Oil and Gas Valuation: 5 Things to Consider When Using Equities as Consideration | Opportunistic LLP
In recent years, shares of an acquiring company have become a more commonly used currency in upstream oil and gas merger and acquisition transactions. As shown in the table below, since 2016, the stock as a percentage of total consideration in upstream oil and gas transactions has increased significantly:
Companies that plan to use their stocks as a form of consideration in a transaction should keep the following five concepts in mind:
- Establishment of the purchase price – When the acquirer is a listed company, establishing the amount of the purchase price is relatively straightforward. However, if the acquirer is a private entity, establishing the purchase consideration to be awarded may be more difficult to accomplish. In this case, the shares of the acquirer that are used as consideration will need to be valued to establish the amount of the consideration. This would include estimating the enterprise value of the business (i.e. the total value of the asset), using one or more of the three generally accepted valuation approaches (income, cost and / or market approach). If the acquirer has a complex capital structure, with various categories of equity that have different rights and preferences, this will also include assessing the applicable categories of equity.
- Purchase price allocation requirements – In an operation where the stock is used as consideration, as for all acquisitions, ASC 805, Business combinations, requires that the allocation of the purchase consideration be identified as property, plant and equipment and intangible assets for financial reporting purposes.
- Changes in market conditions before closing – The value of the shares to be issued in consideration may not always correspond exactly to the value of the assets acquired. Market conditions and other forces can cause changes in the value of both the equity considered and the assets acquired, between the time the transaction is announced and the time it is closed. Valuation analysts should keep in close contact with the management of the acquirer and the respective auditor, to ensure that there are no surprises when the transaction ends and the final allocation of the price. purchase is made.
- Consistency of valuation assumptions – In cases where the acquirer’s shares are valued to establish the amount of consideration, care should be taken to ensure that the main valuation assumptions are consistent between the valuation of the acquirer’s equity and the assets of the acquired business. These assumptions must also be consistent with previous fair value analyzes. Examples of such valuation assumptions in the upstream oil and gas industry would include commodity prices, volumetric risk and discount rates. If there are substantial differences between the respective analyzes, there should be justifiable reasons why such differences exist.
- Use of a control premium – In some cases where equity is used as consideration, the question may arise as to whether a control premium should be applied to the consideration paid. This will require the appraiser to understand the terms of the purchase contract and to understand whether an element of control has already been built into the transaction price. For example, in the acquisition of a limited partnership, a general partner may also have been acquired in the transaction. Often, the amount paid for that partnership interest may represent the “controlling” factor (i.e. the ability to influence the change in projected cash flows, beyond the acquisition. of the limited partnership).
The use of shares as part of the consideration has become much more common in today’s oil and gas acquisition market. In cases where a company’s shares are used as consideration for a merger or acquisition, the above factors make it more critical than ever to have a solid and defensible valuation supporting the value of the consideration paid, as well as the purchase price allocation.