The current industry standard of project-specific, limited buyside advisory suggests a need for a new, innovative process in acquisition guidance. Strong competition for upstream oil and gas assets in the U.S. unconventional market provides a significant test for even the most experienced energy companies that are challenged in the pursuit of acquisition opportunities.

Some investment decisions, however, suffer from a lack of adequate insight and intelligence that would be afforded by more experienced boots on the ground. Successful investment decisions require resources and skills to identify, screen and evaluate the large volumes of opportunities available in the market. A clear strategy is essential.

The advisory business has grown dramatically over the past 10 years based on a focus on the sellside, where hyperbole has dominated good financial decision making. Commodity markets never re- main in contango and even development drilling meets with a fair degree of failure. Yet, buyers are rarely sensitized to these common experiences in the market. Oftentimes their staff is charged with a demand for growth and lacks the resources to assess the underlying risks associated with an acquisition.

The dramatic shift in focus from conventional to unconventional resources demands a strategic operating and capital-budgeting discipline to safely steer the large capital requirements of uncon- ventional asset acquisitions. Often, shortsighted capital-budgeting decisions can jeopardize long-term investments.

A prime example is opting to drill a lower-cost and lower-return vertical well program versus a horizontal well program with the potential of larger returns and a higher capital risk. Decisions such as these usually follow unsuccessful development programs that are poorly crafted and executed. In short, the capital-budgeting decisions are flawed.

Buyside mandates

The question then becomes, why have so many buyside mandates experienced such unfortunate and unforeseen returns? The answer lies in the nature of the business. Buyside advisory is hard, time consuming work with a statistically smaller probability of concluding a successful transaction for the resources employed. Drawing from the sellside model, clients normally choose to compensate buyside advisors only upon a successful acquisition. Implicitly, the question is why many fail to see the value in losing a deal, when in fact, winning results in financial loss.

One private-equity group recently disclosed that to achieve one successful acquisition, it needed to screen approximately 100 opportunities, ultimately finding 10 acceptable assets to actively pursue. It is hoped the client will be successful in winning one out of the 10 filtered transactions—this is referred to as the “1% rule.”

So how can an acquirer who lacks boots on the ground and an advisor truly looking out for its interests navigate these shark-infested waters? The good news is that acquirers are not limited by asset-acquisition opportunities. On the other hand, the competition has become keener as international oil companies (IOCs), government-sponsored enterprises (GSEs) and private foreign companies have entered and remain active in the market.

Even the most sophisticated acquirers require assistance to optimize sourcing opportunities and develop a systematic acquisition process that is consistent with the strategy of the parent. In the related graphic, we suggest one approach where an acquirer may make effective use of A&D advisory to acquire assets or smaller companies using a series of progressive criteria.

Systematic stage gates are important because they clearly define roles and expectations, saving time while optimizing precious human resources. Full buyside asset evaluations prior to successfully reaching a purchase agreement can easily cost a company $30,000 to $300,000, depending on the complexity and expertise required to get to the offer-recommendation stage. While not an insignificant amount, when compared to the financial experiences of many acquirers over the past five years, it is a drop in the bucket.

A&D advisory teams review a multitude of opportunities. With predefined client screening guidance, they can provide preliminary market valuations with public information similar to the traditional sellside marketing proposals. The technical and commercial team then can identify size, fit, shape and risk of a potential buyside opportunity.

If stages one through four pass all screening and preliminary valuation metrics, a framing session with the client and advisory team is necessary to discuss the evaluation modeling and identify risks and risk mitigations before arriving at an offer recommendation.

The weight of stages five and beyond are generally that of the acquiring company; however, the savings of the sourcing, filtering and preliminary evaluation is a major benefit to the resource-limited acquirers. All of this must take place within the context of a strategy that has been discussed, vetted and understood by both the client and the advisor, a critical first step that is often overlooked.

David Nordt is with Credit Agricole Securities (USA) Inc., and is with Kirk Tholen, David Pantoja and Dennis Petito.