Private equity dash for oil field services

12 October, 2011 Unrest in the Middle East and uncertain commodity prices have left the oil industry in a state of flux this year, although this does not appear to be deterring investors.

 

PwC US's latest mergers and acquisitions report identified a 76 per cent increase in overall deal value during the first quarter of 2011, with much of this growth coming from large and mega deals.

Oil field services contributed almost 25 per cent of the total value of $51.5 billion (£31.8 billion), with seven deals totalling $12.8 billion.

During what was a very robust three months for deal activity, private equity back transactions accounted for $4.8 billion, or nine per cent of the total deal value. This compares to just one private equity deal during the same period in 2010 – and marks part of a wider trend within the oil industry, which sees investors sharpening their interest in oil field services companies.

Halliburton, Schlumberger, Diamond Offshore and Baker Hughes are among those which have recently announced strong results and analysts are devoting more time to assessing the investment potential of the firms and others in their sector.

Zacks Equity Research updated its rating for Halliburton from neutral to outperform on August 8^th, which it said was as a result of the demand seen for its services in North America.

Andrea Sharkey, CFA at Gabelli and company, also saw Transocean and Weatherford as benefitting from the uptick in activity in North America, while Cameron will be a winner in the development of shale gas.

Attractive investment targets are also potentially entering the market. According to a Bloomberg report, RPC Oil services is considering selling itself and sources claim it has enlisted the help of investment bank Goldman Sachs. RPC's pressure pumping technology is set to be in demand as oil and gas companies step up their shale gas projects.

The level of discussion currently taking place surrounding investment within the oil field services sector is likely to catch the ear of private equity houses, who are signalling their intention to move into the space, but this is creating competition for the traditional investors in oil field services.

Rick Roberge, partner in PwC's energy practice, noted: "Private equity firms continue to make a push into the energy sector, although they're facing stiff competition from corporates with strong balance sheets and a desire to make big investments like those we’ve seen in the first quarter.

"As transaction prices get larger, the financial investment for companies and investors is becoming much more significant."

There are concerns about the effect that the increased investment from private equity firms will have on the oil field services market – with some expressing worries that companies are becoming overvalued.

Addressing an audience at the Oil Council's World Oilfield Services and Engineering Assembly, an expert involved in a sell-side analyst panel noted the key indicators being used to value stocks in the sector, Stockopedia reported.

"A lot of people adopt the risked exploration approach and I find that worrying because companies tend to up the potential size of the target to the upper limit, they also tend to de-risk it in their minds.

"That does create some concerns for me about how some of these companies in the market are valued, some of which have got significant market capitalisation just on a bunch of licences in the sea, with no experience out there," he said.

And oil field services companies certainly hold their fair share of risks, as a recent Deloitte white paper outlined.

Among the 11 risks identified as hindering the ability of members of the industry to perform successfully at a sustained level were business continuity issues, security, exchange rates, oil and gas commodity prices, and level of demand for their services.

As incidents this year have demonstrated, the country risks inherent in the locations in which oil companies operate, as well as price fluctuations, have the potential to derail a company.

Kenneth McKellar, partner and Energy and Resources leader at Deloitte in the Middle East, said: "Only those oilfield services companies with sophisticated product lines right across the exploration and production value chain, together with geographically diverse operations that enable them to support customers' full drilling programs, have the strength of cash flow to weather the many plausible risks."

At the same time, the movement into harsher deepwater environments and the targeting of unconventional reserves which require more complex technology to extract is fuelling demand for the services offered by companies operating in the sector.

Shale drilling is expected to present a particular growth area for the companies, particularly those which specialise in the fracking process.

"You've got tougher wells, deeper drilling, longer lateral length, more complex tools and higher intensity. You use a lot of service intensity, such as the number of trucks and people needed on site.

"A well is not a $300,000 or $400,000 event anymore - it's a $4 million to $10 million event because the service intensity is so high. Horizontal drilling and high-pressure hydraulic fracturing have led to a large increase in service intensity," Brian Uhlmer, managing director and senior analyst of Global Hunter Securities' Energy Group, told The Energy Report.

He said the key to picking an investment in the sector is ensuring the company has a management team which you "have confidence in". This is a sentiment shared by Mr McKeller from Deloitte who said: "The competitive position of an oilfield services company reflects its management strategy, as well as its attitude towards risk."

Joe Dubbin, Head of Private Equity at the energy focused headhunter Cripps Sears & Partners added; “We are seeing increased demand from Private Equity for proven management teams in the service sector.”

What is also generally agreed on is that the oil field services industry is on the up, the key point which had prompted the dash from private equity firms.