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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Finding Top Tier Oil & Gas Assets In 2017

Oil rig

With oil prices finally showing signs of life, investors are starting to see signs of something that hasn’t been seen in years – the energy sector IPO. Since prices began to rebound after the OPEC meeting, there has been an uptick in companies filing to go public. Yet, like so many other would-be IPOs in all sectors of the economy, many of the best assets don’t make it to the public any more.

The reality is that the newer energy companies filing to go public are getting bought out before they ever do an IPO if they have attractive assets in attractive jurisdictions. For instance, in the past month two different firms headed for IPOs were acquired instead. Brigham Resources Midstream was acquired by Diamondback Energy in a deal worth $2.4B, while Gulfport Energy agreed to buy out Vitruivan II Woodford.

Brigham operates in the Permian while Virtuvian hails from Oklahoma, but both firms were preparing for imminent IPOs before they got buyout offers. A third firm, Jagged Peak Energy has filed for an IPO, but is reportedly being shopped around for a buyout offer as well.

The energy sector is not alone in this conundrum. The stock market is changing. Here is an important and remarkable stylized fact that many investors are not aware of; the U.S. stock markets have shrunk in size by more than a third since the year 2000. As a result, the number of publicly traded companies on the U.S. exchanges is now roughly equal to the level last seen in 1990. In other words, the stock market that investors are facing today is dramatically different than the one they faced a decade ago in terms of the type of companies that are available to be invested in.

This shrinking stock market comes despite an economy that has nearly tripled in size during that period. The shrinking size of the stock market by number of public firms is also in stark contrast to the increasing total market capitalization of the overall stock market.

The decline in the number of firms is not solely a byproduct of the bursting of the 2000 dotcom bubble, nor the 2008 recession as the figure below shows. Instead, the decline has been measured and persistent for more than a decade beginning in the late 1990’s. The shrinking number of firms, but rising total equity value, has resulted in growth in the mean firm’s size. Related: Oil Drops As Signs Of Rising U.S. Output Offset OPEC Optimism

(Click to enlarge)

For energy investors as a group, the shrinking markets mean that it is time to reconsider how to find new investments. The IPOs that do make it to market these days are probably not top-tier assets. After all, only a masochist CEO would want to put up with the scrutiny of public markets rather than selling out and taking a big payday from an acquisition.

As a result, investors should be very careful about buying into energy IPOs that do come to market over the next year. Instead, investors should look for smaller firms that appear to garner a great value by buying a would-be IPO before those assets come to market. The right acquisition of a private firm could transform a small or mid-sized oil company overnight, giving it access to a hot area like the Permian at potentially a lower cost than a deal with an already pubic firm.

The markets are changing in 2017. Investors need to change with them.

By Michael McDonald of Oilprice.com

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