Gregory Zuckerman, staff reporter for the Wall Street Journal, wrote a Heard On The Street Column Windfall Oil Profits May Lead to Merger Blitz (subscription required).
"Most companies are having trouble growing production and replacing reserves," says Greg Weinberger, an investment banker at Credit Suisse First Boston. "Companies have more cash, and most don't have huge opportunities for internal growth in reserves, so we're seeing them pay up for companies with growth opportunities."
The problem I have with that argument is that it has been true for the last several years. While a company might lack growth opportunities, if it goes on an acquisition binge, it will face an even larger challenge of acquiring a company without destroying value. In other words, the market has assessed its value for a company based upon consensus oil and gas prices. An acquirer will usually offer a significant premium over the current stock price, say 30% more, to effect the takeover. How does it justify the 30% premium? Are there significant synergies to justify the takeover? If there are no significant operational synergies, then the acquiring company is making a bet that it can more accurately forecast higher oil and prices than the market. Because of the uncertainty surrounding future oil and gas prices, that is a very risky bet. Moreover, the shareholders of the acquirer can on their own obtain additional oil and gas exposure. So unless there are synergies, there are no significant drivers for acquisitions.
Oil and gas companies have gone through the boom and bust cycles more times than they care to remember. Over the years, they have lessened their focus on production growth and increased their focus on financial growth. The more disciplined companies will wait until the oil and gas sector is out of favor once again. And then they will pounce upon their targets.
That said, I hope Weinberger is correct and we do see more mergers, because mergers usually cause a higher industry revaluation. A higher revaluation would increase EnCana Corporation's (ECA) stock price, of which I am long through options.
In summary, I am not convinced that oil and gas companies want to chase production growth just for the sake of production growth. Most oil and gas companies are disciplined to returning share value growth. The executives are highly motivated through stock options to increase share values. Because oil and gas prices are near recent highs and thus stock prices, an acquirer will be more deliberate before pulling the trigger. To acquire a company, the acquirer has to recognize that it is valuing that set of assets more than any other entity. If it is wrong and the acquisition is significant, the acquirer will suffer years to come. Moreover, shareholders themselves can easily add more oil and gas exposure. The best reason for a takeover is not to add production growth, but rather to take advantage of synergies between the two companies. If there are no significant synergies, then it is a hard sell.
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