Total declines in market capitalization among Canadian oil and gas companies from July 2014 to February 2016 are estimated to exceed $230 billion
BY JOHN M. MERCURY
In a “lower for longer” commodity price environment, Canadian energy and energy services companies are facing difficult circumstances in preserving value. Total declines in market capitalization among Canadian oil and gas companies from July 2014 to February 2016 are estimated to exceed $230 billion, based on available data from S&P Capital IQ. Management teams have been particularly hard hit. Approximately $11.4 billion of those losses are attributable to shares and options held by management and other insiders.
This environment is causing companies to reconsider how they do business. The severity of current and prospective market conditions is forcing them to look beyond conventional means of cost savings, such as reducing G&A, lowering operating costs or shutting in production. Whether as part of a strategic process or otherwise, companies are increasingly looking at more fundamental alternatives in order to preserve value, with a view to positioning themselves for growth when conditions improve.
One strategic alternative, which is attracting attention in the current environment, is the going private transaction, where public shareholders are bought out for cash and the company delists and becomes a private, non-reporting company. A going private transaction allows management teams to focus on what they do best—create value—without the cost and pressures associated with being a public company. This is especially true for companies who are able to partner with a private equity fund or other source of long-term capital, as those types of institutional investors are able to finance and support acquisitions, capital expenditure requirements and working capital/liquidity needs during an extended downturn.
Since July 2015, there have been three private equity-backed going private transactions involving Canadian energy and energy services companies: Canamax Energy Ltd. (Edge Natural Resources) and Platino Energy Corp. (Denham Capital), both now completed; and Boulder Energy Ltd. (ARC Financial), announced on February 24, 2016. In contrast, there were only 15 going private transactions in the energy sector during the 10 years prior.
I expect growing interest in going private transactions in 2016, and there are several reasons for this. A number of newly-raised energy-focused private equity funds have closed in recent years, and, as a result, there is significant “dry powder” on the sidelines, both in terms of equity and debt capital, looking for attractive M&A targets. Moreover, the low Canadian dollar may generate additional investment interest by US private equity funds in particular, given that Canadian company valuations may be more attractive in U.S.-dollar terms than comparable U.S. companies.
There is also pressure on private equity funds to source new transactions and to back (and thus tie-up) good management teams, especially in areas of the energy sector that are opportune for industry consolidation.
Existing management teams in publicly-traded companies, whose share prices have not reached their potential, often find it appealing to partner with financial sponsors who can not only close the going private transaction, but who will also finance future growth opportunities. This partnership between a financial sponsor and management can also provide the latter with significant economic upside if cash-on-cash returns to the sponsor exceed agreed-upon hurdle rates.
A growing number of public companies in the commodities space have been running strategic reviews for a long time, and, as a result, target board members may be more amenable to recommending.
Energy-focused private equity funds have raised billions of dollars in the past few years and are under pressure to deploy capital. Many publicly-traded energy and energy-services companies in Canada have had been stuck in neutral in terms of accessing capital. Going private transactions, backed by private equity players, could help certain companies move in a positive direction during challenging times.
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