One of the questions we are constantly being asked in these times of commodity uncertainty is whether there are actually any energy service deals being done.

In our experience, there are always deals getting done in any market, although it is currently slower than normal, but the short answer is “yes”, but there are qualifications to the answer, mostly led by “what” – specifically what types of deals, what buyers and what price.

Let’s start first with what types of deals. In a market like this the types of deals that get done can be opportunisitic market share expansions, counter-cyclical investments, distressed M&A or platform investments into a depressed market. The most common are distressed transactions where many service companiies that can no longer make a go of it are forced to sell their businesses to a competitor just to stay afloat. One of the obvious side-effects of a market such as this is that if you manage to hold on to your customers through the downturn, by default you will emerge with a stronger market position on the other side and by adding equipment, manpower and additional customers through prudent acquisitions of good companies suffering hard times, a company can materially enhance its market position. Thus the other side of the distress transaction is the opportunisitc market share grab.

Another common strategy is a counter-cyclical investment. Most of the carnage and blood-letting in the energy space is happening in the upstream drilling and completions space as companies cut back on their growth capex and drilling programs. What they aren’t cutting back on as much is optimizing or maximizing production from existing wells so there are some upstream service companies that are still busy in that area. Companies that service midstream and downstream infrastructure are also extremely busy as these are production oriented entities. The hottest targets would be those companies that provide maintenance, integrity and safety services to the critical infrastructure that gets the energy to market or companies that can bring to market technologies or solutions that enhance the productivity of existing wells.

Calling the bottom is never easy but as prices stabilize, there are also opportunities for top management teams to source capital and make platform investments into market sectors that have been heaviliy oversold and aggregating a space at a discounted value so that when the market turns up they are in a position for rapid growth and market share expansion.

The buyers that we are seeing in the market are a diverse group but are predominantly larger strategic buyers that aren’t experiencing the same levels of volatility in their business or see a need to consolidate to achieve margin stability and financial buyers who have the capital available to make significant investments and an investment horizon that allows them to see past the short term, bottom of the cycle. In particular, there is significant interest on the part of private equity buyers who understand the energy services space and have capital to deploy. Ultimately these funds can take advantage of lower valuations to boost returns and in the case of US funds investing in Canada, a significant return advantage from a discounted currency.

As it regards the question most on anyone’s mind whether as a buyer or a seller, valuations are all over the map. The longer we get into the cycle, the more expectations and acknowledgements of valuation reality set in. That said, as we tell clients, it’s not the multiples that are changing, it’s what is being multiplied. The company that would have sold for 4 times trailing 12 months EBITDA in November 2014 will still sell for a 4 times multiple today, but that multiple will either be on immediately trailing results which include much of the activity drop-off or, more likely, a forward cash flow based on actual work in hand and contracts that would fully reflect the new reality and margin compression.

Regardless, the Entreprise Value for many upstream oriented businesses will be materially different today than it was 12 months ago and for many vendors that makes deals at this time a non-starter. But for others, they may have no desire to go through another cycle to get their cash out or perhaps the idea of a private equity partner to share the risk going forward makes sense. Or, as stated above, maybe they are in a production-oriented business and their value hasn’t changed so much because of what they do and where they operate.

In the distressed M&A market, businesses trade off a different base. Because revenue and cash flow destruction has been so severe for many of these companies, it is hard to place a multiple of cash flow on them so the buyer’s attention instead shifts to the balance sheet. In these instances, entrerise value is much closer to a net asset value plus a small amount of goodwill based on the idea that a company has exisiting customers, staff and insitutional knowledge. A step-up from taking the equipment to auction, but still a heavily discounted value.

So – are deals getting done? Absolutely, it’s just not the heady market of the last two years. And while we may be at a low point now, our view of the Western Canadian market is that M&A activity will pick up as we move into winter and it becomes clearer what companies in what industry vertical is going to emerge reasonably healthy from the chaos. But that is a topic for another post – I am still on vacation after all.

Prices as at August 21, 2015 (August 14, 2015)

• The price of oil continued to decline during the week as heavy negative sentiment pushed the market to lows not seen since 2009
  • Storage posted a surprise increase (not really a surprise though right? Wasn’t a major refinery on an emergency shutdown?)
  • Production decreased marginally, but that news was overwhelmed by inventory data and negative economic news out of China
  • The rig count posted a slight increase (seriously – very slight)
• Natural gas lost ground during the week on the general commodity drag and mild weather

• WTI Crude: $40.27 ($42.16)
• Nymex Gas: $2.680 ($2.809)
• US/Canadian Dollar: $0.7594 ($ 0.7613)

Highlights

• As at August 14, 2015, US crude oil supplies were at 456.2 million barrels, an increase of 2.6 million barrels from the previous week and 93.7 million barrels ahead of last year. A large portion of this build was from imports – well played Canada
• The number of days oil supply in storage was 27.0, ahead of last year’s 22.1.
• Production decreased to 9.348 million barrels per day from 9.395 with lower 48 decreasing marginally and Alaska picking up the rest. Production last year at the same time was 8.507 million barrels per day.
• As of August 14, 2015, US natural gas in storage was 3,030 billion cubic feet (Bcf), which is 3% above the 5-year average and about 19% higher than last year’s level, following an implied net injection of 53 Bcf during the report week.
• Overall U.S. gas consumption increased by 2% this week, with a 7% increase in esidential/commercial use leading the way
• Oil rig count at August 21 was up to 674 from 672 the week prior.
• Natural gas rigs drilling in the United States was unchanged at 211.
• As of August 17, the Canadian rig count was up slightly to 200 (27% utilization), 132 Alberta (25%), 36 BC (43%), 27 Saskatchewan (22%), 5 Manitoba (28%)). Utilization for the same week last year was 49%.

Drillbits

• The TransMountain Pipeline expansion application is now moving to its oral presentation phase to the NEB in Calgary and Burnaby. The main proponent of the pipeline will have a 90 minute presentation while others will be afforded 15 days of hearings.
• The Canadian election campaign continues to heat up the summer airwaves as Canadians are subjected to the daily spectacle of the Mike Duffy trial. While still too early to call, it is becomoing apparent that the conservatives are in a tough fight.
• In non-energy news (but really is anything in Calgary non-energy?) the Calgary Flames revealed their long awaited plans to develop a multi-purpose hockey/football/soccer/athletic facility in the blighted west end of Calgary’s downtown. Response from municipal and provincial government leaders was vague as expected.
• South of the border, Donald Drumpf remains Donald Drumpf. It is only a matter of time until Jon Stewart is forced out of retirement.