The current downturn in market conditions, fall in share prices, unprecedented liquidity, and volatility in credit markets all provide a challenging environment for the merger and acquisitions (M&A) sector. So is the market now primed for a round of opportunistic takeovers with businesses trading at a discount to their net asset values?
Since the peak in oil prices nearly a year ago there has been a steep decline in both prices and quoted share valuations. Many companies believe the latter is driven by sentiment and is not justified by the underlying fundamentals. It is, however, proving hard to communicate this to what is currently a sceptical market.
It helps that oil prices appear to have stabilized, settling above $50/bbl in the second quarter of 2009. Share indices are beginning to recover also, with the Dow Jones US Oil and Gas Index increasing by around 25% between March and early May. In the UK, the FTSE 350 Oil and Gas Index has risen by a similar extent since its low point in October 2008. Is this the evidence companies have been waiting for prior to re-entering the M&A arena?
It’s a hard call to make, but there have been significant transactions such as Suncor’s acquisition of Petro-Canada, and in the UK Premier Oil’s bid for Oilexco, Dana Petroleum’s acquisition of Bow Valley, and Centrica’s 20% stake in Venture Production. All indicate that major players are starting to view the current environment as an opportune time to acquire good value assets to boost their reserve base and achieve synergies.
Speculation has focused on who are likely to be the leaders of M&A activity in the oil and gas industry, even whether there will be a repeat of the mega-mergers effected following the last oil price slump of 1998 (i.e. BP/Amoco, Exxon/Mobil, Chevron/Texaco, Total/Elf). However, our view is that the major international oil companies will adopt a more conservative attitude to risk this time, focusing on preserving liquidity and promoting continual operational efficiency, and resisting making any landmark transactions until there is more certainty over the timing of the next economic upswing.
For the time being, we consider significant cherry-picking of proven, high quality assets in key frontier oil regions more probable than additional “top-tier” consolidation. We also foresee deals arising from troubled parent and other oil companies evaluating their activities and geographical footprint, concluding that certain operations are non-core.
Our view that the current market environment provides a good opportunity for M&A activity is supported by recent Deloitte UK CFO surveys. In December 2008, 65% of CFOs canvassed for opinions (including those from a quarter of FTSE 100 companies) stated that the downturn provided a chance to build long-term presence and capacity in markets. Equally, sentiment towards M&A has turned positive in the last three quarterly surveys, with 56% of CFOs surveyed in 1Q09 expecting increased M&A activity over the next 12 months.
A major issue businesses will need to consider is how to react if a bid is forthcoming. With paper deals more prevalent due to the shortage of liquidity, management teams will need to be able to defend their relative performance. There is never enough time to respond to an unexpected or unwelcome approach, so it is vital for companies to make sure they are best placed to defend their reported strategy, funding position, financial and operational record, and performance against the market or industry peer group.
The challenge is to remain continually prepared by, for example, determining key value messages and defence themes. In this way, boards will be better placed to evaluate an approach and ultimately make the right decisions to maximize shareholder value.
It is a fact that companies listed on public markets cannot prevent an unwelcome approach. However, with stock valuations starting to make a recovery and acquisitions beginning to take place, now is not the time to get caught over a barrel.
Shaun Reynolds
Deloitte, Aberdeen
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