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Narrowing Valuation Gap in Oil and Gas Industry

By Logan Day
Published: September 15, 2014 | Last updated: March 21, 2024
Key Takeaways

It is essential for companies to take pre-deal steps such as developing detailed plans, focusing on future value and looking closely at synergies in an attempt to unlock the highest value from their business.

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Confidence is growing in the Canadian and global economy. This is translating into a renewed appetite for growth. Economic uncertainty and geopolitical risks stalled M&A activity over the last few years, but all signs point to an exciting year ahead for Canadian companies.

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Survey Says

EY’s recent Capital Confidence Barometer survey shows that 79% of Canadian C-suite executives feel that the global economy is improving. That’s up from 24% in our 2013 survey — giving Canada one of the most positive outlooks of 54 countries surveyed.

When it comes to Canada’s oil and gas sector, cautious optimism still prevails. Energy companies don’t all share the broader country’s appetite for growth. A conservative view on commodity prices, along with pressure to deliver capital returns, is behind this mindset.

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M&A, however, is not off the table for everyone. Thirty-percent of all oil and gas respondents plan to pursue an acquisition in the next 12 months. Despite this seemingly low number, companies remain optimistic that deal activity will increase. Ninety-four percent of these same oil and gas respondents expect that their deal pipelines will expand over the next 12 months.

Transaction activity will depend on finding the right deal at the right time. The desire to increase market share, both in existing markets and in new markets, continues to drive M&A decisions.

A narrowing valuation gap is also driving greater interest in deals. A large majority of oil and gas players believe that the current valuation gap between buyers and sellers is less than 20%.

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Shrinking Valuation Gaps

There are a number of reasons behind the shrinking valuation gap coming from both the buyer and seller side, including an abundance of global capital returning to the marketplace, renewed private equity interest and changing demographics.

Banks are once again lending generously and making it possible for buyers to get in the game. Improved credit availability is translating into more buyers in the marketplace who are willing to pay more for assets. At the same time, there’s an abundance of private equity capital sitting on the sidelines. The competition is heating up among PE groups for quality assets. With more bidders around the table, players are willing to pay more. They’re in the race together. On the seller side, aging business owners are reaching retirement age and many are motivated to sell. These owners aren’t waiting for the next upswing in the energy cycle to achieve certain value.

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Pre-deal Steps to Capture Value

This shrinking valuation gap is set to drive deals across the sector. Unlocking the most value possible from M&A will require up front rigor. Companies must consider the following critical pre-deal steps:

  • Focus on future value. Traditional due diligence approaches often place inordinate weight on the past performance of assets. Deal teams need to shift their mindset toward a forward-looking view.
  • Look closely at synergies. Take a holistic approach to determine untapped hidden upsides from all sources.
  • Identify drains on value. Transactions can trigger dis-synergies. Detect potential drains on management’s focus which can create a loss of value in existing businesses and markets.
  • Develop a detailed plan. Ensure a comprehensive plan is laid in order to achieve both synergies and fundamental value propositions.
  • Assign resources and accountability. The right people need to be involved at the right time with the right focus, motivation and support.
  • Facilitate collaboration. Seek input from a number of internal sources and third-party advisors with relevant expertise.

Focusing on the above deal differentiators can mean the difference between M&A success and failure. Involving key business functions early will set the stage for greater continuity of the entire deal process. This is especially important for Canada’s capital intensive oil and gas sector. By undertaking proper due diligence and process, companies across Canada can unlock the most value from M&A.

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Written by Logan Day

Logan Day
Logan Day is a Partner in EY’s Transaction Advisory Services practice, based in Edmonton. Logan focuses on assisting clients with their transaction needs and corporate finance services. He specializes in sourcing deals and advising on mergers, acquisitions and divestitures.

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