggest change to this would be if you just saw a whole bunch of M&A like we did in the late ’90s.
“In the ’80s and ’90s, the majors sold to the large caps. The large caps sold to the small caps, and the small caps sold to the privates. It’s totally flip-flopped today. You really see the private equity market and the private company selling to the publics, and it’s been this way, really, for the last two to three years.”
Nonetheless, deal flow is starting to slow down. Last year at this time the industry had about 90 $50 million-plus deals under its belt for the year. This year that number is about 70, Richardson said.
Public companies really aren’t selling assets outside of Canada and the Gulf of Mexico. Private-equity backed companies sold about $10 billion worth of assets last year but only about $3 billion so far this year. It’s been the private companies that have been bringing assets to the deal table this year, for a number of reasons, Richardson said.
“No. 1, I think they’re really scared of what’s happening in Washington. I think there’s a fear there’s going to be more regulation in the industry. I think there’s a fear of more taxation. With respect to the service cost creep that’s in the market, the private guys are the least resilient to increases in service costs. If you compare that to private equity and public companies, that’s been generating a lot of selling, and then, of course, just the normal generational issues.”
So where is a buyer to go if he thinks prices in this market are too high? One place is the sub-$50 million deal market. Although sellers in this space would like to garner the same metrics enjoyed by sellers of larger packages, “it doesn’t happen,” Richardson said.
“Right now the market is littered with failed deals in the sub-$50 million market. And I know many management teams that have made a career of just buying failed deals. Typically it takes about six months of market therapy, but once a seller, always a seller.”
Look to the fourth quarter for more packages to come up fore sale. “As a buyer, this is the best time to buy. Go after the smaller package, the more poorly marketed package.”
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