Investor lured by low oil prices

David Knott
London
[email protected]

When oil prices are low, like now, petroleum industry companies with any financial flaws are likely to have their weaknesses exposed.

So majors and big contractors look to fill gaps in their portfolios through acquisitions, and smaller firms snap up rivals. An outsider also looking to profit is investment fund manager Mercury Asset Management Ltd., London.

Jeremy Sharman, Mercury director, said, "This is a good time to look around. Lots of investors are shying away from oil and gas because of the oil price.

"We take a counter-cyclic view. Now is a good time to invest, because the oil and gas industry's underlying economics are good, and higher oil prices will come back again."

Sharman said that, provided oil and gas industry companies are not overextended, they are well-placed to survive: "But some companies, rather than take on private investment partners, have overstretched themselves.

"We'd say you need to have a strong cash flow to survive with a debt level of more than 50%. We are looking at a few service companies regarding investment."

PII deal

Mercury invests money directly in companies on behalf of blue-chip pension funds. Sharman said Mercury typically takes a 30-50% stake in companies being released in corporate disposals or simply planning to expand.

During last year's demerger of British Gas plc, BG sought to sell off its pipeline inspection and maintenance unit, Pipeline Integrity International (PII), Cramlington, Northumberland. PII has 450 employees and a £60 million ($100 million) turnover.

Mercury bought a 90% stake in BG's unit for £90 million ($145 million). It recruited new management for PII and gave these executives a stake in the company.

Sharman said that, in 60% of its deals, Mercury backs incumbent management. In cases where new leadership is required, it hunts out executives seeking more freedom: "There are lots of frustrated managers out there."

Mercury operates an investment fund of $1 billion. In the future, about $350 of this will be earmarked for service sector companies, including those operating in the oil and gas industry.

High returns

Sharman said Mercury normally takes a minority stake in a company, about 30-50%, and aims to beat typical stock markets returns by 5-10%/year.

"Historically, we have succeeded in this," said Sharman. "One reason is that, when managers have equity, they work harder. We are big fans of providing a management team along with equity.

"We invest for typically 10-12 years. A frequent exit route from a company is through a flotation. Ultimately, we sell our shares, but we are open-minded as to how realization occurs-for instance, through flotation or a trade sale."

Mercury is also a big fan of encouraging the companies in which it has invested to go for growth. Sharman sees equity partnerships as the best way to encourage growth, both organically and through takeovers.

"We have a good track record of buy and build," said Sharman. "Seventy per cent of our companies have made subsequent acquisitions. Once we trust a company's management, it's a good place to put more money."