Capital Access Driving Upstream Dealmaking
HOUSTON–PricewaterhouseCoopers describes 2018 as exceptional for merger and acquisition activities, a year characterized by megadeals in almost every industrial sector as companies aimed to create scale. That includes unconventional resource plays, which are expected to remain a major driver of M&A dealmaking throughout the foreseeable future.
While challenges continued to emerge–including continued changes to the regulatory environment, a shifting geopolitical landscape, and uncertainties in broader economic markets–PwC says M&A activity is expected to maintain the pace set in 2018.
In its year-end summary, PwC notes that many U.S. oil and gas dealmakers shifted strategies in 2018 to focus on positive cash flows and simpler corporate structures in response to shareholder demands for positive cash flow, the prospect of rising interest rates and pressures to continue to improve efficiencies. Going forward, the analysis says record access to capital will keep deal valuations high and keep the M&A market busy.
“Dealmakers are at the center of an unprecedented M&A cycle in which U.S. investors, particularly private equity firms, have record access to capital,” the report states. “This enduring and unrivaled feature of the U.S. deals market . . . will pre-empt many other variables in driving M&A deals so long as companies are ready and willing to compete in markets where scale increasingly matters and disruption has become the new norm.”
U.S. companies holding the funds to make bold investments is one of the biggest deal drivers in today’s economy, PwC says. For many companies, 2018 was a year of record investments across multiple spheres, including business investment, research and development, and M&A. This was driven partly by a 2018 tax reform law that allowed corporations to repatriate cash held overseas at lower tax rates.
The report says technology companies in particular have used the capital surge to position themselves to continue growing in technologically sophisticated markets. During the first half of 2018, research and development spending saw double-digit growth, according to the U.S. Bureau of Economic Analysis.
Meanwhile, deal values have soared to near-record highs, primarily because of capital availability. During the first nine months of 2018, PwC says values rose to more than $3.0 trillion globally and are on pace to surpass $4.0 trillion, largely reflecting a surge in megadeals valued at more than $5.0 billion. While 2018’s deal values may not beat 2015’s record $4.7 trillion, PwC predicts it may exceed levels seen in 2007 shortly before the financial crisis. Looking ahead, the analysis predicts deal values will stay elevated, as companies with a clear strategy for how they plan to grow will leverage their outsized funds and invest in a future that will be increasingly competitive and disruptive.
Expectations in 2019
Looking at expectations for 2019, PwC identifies several key drivers of deal activity:
- Corporate and private equity investors will continue enjoying record access to capital as they plan for growth.
- Scale drove megadeals in 2018. This trend likely will continue, and it will extend to smaller and mid-sized firms looking to expand their businesses.
- Digital disruption has driven many companies to look beyond their immediate industries for growth opportunities. In 2018, cross-sector deals made up more than a third of corporate M&A, and convergence likely will continue driving mid-sized deals between $100 million and $1.0 billion.
- Despite more oversight in the United States on foreign deals, Chinese investors continue to view America as an attractive place to invest. Expect to see more middle-market deals across industries that typically will draw little, if any, regulatory scrutiny.
PwC says U.S. companies may expect a slowdown in the pace of regulatory change following the midterm elections, although it adds dealmakers in 2019 also need to factor in the possibility that a turnover in state legislatures and governors’ offices could clear the path for new regulations at the state level, particularly regarding privacy laws.
Shale was a major driver of deal activity in 2018, as companies in the sector became increasingly comfortable with oil prices in the $50-$70 a barrel range, and unconventional break-even points continued to shrink. Although cost erosion has slowed, PwC says the trend still is in place, making shale an attractive target for expanding portfolios.
“The majority of the shale acreage additions were done in basins where the acquirer already had a presence, know-how, and potential cost synergies, as break-even costs go down with every additional well drilled,” PwC described. “Not only are U.S. exploration and production companies interested in shale assets, but we also are starting to see supermajors and international oil companies renew interest in shale, and make a commitment to grow production levels from shale. As the massive take-out continues, we expect shale to continue to be a major driver of deals for quarters to come.”
PwC says the Permian finished 2018 as the most attractive shale basin. It notes drivers of that trend include large reserves in the basin that make acreage valuable and economies of scale as contiguous acreage allows for longer lateral wells and increasing returns on investment. Facilities can be combined, decreasing fixed costs and increasing free cash flows. Many of the Permian deals were core acreage additions funded by divestures of acreage in noncore basins. If valuations remain on an upward trajectory and commodity prices stabilize, PwC forecasts, other basins might see an uptick in deal activity in 2019 as well.
“The Permian continues to drive much of the M&A activity in shale because of attractive production economics and an increase in infrastructure capital projects. Divestitures of noncore acreage in basins such as the Haynesville seem to be funding the acquisitions in the Permian. Total deal value in 2018 also was driven by mistream-related party transactions and that trend may continue as midstream players streamline their operations,” offers Seenu Akunuri, U.S. oil and gas valuation practice leader at PwC.
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