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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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Top Shale Takeover Targets

In spite of all the talk about the fall in oil prices leading to greater mergers and acquisitions activity, so far the sector has been relatively quiet in 2015.

When word broke earlier this year that Whiting Petroleum was possibly up for sale, many market commentators thought that would herald the start of more intense M&A activity. Half way through the year, that has not been the case. Instead, there seems to be a disconnect between buyers and sellers on price. That disconnect can be partially alleviated with stock-for-stock deals, but for now, many parties seem content to wait for stabilization in oil prices before making any deals.

Once oil prices do stabilize though, there will likely be two types of deals. First, megadeals like that between Haliburton and Baker Hughes are still going to remain attractive for many firms. ExxonMobil has been cited as a likely buyer of various other major international oil companies as the synergies would be enormous. ExxonMobil also has plenty of cash, and its CEO Rex Tillerson is facing mandatory retirement. Related: U.S. Oil Glut An EIA Invention?

Tillerson may be looking to improve his reputation with shareholders after some notable issues at the firm in recent years, and a transformational deal could do just that. Premiums in these kinds of megadeals would likely be small though since the purchase price on an integrated oil major is so large.

The second type of M&A deal that could see increased traction once oil price volatility subsides are the small ‘bolt-on acquisitions’ of small and mid-sized U.S. fracking firms. These firms have resources that many large companies covet and the oil price collapse provides a good opportunity in that regard. The firms that are most likely to be willing to sell are those with relatively heavy debt loads. Firms that took on a lot of debt when times were good are going to find themselves hard-pressed to pay off that debt in the future.

That’s especially likely to be a developing problem this autumn, if oil prices remain low and many firms will see their price hedges starting to roll off in large quantities. The absence of high-priced hedges to prop up revenues will probably result in a belated M&A wave in the second half of 2015. Related: Major Shift In Asian Commodity Demand Already Underway

Among firms with high debt loads and attractive acreage, a few stand out as notable possibilities for an acquisition. Noble’s purchase of Rosetta last month offers some clues here. EXCO Resources, Penn Virginia, and Halcon are all carrying significant amounts of debt. This will likely cause these firms to explore strategic alternatives and could prompt a sale.

All three companies are risky though in the sense that if they cannot find a buyer, their future is in doubt assuming oil prices stay low. The assets of all three are reasonably good, but they are not well positioned financially for a down-cycle. And all three stocks reflect this reality.

Another firm in the same bucket is Bill Barrett Corp. The firm recently moved to sell $100 million in equity to finance capex, but with hedges on the company’s production likely to wind down over the next six months, BBG could find that being acquired is preferable to additional equity raises. This is especially true if debt-markets get nervous as the Fed starts to contemplate raising rates. Related: Huge Increase In Quakes A Game-Changer For Oklahoma Oil & Gas

Finally, two other possible targets with fairly heavy debt, but very strong assets are Callon Petroleum and Newfield Exploration. Newfield’s stock has not seen the kind of decline that some of the other firms mentioned above have seen. However the firm does have first rate assets, a fairly high debt load, and it’s big enough to move the needle for a major company but small enough not to cause too much indecision for a nervous acquirer’s board.

Similarly Callon has an outstanding growth record, but the company trades at a discount to many peers and its transition from offshore to onshore has yet to be fully appreciated by the market. That could make the firm an attractive target.

All of these companies are realistic takeover targets if their management team is willing to sell. Still investors need to be cautious because the firms that are the most likely to be taken over in a downturn are also the firms most likely to run into financial distress if oil prices stay low and they don’t get a buyout offer.

By Michael McDonald Of Oilprice.com

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