Merger And Acquisition Strategy During Oil Price Decline: Challenges And Benefits

Critical analysis

Explain Strategic Management.

Oil is a major component of the energy sector. The oil price dropped drastically during the last half of the 2014 and as a result of this the stock price of the energy sector declined by 35% (Fitzgibbon, Kloskowska and Martin 2015). The fall in oil price has created lower level of profit and lower level of investment for the project. During the 8^th month of 2014, the price of barrel was $100 per barrel for West Texas Intermediate and it has fallen to $50 per barrel by March, 2015. The price of oil has been dropped by 60% since 2014 to 2016. This drop was quite huge. This hinders operations of many firms in this industry and many projects got cancelled during this time (Tim Bowler 2015). The usage of drilling rigs in US declined from 980 in last quarter of 2014 to 954 in middle of April 2015 (Lv and Spigarelli 2015). This number is likely to decline further as some of the ongoing drilling commitment is soon to be completed. Therefore, the OPEC countries reduced their spending in the exploration of natural gas and oil (Fich, Nguyen and Officer 2015). The firms in the energy sector uses Merger and Acquisition to cope up with the problems. Through this kind of strategies, the energy sector tries to stabilize and improve position by accessing new market; more resource and advanced technology. In this report, the paper will analyze the Merger and Acquisition strategy during oil price decline during 2014 to 2016. The challenges and benefits of M & A within the energy sector will be discussed.

The drop in oil price started to affect M & A strategy and the buying and selling of assets by the companies of energy sector. The Middle East focused on international diversification strategy and long-term investment regionally. Out of deals worth 3 trillion US dollar in 2015, major deals were made between the companies of energy sector. However, the M & A deals were less in 2015 than 2014, the amount of deal among the companies were significant. Many studies have found that in spite of the fall in the oil price, the companies will spend on project in the oil and gas sector because of long term strategic importance (Raice 2014). Many surveys predicted that the spending in project will increase during 2015. The companies that emphasized on traditional non-renewable energy and renewable energy were victim to the rapid change of this industry (Yoo, Lee and Heo 2013). The announced mergers of energy sector, mainly in the oil and gas sector was amounted to 323 Billion USD. This sector was third most important sector for M & A strategies to be implemented. Among many other oil producing countries, the most of the merger and acquisition takes place in US. The M & A accounted for 159.6 billion US Dollar in US during first three quarter of 2015. In this period, some of the mega merger deals revived and this was the striking feature under this scenario where stock price of energy sector was declined significantly (Ng and Donker 2013). The deals in this sector understood the position of the market and synergies played vital role in enhancing the activities in this sector.

Academic Models

While possibility of a short term and low oil price environment continued through 2014, the adaptability of this situation started to grow over 2015. In 2015, the only big deal was between BG Group Plc and Royal Dutch Shell Plc, which worth $70billion. Here, deals of upstream moved towards assets. The other deals were between William Companies Plc and Energy Transfer Equity and between Energy Transfer Partner and Regency Energy Partners. Out of 349 acquiring and merging activities in the energy sector, 48% accounted for 500 million US dollar. In United States, the acquisition by WPX, Noble, Vangard and Exxon has been made in the Shale plays. Vedanta in India and Sequa in Norway and BP’s interest in the Siberian Project led to international purchases. However, the deals were different in terms of numbers and value engaged in it. The two US yield companies, TerraForm Global and TerraForm Power was sponsored by Sun Edison. Sun Edison was the leader in the acquisition and was the leader of the portfolios from Vivint Solar; Renova Energis; Globaleq Mesoamerica Energy; Firstwind and Atlantic Power (Pätäri et al. 2014).  The two crucial acquisitions of gas utility in US was the acquisition of Southern Companies takeover of AGL Resources and Black Hills of Source Gas that operates controlled natural gas utilities. The continuous activity M & A activity gained momentum during the decline in the energy sector, because; the buyers wait for further fall in the oil price and producers wait for price to increase.

The OPEC did not cut down its output due to fall in the price of the product. The reason behind such small and big deals was to find a method of escaping the market turbulence. The companies have taken these approaches in order to address the cost of production of energy sector and cash flow pressures faced by the company. To raise the cash flow of the company and improve financial position many companies in the energy sector sold their highly valued assets. However, some of the companies do not prefer to sell their assets as the price is too low. This has caused downturn of the players; cost cutting. The capital venture started to delay in order to delay cash. 90% of firms in this sector believe that merger and acquisition will rise by 2016. Due to lower price of crude oil, the prices of other commodity also decline (Deloitte Nigeria 2014). As a result of this low price of commodity, the energy sector’s value of assets also declined. This has made merger and acquisition so favourable to the companies. The expansion deals of petrochemical plant between Shell and Saudi Basic Industries and Qatar and Royal Dutch Shell got cancelled because, both buyers and sellers were less confident due to volatility in the atmosphere (Saadi 2015). They perceived that the expectation may become worse instead of having anything better. The sellers think that prices are at its lowest and buyers expect further decline and do not prefer to pay much.

SWOT Analysis

The initial stage of Merger & Acquisition model is the “corporate strategy evolution”. The firms developed the objectives of the M & A strategy. This assists to maximize the portfolio of the running business and to manipulate the interest of the stakeholders. The following phase includes “organizing for acquisition”. The firms prepare itself for effective acquisition by acknowledging value creation logic that can be acquired through acquisition. This results into post-integration success. In the next phase, firms go through “deal structuring and negotiations”. In this phase, firms prepare themselves for negotiation bids to takeover other firms. This involves, developing defence strategy; selecting negotiation parameter and choosing advisor (Hansen, Foldmand Hansen 2014). In the following stage, “post-acquisition integration” the functioning of the operations are included. In this phase, the post-merger valuation is evaluated and delivered. The four kinds of post-acquisition integrations are: “prevention”; “holding company”; “symbiosis” and “absorption”. The five stage model ends with “post-acquisition audit and organizational learning”. The companies who are eager to develop in order to attain success in the M & A process, it is necessary for them to acquire core competence and proficient in it (Karniouchina et al. 2013). Proper strategy implementation and with capabilities, the firms learn how to attain success efficiently and apply further strategies in an effective manner. This model reflects how different process is implemented in the merger and acquisition in the energy sector.

The internal and external factors influencing the M & A strategy in the energy industry can be analyzed through Strength -Weakness- Opportunity- Threat analysis.

Strength & Weakness: The primary motivation behind M & A is the economies of scale. This is the main operating synergies of the merging planners. The smaller firms are more benefitted by the M & A strategy as they can enjoy significantly low cost of production. This is the foremost strength of this policy.

The major internal weakness of this strategy is that M & A strategy involves huge investment. Therefore, by huge cash the acquisition is possible. Managers with less opportunity may use the cash flow in the unprofitable merging venture. The managers with great cash flow may try to destroy the value generated in the M & A process. Extra amount of cash held by the companies of energy sector often hinders the long term investment like exploration.

Opportunity & Threats: The firms face the gap between the capacity of production. As a result of this, the values of the assets reduce. Therefore, there will be a decline in the return to capital that has been already invested. The firms with excess capacity find resources in order to resolved the issues. This is the opportunity for the firm to enjoy the benefits of excess capacity (Kolk, Lindeque, and Buuse 2013). In addition to this, the focus of the corporate and opportunity of market control is a inducing factor of the M & A strategy.

The threat of this strategy is that the plan of the energy sector may fail due to poorly managed resources. Moreover, deregulation in the energy sector might change the scenario, as there is modification in the industrial structure. The competition may tend to vary after implementation of M & A strategy. This is a threat of this strategy as it leads to overestimation or underestimation about the value generation.

By the term Merger, it is meant that firms are operating together as a single entity. In this process the merged firm will have large share of market with lower level of competition. These firms enjoy large economies of scale. This would enable the firm to lowering the average cost of production and this would also enable the firms to charge lower price to the customers. This strategy also helps in competing in the global market and helps in challenging the rivals. This also increases value of the company by improving revenue generation. Since merging brings the firms together, the values of the shareholders are also greater in the new company. Therefore, as a whole merger will bring more profits but this is a risky venture. Merger improves the quality of goods. In energy sector, merging requires huge investment; hence, it is risky but highly profitable. The redundancy is eradicated with greater amount of efficiency. This strategy safeguards the company from shutting down. Those firms struggle to stay alive due to drastic fall in the oil price, they consider merging as a convenient options.

During drop in the oil price, the firm acquisitions of the big companies increase their market power and sell the good at the competitive rate. The acquisition involves buying distributor; acquiring the business; supplier and even the competitors. Acquisition removes the entry barrier in the energy sector. The firms are able to access more resources. The collaboration like acquisition offers lower risk than developing or investing in new product, as risk associated with new techniques of managing financial risks is less due to acquisition strategy (Cartwright and Cooper 2012). Developing completely new product has more probability of failure. Acquisition is of more beneficial when acquisition is more related, i.e. product of similar category or related to same supply chain. The competitive scope increases with dependency of the firm. When the companies are struggling with market related problems, like fall in oil price, then to cope with the situation acquisition is beneficial. The strong company purchases the weak one and the new firm is considered to be more efficient in terms of cost. Acquisition by parent company combines with other one, which in turn increases scale of operations. Acquired firm can have more market share and attain more competitiveness than the weaker situation of the firms before acquisition. The synergies between the firms of the energy sector enable more improvement within the firm then their separated counterpart. Acquisition allows sharing of management expertise of the oil and gas sector. These firms have more access to stronger financial base and capital resource base.

However, with innumerable benefits, merger also faces some challenges. Merging needs to follow some legal formalities that are quite long process. Differences in the culture of firms are one of the major drawbacks. The consumers also have less choice of products due to merger and acquisition. When the acquisition is aggressive in nature, this tends to retrenchment of unproductive labour. Due to this situation, the retained workers also fear of losing job, which distract them from their performance. Acquisition also reduces the competition from the market as new firms attain monopoly power over price. The objectives of the associated firms may cause conflict as they are different in nature. Merging also takes huge costs that increase debt of the firms. Debt is not good for the firms. The firms fell into financial struggle. This in turn reduces the credit rating of the firms (Shimizu 2012). Moreover, firms before M & A already have strong customer base. The newly merged firms may not further create further market for sales. M & A can be failed due to several reasons, for example, over expectation about the expansion; companies engage in huge over investment. Ineffectiveness of the administration eradicates advantageous prospects of the M & A strategy (Kamiński 2014). Acquisition is also suffers from integration difficulty. The targets of the firms of the energy sector are not evaluated adequately. When potential firm evaluates target firm, due to overestimation, the company might pay high premium for the target firm. It is very likely that the firm underestimates the costs and overestimates the synergy. In the oil and gas sector, the diversification leads to low performance. The alliance firms may have conflict of interest among them. Personal motive of any of the firm may lead to failure of this strategy. The lack of motivation behind M & A activities resulted into wrong target firm selection. The status of economy due to significant decline in the oil price, merged or acquired firms encounters difficult challenges in operating successfully.

Conclusion

The perpetual fall in the oil price since 2014, leads to fall in revenue in the energy sector. As a result of this, the companies under this industry involved them in the merger and acquisition. This report discussed about the scenario of the energy sector in the recent years. It has mentioned how the energy companies have been facing challenges due to decline in oil price and involvement in the M & A process. Two academic models have been discussed in the above section; such as, Five stage model of Merger & Acquisition and SWOT analysis of the industry. The paper also identified benefits and drawbacks of the M & A strategy. Some of the examples of current merger and acquisition has also been mentioned in this report.

References

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