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Johnston Carmichael: Has appetite increased for oil and gas deals?

Stefano Vincini, corporate finance associate director in Johnston Carmichael’s Aberdeen office.
Stefano Vincini, corporate finance associate director in Johnston Carmichael’s Aberdeen office.

A new year can provide a good opportunity to revisit plans for the year ahead.

One of the more pertinent questions to be raised by shareholders of companies in the oilfield services (OFS) sector is will the next 12 months be the right time to consider an exit?

While the response to the same question has for several years been met with some hesitation, 2019 might indeed be the right time.

The big caveat is, of course, Brexit and the uncertainty this macroeconomic “elephant in the room” has created.

The business community and public in general still have no clarity as to how the post-Brexit landscape might look.

In spite of the potential impact of Brexit, several factors may point to the next 12 months presenting a good opportunity for those considering an exit.

Despite recent volatility it is hoped oil prices can stabilise within the $60 to $80 per barrel range.

Also, recent supply cuts implemented by Opec members have increased confidence that prices will be supported in the short to medium term. The combination of a general market recovery and cost-cutting measures applied during the market downturn are now being reflected in firms’ accounts.

Visibility for the OFS sector is typically relatively short but the experience gained by management teams during the downturn, and their continued vigilance regarding discretionary spending, provide some comfort that the improvement in earnings is sustainable.

The stronger balance sheets of trade buyers and an increased appetite from private equity to invest in energy related assets have resulted in funding being available – as evidenced by The Carlyle Group’s acquisition of EnerMech for an estimated £450 million in October 2018.

In addition, the valuation gap between sellers and buyers appears to be narrowing. Earnings and pricing multiples have increased from the lows experienced during 2016 and 2017. Together with the uncertainty that a hard Brexit may present, another significant downside risk to the OFS sector, and indeed the wider global economy, is China.

A combination of weaker economic activity and a potential trade war with the US could result in a fall in demand for oil. There are already some signs, however, that talks between the US and Chinese governments have made progress, with a temporary truce on further tariffs until March 2019.

Many commentators also believe a deal will be reached sooner rather than later as it is in both parties’ interests to do so.

On balance, and subject to the outcome of Brexit, the second half of 2019 may present an opportune time for shareholders of OFS companies to exit.

As a general rule it is never too early to start preparing for sale.

Shareholders who are considering an exit should be starting the planning process, if they have not already done so.

This may include producing more regular and timely financial information, ensuring contracts are up to date and/or renewed, and ensuring premises and facilities are compliant with required legislative/Health and Safety Executive requirements etc.

The routes to exit for business owners and entrepreneurs traditionally follow one of two well-trodden paths.

These are either a sale to a (larger) corporate acquirer or financial investor, or a listing on a stock exchange (initial public offering).

But there is a growing trend to explore an alternative route; a friendly, flexible and (potentially) tax-free solution that allows vendors to exit on their own timescales and at a price they can set themselves.

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This can also be done without any need for external funding, and with a post deal structure that both rewards and engages staff. It sounds good, doesn’t it?

EOT (employee ownership trust) is a new favourite acronym for those at Holyrood as it also ensures that Scottish businesses that may otherwise have been sold to a foreign acquirer are kept under domestic ownership.

We are seeing an increase in EOTs and it’s easy to understand why.

Benefits include 0% tax on the proceeds, while EOTs also allow employees to be paid bonuses of up to £3,600 each tax-free (this will incur National Insurance contributions).

Flexibility over price and timing is also key here, especially where vendors aren’t looking to cash out everything on day one.

Vendors can set their own price, take part payment at the date of the transaction or defer the balance to be paid down by the business over a pre-agreed period. This can sometimes allow vendors to set materially higher prices than they may have otherwise achieved from a traditional sale.

It can also reduce the need to source third party funding to deliver the deal.

Despite the frustrations of uncertainty posed by Brexit during the past year, which is among a range of challenges facing the corporate landscape, overall transactions in the UK have grown, both by value and volume.

For RSM, 2018 was another year of growth, with the firm completing 154 transactions – up from 142 in 2017 – at an aggregated value of more than $2.5 billion (£1.94bn).

As EOTs emerge as a genuine alternative exit option, we expect this to continue to encourage and drive transactions, despite the growing clouds of concern as we tick towards life post-Brexit.

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