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  • Roger S. Conrad

Let’s Make a Deal

By Elliott H. Gue on Oct. 20, 2016

Merger and acquisition activity involving oil and gas companies has declined by about 19 percent from year-ago levels, based on the total value of the deals announced thus far in 2016.

(Click graph to enlarge.)
global oil and gas ma

North America remains the most active market, with about 61 percent of the targets and 69 percent of the buyers calling the region home.

With all the upheaval in the global energy patch, many oil and gas industries are ripe for consolidation, especially the hardest-hit portions of the value chain.

However, our long-standing rule of thumb when playing potential takeover targets is to focus on names that offer exposure to a compelling upside story; even if a deal never materializes, our position should appreciate in value.

Accordingly, our screen for potential takeover targets omits the oil-field service and equipment segments.

Within these industries, too many names that offer exposure to the US onshore market have been bid to the moon and trade at valuations that don’t reflect two fundamental challenges: persistent overcapacity and the likelihood that crude-oil prices ranging between $40 and $60 per barrel will moderate any recovery.

Yes, the markets for onshore drilling rigs and the crush-resistant sand used in hydraulic fracturing should benefit from the supply-side discipline that comes from consolidation. But given the valuations in these industries and the challenging outlook, we prefer to remain on the sideline.

Contract drillers that specialize in deepwater rigs continue to contend with declining utilization rates, much lower day-rates and excessive leverage taken on to expand their fleets during the salad years. The industry remains ripe for bankruptcies as well as consolidation.

The likes of National Oilwell Varco (NYSE: NOV) and FMC Technologies (NYSE: FTI) have the financial strength to survive the down-cycle and could be takeover candidates in a deepwater market that must lower project costs to compete.

Industry consolidation could help to improve coordination and drive the push for standardization, but these names look like dead money aside from a potential takeover bid or the occasional rip when a bump in oil prices prompts a wave of short covering.

What about US refiners, a segment we’ve avoided for more than a year because of elevated valuations and declining crack spreads?

Consolidation appears to be most likely among the small fries that own refineries with less flexibility on feedstock. To that end, Alon USA Energy (NYSE: ALJ) on Oct. 14 announced that the company had received a written proposal from Delek US Holdings (NYSE: DK) to acquire the small-capitalization refiner.

And Reuters in the past has reported that HollyFrontier Corp (NYSE: HFC) could be a potential takeover target for Tesoro Corp (NYSE: TSO), which purchased MDU Resources Group (NYSE: MDU) and Calumet Specialty Product Products Partners LP’s (NSDQ: CLMT) Dakota Prairie refinery in June.

But differentials between regional oil prices—formerly a tailwind for well-positioned US refiners—have narrowed significantly over the past year, eroding one of the industry’s major competitive advantages and weighing on crack spreads. At this juncture, the risk-reward balance still appears to skew to the downside.

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