If you’ve been keeping an eye on oil and gas markets, you know there was a significant drop in oil prices in 2014, starting in June of that year. No news there. From a 3 ½ year average of $110 per barrel, prices fell steadily, hitting a low of $29 in 2016.
This had wide-ranging repercussions, of course. But let’s focus here on how investors reacted.
For starters, Master Limited Partnerships, which had been a favored investment for more than two decades and had benefited from the Shale Revolution, were hit hard, with many going bankrupt or facing restructuring.
The fall of MLPs set the stage for opportunity. And, from 2014 onward, Private Equity filled in the gaps and has made increasing investments in this sector as the downturn continued.
What happened to MLPs, which were the structure historically used by “midstream” companies that transport and store oil and gas? Even as oil prices rise, they haven’t regained their popularity.
The most recent tax reform bill reduced some of the tax advantages they had over corporations, for one. Then rising interest rates made other investments more attractive.
Fast forward to present day and MLP’s loss is PE’s gain as the price of oil increases. Since the bust, PE firms have been investing in smaller acquisitions through portfolio companies and snapping up acreage at discounts during the oil bust. And now they’re getting ready to cash in.
There are some obstacles in the form of a slow-down in M&A in the energy sector in the last year or so.
But, inevitably, these conditions are changing. The energy market, especially oil and gas, are irrepressibly cyclical in nature. So, while M&A activity has been slow recently, there are numerous signs of an increase in the coming year:
Look for Private Equity to lead the charge in M&A in the energy space for two reasons.
1. All the dry powder. Investors don’t want to sit on the money; they want to invest and make it work for them.
2. The availability of companies for sale at bargain prices due to the downturn.
While opportunities abound, the scale of capital required compels players to use caution.
Here’s what you need before engaging in any Mergers and Acquisitions in the energy industry:
You need the right advisors. You must have an investment banker with experience in energy and an M&A lawyer experienced in doing your type of deal. Don’t be scared of high fees from these experts – it’s worth it because they know the network and the relatively small energy M&A community.
It’s unlike other industries in that, because of the hundreds of millions used in capital projects, one little “mistake” could cost millions. The energy industry has its own language and legal/regulatory requirements. It’s complicated. Savvy Buyers seek expert help when conducting due diligence on potential acquisitions and during the transaction.
But it doesn’t hurt to have some extra protection for peace of mind.
This is why Representations and Warranty (R&W) insurance is essential to cover deals in this industry and is increasingly used.
An R&W policy removes the risk from the transaction from either Buyer or Seller and shifts it to a third party – the insurance company, who pays out if there are any breaches post-closing.
When Private Equity is on the sell side, they want a clean exit and the ability to distribute the proceeds to their investors quickly. R&W coverage accomplishes that by ensuring less money is held in escrow. And M&A is a great way to reduce risk and get a clean exit with no worry about clawback. Not to mention, it makes for much smoother, less contentious negotiations.
My recent podcast interview with Jimmy Vallee, partner in the M&A and Energy practices at the Houston office of law firm Paul Hastings, was invaluable in gauging where the energy sector is today and where it’s going – and why.
You can get more details here: http://www.paulhastings.com/home.
There’s been a lot of talk lately that M&A activity will trend downward in the coming year because of…
These factors do have an impact on the economy, but I think the impact on M&A specifically has been vastly overstated. It’s not hard to see why, when you consider those issues popped up in the last 60 days of 2018. It was overwhelming bad news in a short timeframe. It made people nervous.
But, when you look at current real market factors, the same ones that made 2018 a banner year for M&A, you’ll see that the same conditions are projected for 2019.
In the first nine months of 2018 alone, there were $1.3 trillion worth of deals for American companies. If you look at the worldwide figure – it’s $3.3 trillion.
This is the most in the four decades that records of M&A transactions have been kept.
There may not be a mad frenzy of buyers, because they have so many options for acquisitions. But especially for transactions in the $50 million to $300 million range, it’s going to be a good year.
Corporate America and private equity firms have plenty of cash on hand, popularly known as dry powder, and they’re spending it to increase their market share, obtain valuable intellectual property, and more. As of June 2018, there was more than $1.8 trillion in capital waiting in the wings, which is a record.
Investors are also driving this trend, as when they give money to a PE firm, they expect them to buy something. Investing in other companies is a more efficient – and profitable – use of the money than sitting on it. That’s the attitude. And with so many attractive acquisition targets (see #4 and #5 on this list), who can blame them.
It’s true that interest rates have gone up. The Fed raised its benchmark rate to 2.5% in December 2018 and has announced plans to go to 3% in 2019. This is up from a low of 0.25% in 2008, at the kickoff of the Great Recession. It’s gradually gone up since then, starting with a hike to 0.5% in December 2015.
But, when you look to the past, you’ll see that current interest rates are actually quite low in comparison. In 2007, the rate hovered around 5%. It was at nearly 10% in 1989. And in the late 1970s, early 1980s, rates were all over place, ranging from 8% to over 20%.
Today’s interest rates are tame by comparison.
The M&A market has been very seller-friendly based on macro issues, including the use of auctions rather than negotiated sales and an increase in private buyers. But this year things are going to even out, and may even tip to a more buyer-friendly market.
It’s all that dry powder. Buyers have all this cash and are getting more favorable valuations for target companies. Something that was valued at five times earnings is, in this climate, valued at four times earnings.
Another factor here is that Boomer business owners are ready to retire and looking for an exit. They’re ready to sell now. And Buyers know it.
More than ever, companies today are being created and carefully built for acquisition, not an IPO. I’m not talking about the headline-garnering acquisitions like Disney buying Lucasfilm for $4 billion back in 2012.
The real heroes are those companies that get sold in the $50 million range. These deals just don’t get the press, even though they’re often very beneficial to investors and Sellers.
Imagine two scenarios. In the first, you’re an investor in Uber, which is planning to go public later this year. Consider your return on investment with a small piece of the Uber pie and compare it to having a 40% stake in a small tech firm that gets bought for $50 million.
In one recent case, a tech company was sold for $80 million. Husband and wife owned it 100%. They would have never gone IPO. But, by building a solid company, they were able to be acquired for a tidy sum. And with the proceeds, they were able to give $1 million to each of their 15 employees.
In the current market, more companies are simply well managed and well run, with professional and effective leadership. Management is given the resources it needs to be successful. And good ideas are supported.
The days of the Dotcom era where companies were slapped together, investor money was thrown around freely, and “management” was a dirty word are long gone.
This means there are plenty of solid companies with good financials and management teams out there, ripe for acquisition. And often management stays on in the transition.
All these factors provide a rich environment for M&A that is strong and sustainable. And there are more that I believe are contributing to an ongoing M&A boom.
To get the full list, just get this free download:
This episode was originally published on October 3, 2018.
Many technology companies are sitting on an untapped resource that could add 5%, 10%, 20%, or more to their company’s value, says Dr. Elvir Causevic, managing director of Houlihan Lokey’s Tech and IP advisory department.
Problem is that if you wait until you have an M&A deal… all that value is lost to you – it automatically goes to the buyer.
Elvir and his colleagues have been innovating a new way to make sure companies, especially those in Silicon Valley, avoid that fate. And we go through that process, step-by-step. It’s actually pretty straightforward once you know the trick.