A Qualified Opinion: Philip Dunlap
Philip Dunlap, the office-managing partner in the Houston office of law firm Balch & Bingham LLP, corresponded with MMG about M&A activity in the energy sector.
This article originally appeared in the July/August 2020 issue of Middle Market Growth.
Philip A. Dunlap is the office-managing partner in the Houston office of law firm Balch & Bingham LLP. His experience includes advising energy and energy services companies, private equity investors, privately held companies and startups on a wide range of corporate matters, including mergers and acquisitions, securities and financing. He recently corresponded with MMG about M&A activity in the energy sector.
Q. What types of M&A transactions are you seeing in the energy industry?
The combination of worldwide stay-at-home orders and the steep decline in oil prices has caused most energy transactions to be placed on the shelf or terminated completely. However, as people begin to reengage in the market, I think certain types of deals will manage to get closed.
“Even private equity investors with excess dry powder may not be able to justify making their typical investment if they cannot finance the transaction with the right mix of debt and equity in their capital stack.”
Across all sectors of the energy industry (upstream, midstream, downstream and services), opportunistic buyers, particularly strategic buyers, will find a way to acquire distressed companies or assets from sellers who need cash to survive. This will lead to a consolidation of stronger key players in each of these industry sectors.
In the upstream sector, we may also see large operators strategically selling assets in order to exit certain regions. As a counter to the doom and gloom of the upstream sector, the dramatic reduction in oil production has caused a corresponding reduction in byproduct natural gas production. As we get to the fall and winter, that reduction in supply should result in higher prices for natural gas, making deals in that space attractive to many buyers.
As parties begin to negotiate potential transactions, the uncertainty caused by the first half of 2020 is leading to more contingent and delayed payments in purchase price structures. Additionally, buyers are working through new diligence issues specifically arising from COVID-related issues. Buyers and their advisers are looking at the target companies’ PPP loan applications and forgiveness applications. They are also digging further into recent employment trends, including whether targets conducted layoffs or furloughed any employees during the stay-at-home orders.
Q. How do you expect private equity investment strategies in oil and gas to change going forward?
While strategic buyers with access to cash will most certainly be those opportunistic buyers discussed earlier, the lack of available debt may cause private equity buyers to wait longer in the market cycle before investing in energy. Even private equity investors with excess dry powder may not be able to justify making their typical investment if they cannot finance the transaction with the right mix of debt and equity in their capital stack. However, private equity buyers who have significant experience investing in or managing distressed companies may continue to look at targets in the energy industry.
Groups that focus on exploration and production (E&P) may not want to back brand new management teams or take chances in this space in the near term. I do expect those E&Pfocused funds to consolidate some of their portfolio companies in order to cut down on expenses. Private equity funds that have typically invested in midstream or oil field services will still work in this space, but they will be more cautious and disciplined in their investments. Oil field services companies that have some sort of proprietary technology or a unique space in the industry will continue to be attractive. Any target that has demonstrated a good source of recurring revenue will also merit serious consideration from private equity.
Q. Will we see an uptick in M&A activity involving renewable energy businesses?
The renewable energy market has been strong for several years, even before the current decline in oil and natural gas prices. While I expect this to continue to be a strong market and therefore a good target for M&A activity, I do not expect there to be a substantial uptick in M&A activity for the renewable energy sector. As federal subsidies for wind and solar projects phase out, the attractiveness of this sector of the industry may not be as strong as it has been in recent years.
As uncertainty related to government tax credits and subsidies continues (related both to the timing of these benefits and potential changes in the political environment), I expect that buyers who are familiar with this space will continue to be active, but we will not see significant growth in this sector in the near term. However, as major energy companies seek to diversify their portfolio and financial investors tire of the volatility in the oil and gas markets, I do expect the renewable energy sector to be ripe for growth with help from both strategic and financial buyers.
