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Does The Drop In Oil Price Offer Major Opportunities For M&A Activity In The Oil & Gas Sector?

Does The Drop In Oil Price Offer Major Opportunities For M&A Activity In The Oil & Gas Sector?

The last few years have seen significant interest from private equity (PE) funds in oil and gas growing steadily, with 2014 in particular bringing healthy PE-backed M&A activity to the North East economy, predominantly in the service sector.

But no doubt, the biggest story to come out of 2014 was the steep decline in oil prices during the last six months of the year. Whilst the fall did not visibly slow deal activity and flow up to the end of the year, the reason for this can be attributed to the fact that hands had been shaken on those deals long before the full extent of the plunge in prices was apparent.

With the dawn of 2015, and a new era of oil price uncertainty, PE attitudes to investment in the oil industry seem uncertain.  It is possible that prices on deals being negotiated but not yet agreed will be influenced by fears that profits and related factors such as Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) cannot be sustained or will deliver lower than anticipated growth during a period of intense cost-control, delayed capex spend and potentially cancelled projects. 

It is also possible that some sellers will be reluctant to accept the almost inevitable lower prices, in favour of sitting tight and waiting to “see what happens”, leading to a slow down in transactions.  However, for those PE houses who understand the sector and the underlying businesses, 2015 could create opportunities to invest at lower prices in a less heated market.  With cost-reduction being one of the main drivers, the large oil service companies may well look to divest themselves of non-core divisions giving opportunities to create strong buy-and-build platforms for future growth.

Although average leverage these days is lower than it was before the financial crisis, PE may well see investment opportunities from distressed situations - where further bank debt to fund growth is either unavailable, being withdrawn or becoming more expensive due to increased scrutiny and risk of covenant breach. 

Additionally, certain sub-sectors in the industry may be attractive to PE - especially businesses which can effectively deliver innovation and efficiencies into the supply chain or environmental or health and safety advantages to enhance regulatory compliance.

So, although lower oil prices present challenges and will mean lower multiples being paid on M&A deals in 2015, potential certainly exists for smart PE investors to take advantage of the cyclical nature of the industry to acquire robust underlying businesses at attractive prices.

Helen Dickson
Partner

This article was originally published in the Press & Journal on Monday 16 February 2015.

LChalmers