After a period of relative quiet, North Sea oil and gas is increasingly in the private equity spotlight, amid renewed confidence that has spurred an appetite for deal making.
Whilst sponsor investment in upstream assets have been taking the majority of headlines, the deep legacy stock of services assets with private equity backing are beginning to show signs of renewed deal activity as well.
Specialist private equity firms have been at the vanguard of North Sea upstream investment in recent times, chalking up around $12 billion of acquisitions since November 2016.
The uptick in activity reflects a shift in mindset, both among investors and traditional operators. As many North Sea assets reach the end of their productive lives, the bigger incumbents are better placed to return value to shareholders and owners by deploying capital in large-scale developments, rather than adopting operating models to maximise returns on mature stock.
As such, a transition of ownership to younger and more nimble entities, often backed by private equity, has been welcome opportunity to divest. However, volatility in commodity markets since 2014, an inability to transfer the tax history of assets and the challenges of how to handle decommission liabilities , have created hurdles to dealmakers trying to reach a unified view on valuation, shared risk and deal structure..
Happily, an extended period of stability in commodity price has allowed the expectation gap between buyers and sellers to narrow, paving the way for a smoother transfer of ownership from traditional operators to sponsor-backed entities.
Away from upstream, the private equity transaction landscape is somewhat different. The North Sea services market, for example, has a far more mature relationship with financial sponsors, after attracting high levels of investment and returns prior to the 2014 downturn.
Today, this market is increasingly bifurcated between specialist energy funds and their more generalist peers, many of which are holding investments for extended periods following the change in market conditions post 2014.
Among sector-focussed sponsors, the past 18 months has seen a range of platform acquisitions and strategic bolt-ons, ahead of an expected gradual market recovery. In contrast over the same period, generalist funds with incumbent assets, have largely focused on trading recovery, operating models and management of lenders.
However, as the relative stability and moderate price recovery – that has facilitated upstream assets – entered an extended period, funds are increasingly laying the groundwork for eventual exits. This has included renewal of business plans, refreshed management teams and their related incentives and, in some cases, targeting of modest acquisitions to broaden product offering, geography, technology or capabilities.
The strategic rationale in these cases is to take advantage of improving macro conditions to bolster the quality of earnings ahead of a potential divestment later this year or in 2020.
For those without existing North Sea exposure, there remains understandable caution about the sector’s recovery, combined with a challenging and a return limiting lending environment.
However, as the value expectations of sellers become more normalised compared with other ultra-competitive sectors, it may not be long before investment committees recognise value in a sector with tangible growth potential and in some cases, limited exposure to broader uncertainties such as Brexit that impact the wider UK deal market.
For owners of oilfield services companies, the evolving environment creates a strategic imperative. Those with private equity shareholders may wish to ensure the business plan is in shape (reflecting the growth story), adjust management schemes and assess tactical acquisition opportunities.
For those considering a sale to financial sponsors, the development of an attractive equity story, consideration of acceptable and realistic valuations, and identification of the medium-term management team are important first steps.
Finally, for any leveraged transaction, the position of lenders will be key. In general, banks have remained supportive and have been happy to retain extended leverage in sponsor-backed situations, recognising the shared ‘skin in the game’ with investors.
However, all sellers need to make reasonable assessments of sustainable levels of leverage and how this interacts with value expectations, particularly in primary or secondary buy-out situations, recognising that the levels of debt previously available for structured transactions has diminished, against a backdrop of broader challenges for lenders across the UK, as well as continued scrutiny from credit approvers.
So whilst the next 18 months is likely to see transactions involving private equity shared between upstream and services, caution and grounded expectations are likely to permeate the approach on both sides of the deal making field of play.