By OGJ editors
HOUSTON, May 21 -- Merger and acquisition activity within the oil service and supply sector will likely continue apace over the next 2 years, adding to the overall health of the oil and gas industry. Over the last few years, M&A activity among oil service companies has led to the formation of a "big three" set of companies within the sector.
These were a few of the key findings in a report released last month by Houston-based Simmons & Co. International. "In our opinion, the consolidation that has taken place over the past decade has helped contribute to a healthier, more profitable industry," Simmons noted. "We also believe that the pace of consolidation within the oil service industry, relative to the current level of M&A activity, will pick up as we begin another cyclical upswing for the energy industry," Simmons said, adding "This is not the best way for companies to acquire 'cheaply,' but history shows that oil service companies are momentum buyers."
Product and asset companies, meanwhile, are continuing to merge as well, with product companies also heading toward the formation of a "big three" set of companies and asset firms remaining relatively fragmented. Regarding asset firms, Simmons forecast there would be "the potential for meaningful consolidation" within the segment, "especially among . . . offshore and land drilling contractors."
The Rule of Three
According to Simmons, the "Rule of Three" specifies that "the optimum competitive landscape for an industry is comprised of three broad-line generalist companies and various, smaller niche companies." Currently, this "Big Three" dynamic is present within certain oil services segments, including pressure pumping, wireline logging, drilling fluids, electric submersible pumps, and measurement-while-drilling services. Other segments, meanwhile, remain fragmented, including companies handling land rigs, offshore rigs, and supply boats, Simmons said.
"Over the past 10 years, there have been hundreds of [M&A] transactions consummated within the oil service industry, 122 of which were deals encompassing consideration greater than $100 million/transaction. These. . .transactions totaled nearly $90 billion in consideration."
The frequency of these transactions, Simmons noted, tends to follow the industry cycle: "The number of major transactions reaches its apex at industry cycle peaks, and the corollary similarly holds true, i.e., the number of transactions bottoms at industry cyclical troughs," the firm said. "For example, from 1996 through 1998, a period of strong industry fundamentals, the number of transactions was considerably greater than in the 3 years preceding this period. Similarly, as industry fundamentals improved meaningfully in 2000 and 2001, there was a significant increase in the number of deals during this period compared to that in 1999," Simmons said.
Also, the average transaction size increases "noticeably" as the cycle unfolds, Simmons said, citing the rise in average transaction size during 1992-98 and 1999-2001. "However, the cycle-to-cycle comparison shows little change in the average value of transactions at either the troughs or the peaks," Simmons noted.
"Despite the large number of transactions and the increased deal size over the past 10 years, the 'Rule of Three' has yet to fully manifest itself across the vast product service lines [PSLs] within the oil service industry," Simmons said. "Contrasted with our 1998 analysis, only three more PSLs were consolidated into a Big Three, namely drilling fluids, marine seismic acquisition, and US land workovers," the firm noted.
"Given the trend toward the 'Rule of Three,' the opportunity to further consolidate this industry, the willingness of the industry participants to consolidate, and the considerable benefits to be derived from consolidation, we believe a healthy pace of M&A will continue for the foreseeable future," Simmons remarked.
Two of the most "ominous" threats to further consolidations within the oil services sector, meanwhile, include a cyclical explosion or implosion. "Should the cycle explode, with commodity prices rising dramatically and [exploration and production] capital spending correspondingly rising in tandem. . .unbridled capital spending and expansion within the oil service industry would likely unfold," Simmons said.
"Conversely, should the cycle implode, with commodity prices collapsing and E&P spending declining dramatically from current levels, the M&A bid-ask spread would likely widen due to a dislocation between buyer and seller expectations. Such cycle occurrences are of short duration, thus the impact to further industry M&A would likely be short-lived," Simmons deduced.
Drivers for M&A activity within the oil services sector have shifted over the years, Simmons said. "The major change has been away from integrated services and toward more traditional strategic objectives, such as classic consolidation [that reduces costs and increases pricing], line extension, and infrastructure leverage," the firm noted. "Further, technology has emerged as a new strategic rationale. While we have attempted to categorize historical transactions into one of these major categories, drivers of M&A transactions typically encompass more than one strategic objective," Simmons concluded.
