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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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Why Has There Been So Little M&A Activity During The Oil Crisis

Among stock market investors there is often no more welcome news than the news of an acquisition or buyout of a company the investor owns. Those buyouts usually come with a hefty premium attached – sometimes as much as 30 percent or more of the pre-acquisition stock price. But why is this the case? Why are acquiring firms willing to pay substantially more for a stock than investors were just days earlier in most cases? The answer is synergy values.

Synergies result from additional cost savings and revenue generation that come from combining two firms into one larger firm. Synergies give economic rationale to M&A deals. Yet despite that, there have been very few M&A deals proposed during the current oil crisis, which suggests that energy companies could be missing an opportunity. To be clear of course, not all M&A deals work well for investors – but it’s unrealistic to believe that there are no attractive opportunities that could make energy investors on both sides of a transaction better off.

For instance, offshore drilling companies which are combining might be able to share salesforce costs. Certainly only one CEO and corporate HQ will be needed for the combined firm. Beyond cost savings though, there are often cross-selling opportunities that arise from mergers. For instance, two industrial manufacturing companies that make related products used in the energy supply chain might be able to tap one another’s customer bases after a merger. Despite these opportunities, outside of the failed BHI/HAL merger attempt, there has been precious little M&A activity. That lack of activity may be due to dual pressures in the industry; larger firms lacking the balance sheet flexibility to do deals and smaller firms lacking the understanding of M&A benefits.

The concept of synergies applies to firms of all sizes, from publicly traded goliaths to small privately-owned companies. While there are roughly 5,000 publicly traded firms in the U.S. today, there are hundreds of thousands of small and medium-sized privately owned firms. These small firms often enter into M&A deals as well, and unlike larger publicly traded firms, small firms often fail to account for synergy values. This is a missed opportunity that may derail many smaller firms from considering otherwise attractive deals. The reality is that M&A deals for small firms are complex enough as it is, and there is no reason for small firms to miss any opportunities unnecessarily. Related: Solar To See Twice As Much Investment As Fossil Fuels By 2040

While there are small investment banking firms that help middle market companies with M&A transactions, synergies may or may not be included in any given IB-assisted transaction. Again, that’s a missed opportunity.

Synergy values have to be examined carefully. In many cases, publicly traded synergy values can be overly optimistic. In a few cases though, an acquiring company may have been acting opportunistically, thus short-changing existing shareholders. To determine which situation is more likely, various forecasting techniques should be used. Probably the most accurate and most defensible technique for doing this is regression forecasting.

Regression analysis is a statistical technique that uses a set of existing data points to assign importance weightings to various facets of a question. For instance, when trying to determine the effect of an increase in interest rates on oil prices, regression analysis would determine the impact that a change in interest rates has, but it might also take into account the effect that that consumer confidence, industrial production, and gas prices have on oil prices. In other words, regression analysis allows one to determine the effect of an interest rate hike on oil prices after accounting for all other observable factors that would impact employment. Related: Can Trump Change The Direction Of U.S. Energy?

This same concept can be applied to valuation work for firms. Regression forecasting can be used to determine the price that one would expect a company to be acquired for after accounting for characteristics of the target firm such as sales growth, profitability, assets, intangibles, and the industry the target and acquiring company operate in. Synergy values could also be included in this list.

There are very few oil crises comparable to the current one. Valuations on natural resources firms are more depressed than they have been in decades. Small firms that are looking to grow should not waste the opportunity.

By Michael McDonald of Oilprice.com

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  • Ryan Cobb on June 16 2016 said:
    Upstream E&P valuations are still out of whack- might have something to do with it. Look ok from trailing earnings perspective but on forward earnings basis a company paying a premium to a

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