Energy M&A: A Love Story

“It is a truth universally acknowledged that an energy company in possession of a healthy balance sheet must be in want [or search] of a merger partner.” (Pride and Prejudice, reimagined)

It’s hard to be a seller in a volatile market, a market that is down significantly year-over-year or a market with limited supply and demand visibility. It’s harder still when the offer on the table represents little or no premium to the share price, even to the current depressed valuations. It’s a tough sell to convince shareholders to swipe right.

But deals, particularly all-stock deals, are like marriages. Shareholders of both companies will have a continuing stake in the success of the combined company. So when the valuation alone isn’t conventionally attractive to the seller’s shareholders, it’s up to the sellers to woo them: “We’re not marrying for money. We found the right partner to grow old together.”

Securing buy in for a no- or low-premium deal in such a challenging market therefore requires a shift in how deals are communicated. The betrothed companies need to describe the greater opportunity for shareholders (and ideally employees and customers) that exists if the seller is part of a larger or stronger organization. This approach has always been used for so called mergers of equals, where each party typically contributes evenly to the combined company’s governance and culture and both retain stakes in Newco, but now merger partners using acquisition structures may need to tell a similar love story.

“How do I love thee? Let me count the ways.” (Shakespeare’s Sonnet 43)

More than ever, effective deal announcements in this environment should highlight the future potential of the union rather than focusing purely on valuation, and should share extra color on these key elements of the combination:

Benefits of scale
Deal announcements in the energy sector typically tout scale, but size in and of itself isn’t a benefit in the current market. (If we already have excess capacity or inventory, why add more?) Instead, companies combining in the current market need to focus on how that scale enables them to compete favorably: for example, through greater efficiency, reduced environmental impact, enhanced access to capital, expanded operational optionality or more resiliency.

Synergy 
Cost savings are always attractive, but in a difficult market being lean, nimble and efficient is the highest imperative. Focus messaging not just on the scope and source of synergies but on how the new structure will yield a strengthened operating model for the long run. A word of caution: companies touting synergies should also be prepared with messages about how the cost cuts are necessary to preserve future jobs and value, and a robust outreach plan to key politicians and regulators who are particularly attuned to job losses in the current environment.

Acceleration of capital returns
If shareholders aren’t getting a substantial premium, the seller needs to make the case that the deal enables more future free cash flow generation and therefore greater returns of capital to shareholders. Even better, if the combined company can swing it: make this point tangible in the deal close by announcing a dividend or buyback.

Acceleration of both partners’ strategies
While the buyer will likely call the shots in the future, the seller’s shareholders need to understand how their strategy is accelerated or strengthened by the resources and capabilities of the buyer. Without that, they have no reason to embrace the future of the union.

Be realistic
Market conditions have changed so suddenly and dramatically that some seller shareholders may not recognize a good deal when they’re looking at it. Part of the seller’s imperative is to reset expectations, helping investors more accurately value the assets in the current market (not as it used to be) and recognize that because the currency of the buyer is also depressed, they may be getting more upside with the stock than the value they would get in cash.

Culture fit
Don’t forget the most important part of the marriage: you really have to like each other. There has to be a cultural fit that everyone sees. Energy deal announcements need to pay more than lip service to culture. If you’re selling a story about the long-term benefits of a union, you have to make the case that there’s a natural fit or the marriage won’t be a happy one. If you’re handing shareholders a pile of money then they may be more willing to overlook a few flaws. But if the prize of matrimony is a partner, the fit needs to be right.

“What’s in a name? That which we call an MOE by any other name would smell as sweet.” (Romeo and Juliet, reimagined) 

For those stock deals that really are mergers of equals: keep in mind that the media are skeptical of this positioning and are unlikely to report the deal as a true union of two equals. In fact, calling a deal a merger of equals is an open invitation for reporters to dig into the deal to identify the buyer/seller or winner/loser. They will tick through a checklist to determine if the deal fits certain MOE criteria – premium, stock ownership of pro forma company, leadership team, governance/board composition, headquarters location, branding, etc. – and they’ll often find a way to foment discussion and clicks by arguing that the merger isn’t equal at all.

If you are positioning a deal as an MOE, make sure your communications sufficiently reflect elements of the deal structure that reinforce that concept. The deal announcement tactics can signal a union without using the words: a joint press release, joint CEO video or town hall for employees, joint interviews, balanced leadership and integration teams, etc.

Finally, remember that just as a beautiful wedding ceremony is only the start of a successful marriage, a smooth merger announcement is only the first step on a lifetime journey together. Integration planning, and the communication around that to employees, customers, partners and other stakeholders, are essential components of that success, and your thinking around that should start before you even begin the courtship.

Sydney Isaacs leads the Houston office of Abernathy MacGregor, where she advises clients on a range of major corporate issues and events, including restructurings and bankruptcies, M&A, proxy issues and crises. Sydney works across industries with a particular expertise in energy, and she is a leader of the firm’s bankruptcy and restructuring group.

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