Following a busy period for M&A transactions in late 2016 and early 2017, a softer market for E&P equity prices has changed the tone of the market. Now, companies are more cautious about relying on public equity issuances to fund acquisitions. As a result, many buyers are focusing on opportunities that can be purchased with existing cash flow or liquidity (without aggressive leverage), or in which a target’s shareholders are open to equity as a consideration.
Disciplined deal-makers, post-2017
Forward-thinking companies are seeing the value of getting bigger to improve their overall economics, partly in response to demands from investors that energy companies live within cash flow and return cash to shareholders. That’s not easy in a growth business, but companies in the right resource basins, with the right balance sheet, scale and operational capabilities can do so – and they are turning to M&A to get there.
A market ripe for M&A
There is certainly opportunity for this growth, as a result of the reduced investment in upstream assets outside of the U.S. since 2014. This led to lower oil and gas production in a number of countries, allowing significant room for U.S. volumes to increase, aligned with global economic growth. We have seen the U.S. unconventional space, particularly shale oil and gas, account for most global supply growth as production volumes stagnated elsewhere. This has created a constructive environment for U.S. producers.
While we witnessed considerable M&A activity in the last several years, we are now at the point in which U.S. unconventional firms have acquired the key properties and are currently in the asset development phase. These companies are eyeing M&A to get the best properties and bolster scale.
Another potential driver of M&A activity is the return of international players to the market. In recent years, we saw a decline in U.S. acquisitions among international companies, as they stepped back amidst the dramatic technology change that fueled unconventional growth. While U.S. incumbent players have been most prominent until recently, we see the majors again becoming an important element of new equity capital to support broader U.S. shale development.
Deal-makers target strategic consolidation
In light of the factors described above, we expect to see a material increase in corporate consolidation over the next 18 months, notably among deals valued over $5 billion – a market that has been overshadowed by asset transactions, more frequently in the $500 million to $1 billion range, in the last few years.
Deal-making companies will be looking to achieve scale, both financially and operationally, since operational efficiencies are crucial for companies looking to develop the unconventional resources within their portfolios.
As this consolidation occurs, we expect to see some companies shaping themselves into pure plays with scale positions in the most highly valued basins. In addition, we are observing the emergence of the ‘Super Independents’. These are larger companies with the ability to operate across two to four core growth basins, as well as deliver strong cash flow and return to shareholders given their quality assets, operating capabilities and significant volume growth.
As companies increase their strategic focus on one or more core basins, other assets in their portfolios will become available via the A&D market. In many cases, these will include high quality acreage in a basin in which the selling company was simply sub-scale – thereby creating strategic opportunities for other companies focused in that area.
The flight to quality
There is a real flight to quality among buyers, in terms of ‘quality rock’ and also quality companies from an investor perspective. We’ve seen this in the past several quarters, as investors have rewarded oil and gas firms that can deliver volume growth on their assets.
We also see an emphasis on the most efficient operators who can offset the significant capital outlays required for asset development. There is definitely an opportunity to inject this sort of efficiency into the sector. For example, companies that can bring acreage that is directly adjacent to an incumbent firm’s immediate asset can reap true cost savings and economic efficiencies by drilling longer, horizontal wells across asset boundaries.
The winning bidders are not only the ones who can identify the best rock but also those partners who can deliver true industrial synergies. This will likely result in more, larger cap, independents and super independents with admirable balance sheets, financial prowess and operational efficiencies.
Ready for an intense M&A landscape
In summary, we expect an intensifying M&A landscape in the next 18 months as a number of private companies are sold or go public, public company consolidations heat up, and companies turn to the A&D market to focus their portfolios on basins in which they have strategic advantages. In looking to improve their cost structures and shareholder returns, we will see more companies looking seriously at consolidation, M&A and restructuring their businesses.
With many attractive companies on the landscape, our M&A, finance and technical specialists across the upstream, midstream and other core segments are ramping up to provide clients with new ideas, and to work through existing ideas that are suddenly feasible due to current market catalysts.
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