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M&A Activity Lukewarm as Oilfield Services Sector Focuses on Profitability
As crude oil prices strengthened during the first quarter of this year, many oilfield services (OFS) companies in Western Canada expressed cautious optimism for an upswing in 2017. The industry could be marking a turning point towards a sustained level of higher activity and better margins, although for some, it came too late.
Some businesses with higher debt levels have headed towards the auction block or have been placed in insolvency proceedings due to the lack of financial options.
While increased consolidation is still a likely outcome across the sector, to date there have been fewer deals struck than might be expected, given the severity of the downturn, says Jeremy Rondeau, MNP Vice President, Oilfield Services. Valuations remain a stumbling block, he notes.
“In many deals, valuations may have to be based on net asset values because there hasn’t been enough cash flow to support a goodwill number,” says Rondeau. “The sale is akin to an equipment liquidation.”
Another challenge that arises in any decision to pursue merger and acquisition (M&A) deals is the time, effort and money that go into the process. When companies are trying to repair their own balance sheets after a prolonged downturn, there may not be enough free cash flow to put into an opportunity that may - or may not -work out in the end.
Margins for OFS companies have been decimated during the past three years, due to lack of work, producers demanding pricing concessions or services companies bidding low to win contracts and keep employees at work. “The margins have just been so thin that it makes it really difficult to go out and either use your own cash from operations or obtain debt to buy somebody out. It’s challenging,” says Rondeau.
Last year the total value of M&A activity in the Canadian oil patch rose to $24 billion, a dramatic increase from $15 billion in total value in 2015 but still lagging significantly from the $49 billion seen in 2014, according to Sayer Energy Advisors. In 2016, the activity was split between assets worth approximately $14 billion and corporations worth approximately $10 billion.
M&A Activity in 2017
From an M&A standpoint, Rondeau expects only a handful of large mergers will take place. For example, at the end of March Trican Well Service announced a friendly deal to acquire Canyon Services Group for $637 million. Meanwhile, Western Energy Services and Total Energy Service have been in a protracted battle for Savanna Energy Services.
Aside from these “anomalies,” asset deals will continue to be the norm during 2017, he says, as they were in 2016 — at least until service companies can build their margins and generate some free cash.
OFS companies will continue to pick up equipment they think they can use down the road, to fill in holes from a fleet or equipment standpoint. Many of these sales from distressed companies occur at a fraction of what it would have originally cost to buy the equipment.
The M&A action that does unfold will likely involve strategic mergers of companies trying to spread overhead costs over a bigger operating company, Rondeau says. “You’re looking for something to scale up and maybe trim some of your fixed costs — you’re looking to build profitability or put yourself in a position to be profitable again,” says Rondeau. “I would suggest the M&A activity will be focused on strategic mergers that will support that.”
The strategy may also involve spreading overhead over a wider geographic reach, with companies moving into new play areas. Scale and geographic breadth could also become more of a requirement for larger exploration and production companies seeking alliances with larger OFS companies that can offer a range of services and provide better deals.
Playing the Waiting Game
Rondeau believes some companies with healthier balance sheets are playing a bit of a waiting game. These stronger companies, ones with less debt and proper leverage, are unlikely to pay a premium for a takeover target and will wait for weaker companies to run out of options.
He warns the recent uptick in industry activity might not be the panacea many believe. Increased activity does not necessarily always mean increased profitability.
“So the activity increase is great; it’s the pricing piece that continues to be a challenge,” Rondeau says, noting service companies need a sustained recovery in activity levels during the second half of 2017 to return pricing for oilfield services to more sustainable levels.
Vic Kroeger, Director of Corporate Recovery Western Canada for MNP, believes the post-spring breakup period will be a critical period as some companies struggle to survive.
“Are companies going to be able to last another down, or slow, period? We just can’t say. Banks are usually willing to work with companies in financial difficulty as long as the companies don’t ask for more money. If they start saying they can’t pay their administration costs, that’s when banks will start to consider their other options,” he predicts.
Kroeger notes producers still have a tight rein on capital spending as they need to replenish their own bank accounts before going out and spending more, which would create a positive trickle down effect for OFS companies.
A big question mark for Rondeau is the direction of interest rates. An increase in rates may push some companies into receivership.
“Margins are that thin that an interest rate increase could have a big impact,” he notes. “It would definitely encourage some companies that were on the fence to throw in the towel.”
Or the towel will be thrown in for them, Kroeger says.
Sample of Publically Announced OFS Asset Sale Deals 2016-2017
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Client Groups:Oilfield Services
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