While M&A activity will remain robust in 2008, deal prices will trend down due to over-exuberant bidders for assets becoming more conservative in their deal analysis, according to Martin Lovegrove, M&A analyst and vice chairman of oil and gas for Standard Chartered Bank.

In 1999, he co-founded U.K.-based M&A advisor Harrison, Lovegrove & Co., which was purchased by Standard Chartered in December. The firm and U.S.-based energy-research provider John S. Herold Inc. review global M&A deal-making annually. (For the 2007 report, see “NewsWell” in this issue.)

Beginning in 2005, he says, it was common to see one bidder make a play on an asset package that would come in well above all other bidders, sometimes as much as 60% to 100% higher. “A lot of the deals in 2005 and 2006 had winners that were really quite ahead of the second- or third-highest bidders.”

This is the “cappuccino buyer,” he says, as this buyer is frothy. That over-the-top buyer is becoming less prevalent, resulting in deal prices coming down, at least statistically. 2007 marked the turning point.

Deal margins were affected by rising costs and higher taxes internationally. The value of maturing assets began to fall with little upside potential. Market financing has become more difficult to secure, resulting in some deals that just fell away.

“Deal prices actually fell last year. They fell in the States and they fell overseas—a large amount overseas.”

In contrast, the deal value as represented by the “pack” of bidders actually increased roughly 10% in relation to rising commodity prices, says Lovegrove. This fact has gone unseen until recently because the winning bid is the only one that gets calculated in the metrics.

“Without any movement in oil prices, if you took that guy away, then you would drop down to the value offered by the more conservative bidders. That is your cappuccino froth,” he says. “We saw fewer incidences this year than the previous year.”

Deal prices will by and large be more “reasonable” this year, while still aggressive, he forecasts. “To win deals, you have to be aggressive in your assumptions, but I think people will get much more cautious in their assumptions.”

MLP deal-making. Contrary to popular belief, MLPs were not the reason for price run-ups on deals, says Chris Sheehan, John S. Herold senior vice president and director of M&A research. “They were generally in the range of market value pricing.”

He says the valuation of MLP acquisitions compared with what other entities were paying for similar reserve life and oil and gas weighting was analogous.

More interesting, he notes, was the percentage of overall deals by MLPs. Up until August, MLPs contributed to 15% of all deals, “a significant part of the pie.” Post-August, it was a trickling. “Most of their deal activity had come through before the credit crunch, then it fell off quickly.”

Toward the end of 2007, credit issues also certainly affected upstream M&A activity, says Lovegrove. “We saw one or two deals where buyers put in offers contingent on financing and that financing wasn’t forthcoming. The banks’ capacity disappeared for a little while.”

In relation to the oil and gas sector, banks will become cautious in some of their lending in spite of the sector being strong. This is due to them taking an “umbrella” view of the overall market and not just a sectorial view.

“If you’re a big company with well-established credit, it almost certainly won’t be a problem—provided you come up with the right deal. If you’re a small new company looking at a very big development and you don’t have a credit history, then the banks will say it’s a bit risky. Once you’ve been bitten very largely in the backside, you start to worry about things that are simply slam dunks.”

U.S. plays. Unconventional resources are the hot trend in North America presently. In Canada, the oil sands are highly sought after, and prices have increased. “The buying pool is very strong from both North American and overseas buyers,” says Sheehan.

In the U.S., shale gas plays are a strong focus area. Consolidation in the Barnett, Woodford and Fayetteville shales has been the trend for the past two years, particularly in acreage, and now producing reserves are being targeted.

The Gulf of Mexico is robust, especially the deep water where some of the highest prices are being paid for reserves. A competitive buying pool of North American, European and Asian companies dominate the scene.

Lovegrove believes the trend of foreign companies buying in the deepwater Gulf will wane. “The foreign companies have established themselves. I think they would like to buy more, but they will have to start buying out companies.”

Companies holding deepwater assets often hold assets onshore U.S. as well, which would not be attractive to a foreign operator, says Lovegrove. “The companies coming into the deepwater from overseas have absolutely no interest whatsoever in the Gulf shelf or onshore.”

Middle Eastern players—the sovereign wealth funds—are beginning to make their presence felt on the global M&A scene, he says. “They were virtually nowhere two years ago. In 2007, they came in with a bang.”

Conversely, the Chinese almost disappeared from the scene in terms of buying, affected by overpaying for certain deals.

“This year, if prices become more reasonable, you will see the Chinese and the Indians returning to the market, and you will still get the sovereign wealth funds. You will get quite a lot of activity this coming year.”

Where in the world will M&A be active in 2008? Says Lovegrove, “The U.S. always has the greatest deal flow, of course. Statistically that’s not a surprise. Asia should be pretty active. Africa should be pretty active. Europe probably not so. Latin America wants to be, but the way it’s working—probably not.”

—Steve Toon