Most people involved in the A&D market are aware of the adage that the fourth quarter of each year is the busiest in terms of deals for sale. In fact, 34% of annual deal volume occurred in the fourth quarter, on average, over the past four years.

There are several reasons for this phenomenon: completion of portfolio review for reserve reporting; satisfying anticipated financing shortfalls for an upcoming capital budget; the psychological effect of finishing a year by optimizing a company’s portfolio; and trying to squeeze transactions in before an anticipated increase in capital gains tax rates.

The effect of this phenomenon, however, is almost always the same: Asset valuations can, and usually do, suffer in the fourth quarter as a result of an oversupplied A&D market.

Cash flow metric proof

The most reliable way to show this phenomenon is to review future 12-month cash flow from proved developed producing wells (FTM PDP CF) for assets with more value attributed to production than to undeveloped acreage/upside. This is because FTM PDP CF equilibrates for changes in commodity prices that can skew other metrics, and producing assets are more predictable and tend to trade in a less volatile range than undeveloped acreage.

In three of the past four years, FTM PDP CF saw a reduction of 15% versus that same metric for the other three quarters in that respective year.

The anomaly in four-quarter 2010 can be explained by two occurrences: The high-yield market exploded in second-half 2010 with $11 billion in E&P-related capital raises (nearly double the amount in any six-month period since the financial crisis), allowing buyers to finance acquisitions with more debt; and a high proportion of that quarter’s deals had a relatively large amount of upside (downspacing in the Wolfberry to 20-acre locations, re-fracs in the Barnett shale, etc.).

The other years in the study, however, show a significant reduction in value resulting from an A&D market flooded with assets. The fourth quarter’s volume for producing assets made up 43% of that year’s total volume on average from 2009 to 2013.

Spread thin

Feedback from process participants anecdotally supports what the data suggests regarding value degradation in fourth-quarter sales. Robust buyer participation is much more difficult in the crowded fourth-quarter market, as companies are very selective in deploying their limited evaluation resources. Companies that are typically eager to attend several dataroom presentations throughout the year are forced to high grade which ones they will attend in the fourth quarter. This reduced potential buyer pool results in a lower probability of maximizing value to the seller.

As an advisor, we generally recommend marketing assets to a broad audience to ensure that the outliers (or “aggressive bids”) for the assets are obtained and that the client receives the highest price. One way we measure the ability to obtain these aggressive bids is by comparing the high bids against the median of the bids received; the higher that ratio, the more certainty we have that we indeed cleared the market and found the outliers.

In reviewing RBC Richardson Barr’s producing asset deals over the past four years, one can observe that the crowded fourth-quarter A&D market casts uncertainty on achieving those aggressive bids. The average aggressive bids/median bid ratio was 1.4 x for deals marketed in the first three quarters of a calendar year during that time frame, whereas fourth-quarter deals managed only a 1.2x aggressive bids/median bid ratio.

To put this difference in more absolute terms, consider a hypothetical deal with a median bid of $100 million: Sellers in the first three quarters would realize an additional $20 million, versus marketing that same deal in the fourth quarter. Given that incremental proceeds from a higher purchase price typically go directly into the pockets of the seller, this timing difference is substantial from a wealth perspective.

Divest wisely

Buyers who would otherwise have potentially submitted the outlier bid for an asset package may have eliminated that potential transaction from their busy fourth-quarter evaluation queue, and the seller, by not maximizing participation, ultimately may not have maximized value. This may also be evident in fourth-quarter deals that ultimately fail to transact: $15 billion of failed transactions in fourth-quarter 2010 and another $20 billion in fourth-quarter 2012.

Sellers do not always have the luxury of determining when they go to market with their assets, as changes in investor sentiments or capital budgeting may dictate timing. For sellers that do have the luxury of choosing the time to market their assets, we recommend those sellers avoid the crowded fourth-quarter A&D market in order to maximize participation and ultimately achieve the best possible price for their assets.