By Todd Garner
M&A activity in the oil patch appears to be on hiatus as Wall Street skepticism rises over whether there’s actual money to be made in the country’s current shale development environment.
Dropping natural gas prices and the rising cost of oil production and exploration would seem to indicate a market ripe for M&A, but not much has hit the radar since the bidding war between rivals Chevron and Occidental to buy Anadarko Petroleum in Q2. Still, hope springs eternal.
A sector built on decades of risk-taking seems to have turned risk-averse as Wall Street pummels energy stocks. Even though Occidental Petroleum “won” the Anadarko Petroleum deal, stockholders have been exiting as Oxy has taken on a staggering quadrupling of its debt, a stock price that’s plummeted to a 10-year low and a proxy fight with investor Carl Icahn. Its stock market value is down about 25% since the spring.
Wall Street has punished others in the oil & gas sector as well. A contact at a major money center bank tells me that skepticism about whether companies can make money from shale production in the Permian and other basins began a couple of years ago, when aggressive drilling to increase reserves fell out of favor. By then, the top acreage in the Permian Basin was essentially spoken for.
In today’s skeptical investor climate, spending company cash or piling on debt for an M&A energy transaction, even if it pencils well, appears to raise a lot of eyebrows. As a result, we expect a muted second half of 2019 for deal making in the oil patch.
Houston Chronicle energy reporter Jordan Blum tells it this way: “The environment for oil and gas companies, let alone those looking to spend big and take on debt to finance mergers, is far from hospitable. Despite the stock market rally that has lifted the S&P 500 Index 6 percent over the past year, stocks in S&P’s Energy Index are down more than 15 percent during the past 12 months.”
Total production in the Permian, as reported by the Texas Railroad Commission in 2018, was 2.474 million barrels/day. Lack of pipeline capacity has been cited as a problem for the area, according to The Odessa American. More capacity is scheduled to come online by the end of the year, and the area may see drilled but uncompleted (DUC) wells become active at that time, the newspaper reported.
Energy companies experiencing declining asset values
On the other hand, there are good reasons why we predict some select M&A opportunities to surface and to be monumental buying opportunities for those with equity and an appetite for calculated risk. The M&A energy market is seeing declining values for assets. In a recent auction of a mid-sized asset (~$400 million), all bids were well below the PV10 (present value discounted at 10%) of the proved developed producing (PDP) assets — the estimated value using discounted cash flow techniques and projections of producing properties. One bidder said they were bidding at PV20 on PDP assets only and that was confirmed by a senior energy banker.
Assets going at discounted rates appears to be an accelerating trend. In a conversation with another energy banker recently, I learned there will be some real bargains coming to market over the next six to 12 months, as values of E&P companies continue to decline, and the debt they’ve taken on becomes an issue for their lenders.
Every six months companies that have taken on debt must obtain a reserve audit/appraisal from an outside engineering firm, to demonstrate to their lender that their property has enough value/collateral to sustain the debt borrowed. Some readjustments to property values may come to the fore during this process.
Another energy banker relayed to me that in this environment, asset values have sometimes been trading at less than 4 times annualized EBITDAX (earnings before interest, taxes, depreciation, amortization and exploration expenditures — a measure of profitability). Many banks have leverage covenants that restrict the amount of debt as a ratio of EBITDAX at 3.5 to 4.0. But, think about it this way: If a company has more debt than its market value as defined by this common EBITDAX multiple, there’s a fundamental problem. Taken one step further, if the industry’s asset values are trading below this common EBIDTAX multiple, there will likely be multiple forces that may cause assets to change hands.
There’s also likely to be some restructurings, equity infusions (if private equity is still available for sponsored E&Ps) or divestitures, among other possible scenarios over the remainder of this year and well into next. Deals will be available for those willing to take on the risk — or to take on Wall Street’s ire. For those with dry powder, the time for bargains is approaching. For those with debt, the time to recapitalize may be here.
Capital Alliance’s close working relationship with Oaklins International bankers worldwide, coupled with its specialization in the middle market, makes it a solid choice to offer up both sell-side and buy-side options, as well as to find the right capital source when oil patch M&A heats up.
Capital Alliance Corporation is a Dallas-based investment banking firm with a four-decade history and deep operational and M&A experience across many sectors, including upstream energy and energy infrastructure. Capital Alliance is affiliated with Oaklins International, the world’s most experienced mid-market M&A advisor, with 800 professionals globally and dedicated industry teams in 40 countries worldwide. We have closed over 1,500 transactions in the past five years. Capital Alliance provides advisory services to buyers and sellers of oil and gas assets. This includes acquisition and divestiture (A&D) services and support for attracting capital sources for acquisition and development projects.