Through interviews with senior Oilfield Services (OFS) executives and private equity practitioners conducted as part of our latest “Dynamic Dealmaking” survey, Ernst & Young has established that merger and acquisition (M&A) activity in the segment is expected to increase.
Those polled say deal-making will be strong, despite – or even because of – the various pressures on the OFS industry, including market volatility, changing regulations and uncertain economic conditions.
Numerous drivers, such as new technology and the integration of services were cited as drivers of M&A activity, although the majority (88%) of those questioned identified access to new markets and customers as the key rationale.
One respondent said: “With a slow economy, organic growth is challenging; thus, M&A is an attractive alternative. Many prospective strategic buyers have an abundance of cash, are being aggressive in assessing value and are able to structure deals effectively for their benefit. M&A fulfils many aspects of growth strategy, like access to new technology, access to new markets and much-needed diversification of business.”
Restrictions to the flow of capital have eased to some extent after the gruelling economic conditions of 2008/09, but capital and debt markets still remain relatively tight. Nevertheless, respondents expect deal financing to be much easier over the next two years.
Indeed, most believe OFS companies will be increasingly able to access equity in the capital markets. Many point out that the restructuring of companies’ operations and balance sheets has netted better margins, making OFS operations more attractive to investors.
On the other hand, debt markets are expected to be challenging, according to respondents, with the overhaul of the financial services industry, rather than the OFS segment itself, pinpointed as the root cause.
A recurring theme throughout the interviews was how important it is to vertically integrate products and services.
One respondent commented: “Continuing uncertainty in macro-economic conditions and relatively high levels of market volatility has rendered extending services to reach a larger customer base through vertical integration essential.”
It is our view that the vast potential in various global offshore exploration projects will be at the heart of many acquisitions, with deepwater areas in Brazil and Africa, and offshore basins in Australia, having moved up the priority ladder.
Economic, regulatory and political pressures notwithstanding, respondents remain cautiously optimistic about the OFS segment’s future and its ability to meet new challenges head-on.
o Assessing the business environment
Prior to determining business strategy, OFS executives must consider the micro and macro-level factors affecting their environment.
As one executive noted in a comment echoed across the responses: “OFS companies are so tied to oil prices that shocks immediately impact on all aspects of their business in significant magnitudes and make it impossible for companies to shield themselves from the volatility.”
One fifth of respondents say political upheaval in major oil provinces represents the biggest macroeconomic threat, with an additional 20% singling out the possibility of resource nationalism as the primary challenge.
In terms of regulatory change, respondents were concerned about fiscal regimes. Although fiscal regime changes indirectly affect OFS companies – their clients react to such changes, which, in turn impacts demand for services – a stable fiscal environment goes hand-in-hand with predictable resource development.
Other changes that could have substantial impact on OFS companies include increasing local content regulations, such as those now in effect in countries including Brazil and Nigeria. The potential for increasing environmental requirements will also affect the segment, with several respondents pointing to the debate around hydraulic fracturing as a key example.
o Accessing capital
After the period of restricted access following the near collapse of the global financial system, the flow of capital has finally started to open up. Obstacles to companies’ financing still remain, but survey respondents expect OFS companies to have greater access to equity over the next one to two years.
Those polled by the survey believe the re-emergence of short-term financing will help OFS companies raise debt, with one executive saying: “Debt providers are on board with lending for a short time as it fetches them high returns. Capital is returned in a shorter span, which reduces risk.
Private equity was also highlighted as a route to capital for OFS companies by respondents, given the lengthy and costly processes they have to engage in when sourcing capital from banks.
The optimism creeping back into the segment is reflected in the fact the majority of those surveyed said they expect to finance projects externally, with 88% stating they intend to raise external capital in some form over the next 24 months.
o Areas of M&A activity
Nearly three quarters of the respondents said they plan to make an acquisition within the next two years, with companies based in North America expected to lead the rest of the world’s regions in activity, followed by Asia-Pacific.
The emergence of shale gas/oil in the US has seen a marked increase in exploration and production activity in many parts of the country, including the booming Bakken and Eagle Ford shales.
Canadian OFS companies are also being targeted by Asian businesses keen to get a better understanding of the technology used in the extraction process. Rising domestic demand in Asia is also expected to push major National Oil Companies (NOCs) to ramp up their activity around the globe.
Taking all of these issues into consideration, the challenge facing the segment is summed up succinctly by another of the respondents: “The pressure is on OFS companies to provide greater efficiencies in their services. To stay competitive, [we] must become more nimble businesses, with the ability to scale resources up or down.”
Ally Rule is a transaction advisory services (TAS) partner at Ernst & Young in Aberdeen