2014 Deals Will Be Less Chainsaw, More Scalpel

A quarter into 2014, it seems this will not be the year of the megadeal.

So far, deal flow hasn’t taken a sharp upturn from last year. However, deal activity is expected to be steady as companies consolidate core businesses, grow geographically and get their hands on new technology, according to the 2014 M&A Outlook Survey issued by KPMG LLP.

Overall, several respondents said they were focusing less on cost cutting and more on growth. “We are changing from divesting noncore operations to expanding new operating areas,” an oil executive told KPMG.

Of the 101 oil and gas executives surveyed, 56% expect their company to initiate an acquisition in 2014 and 39% plan to offer up assets for sale.

Middle-market deals are likely to dominate mergers and acquisitions (M&A) activity in 2014. More than half of survey respondents see deals that, financially, are the equivalent of bolt-on acquisitions, falling below the $250 million mark.

Of the 54 exploration and production (E&P) deals that disclosed a price, so far this year four totaled more than $1 billion, according to Hart data. About 76% were deals of less than $250 million.

Tony Bohnert, KPMG's energy sector lead partner for transactions and restructuring, said most deals appear headed toward the low end of the middle market.

“If you think about it $250 million is not that big of a deal, particularly if you’ve got a lot of oil involved in it,” Bohnert told Hart. “It really points to people being very selective about what they’re going to look at and clearly a vast majority not focusing on any kind of large or transformational type of a deal.”

Instead, companies are likely to pick up acreage that’s adjacent to what they own already or opportunistic deals with low execution risks.

Overall, E&Ps are continuing to rebalance their asset exposure, concentrating development resources in liquids rich plays such as the Eagle Ford and Bakken and areas with adequate midstream infrastructure, market access and logistics Bohnert said.

“We're also seeing a wave of deepwater M&A activity in the Gulf of Mexico as companies look to boost production as fields mature and further expand geographic and geologic diversity,” he said.

Of oil and gas executives surveyed, 57% expect the United States to experience the highest level of M&A activity in 2014, followed by Western Europe (27%) and China (26%).

However, U.S. acquisitions and divestitures (A&D) activity faces some headwinds.

For instance, deals are being held back by the inability of buyers and sellers to find middle ground on values.

The value gap is usually due to smaller, privately held companies that have no urgency to sell but know of high priced, one-off transactions or assets that are highly valued.

“They don’t let go of that,” he said, noting oilfield services and other sellers are also of the same mind.

Bohnert said he’s heard from buyers of fairly wide gulfs between seller expectations and what the buyers are willing to pay.

“If the buyer paid what sellers wanted, they pretty much lose money on the P1 reserves,” he said, referring to proved reserves.

Instead, sellers want to use probable (P2) and possible (P3) reserves as part of the deal.

“It’s all being hung up on P2 and P3s and all the execution risks that come with it,” he said. “You start doing the risk adjusted evaluations on P2s and P3s and a lot of times you just can’t get there.”

Uncertainty over environmental regulations also continues to be a stumbling block.

While the U.S. Secretary of Energy has applauded the oil and gas sector’s gains and suggested reviewing the ban on oil exports, operators are still wary of President Obama’s administration.

For instance, the administration has used the Environmental Protection Agency to “basically trying to regulate coal out of existence,” Bohnert said.

Without a formal long-term energy policy, “it does cause some uncertainty which can cause some people to not necessarily make big bets,” he said.

KPMG surveyed a total of 1,001 M&A professionals in September 2013.