The industry view: balance sheet health critical for future of oil services companies, says EY expert

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What do you think the next 12 months holds for the oilfield services sector globally?

2016 is going to be a difficult year. 2015 was also a difficult year but many companies had the benefit of strong order books coming into the year as well as some opportunities to cut costs in areas that were relatively easy to manage. As we go into 2016, many companies in the supply chain don’t have the benefit of good order books and cannot achieve incremental cost savings as easily.

We are going to see distress in certain parts of the sector and I expect distress to be focused on capital-intensive and exploration-focused areas such as seismic, subsea,drilling and offshore support vessels. For companies with strong balance sheets, the distress is likely to create opportunities and I suspect those companies with weaker balance sheets will be working very hard with both their customers and their capital providers to make sure that they are still here this time next year.

Consolidation has clearly started amongst the biggest OFS companies and is likely to continue into 2016 and 2017.

How can corporates weather this environment and what are the strategic ways they can hedge against this?

As this research indicates, companies with strong balance sheets and a strong customer base could use this as a time of opportunity to expand their product range and expand their geographical coverage by buying companies. Companies with weaker balance sheets or who are reliant on a small number of customers who may also be going through challenges, will be focused quite extensively on cost discipline and managing their relationship with providers of capital and may even pursue defensive consolidation type transactions.

The more distressed companies will be typically smaller or medium-sized companies that are reliant on a small number of products, a small number of customers, or a small number of geographies, so more vulnerable to shocks with one or two customers or one or two projects.

Do you think that a lot of companies will be looking to acquire technology rather than invest in in-house research and development?

In the long term technology can allow companies to do things more efficiently, more effectively and give a real competitive advantage. But at the moment companies’ focus on costs probably means that they are not going to allocate more capital towards R&D in-house. If you have a competitor who has a neat piece of technology, now may be a good time to make an opportunistic proposal to buy it.

Where do you think we'll see a lot of the targets emerging?

We will see some consolidation of companies trying to aggregate capabilities and broaden customer relationships rather than necessarily targeting a regionally specific play. Buyers are likely to be the larger oilfield services companies with strong balance sheets and the opportunity to expand their product range. We should also expect more vertical integration transactions as companies focus on increasing efficiencies along the supply chain.

The challenge will be access to finance. While there is quite a bit of capital out there targeting the oil and gas sector, it has not been deployed yet amidst the uncertain sector outlook. 2016 may be the year when greater transaction consensus crystallises this capital to flow. Nonetheless, consolidation-type deals may will happen here in Europe and not necessarily require a lot of cash to change hands.

Do you think there was a buyer/seller valuation gap in 2015 and will we see more alignment of that over the coming year?

Most people probably view that at the right price most businesses are for sale. The challenge is working out what that price is. In the oilfield services sector you see more multiple type valuations and the challenge is not so much agreeing on a multiple but agreeing what you are going to multiply it by. Getting visibility on what the long-term performance or long-run potential of a business is, while the oil price is falling and order books and margins are under pressure, was very difficult for both buyers and sellers through 2015.

One of the difficulties has been that buyers with capital who are looking at distressed businesses believe we haven’t reached the bottom yet and that’s certainly been the case in 2015. Meanwhile, potential sellers had not, and probably still haven’t, fully appreciated what the impact of their customers’ challenges is going to be on their business in terms of margins and volumes.

The gap still persists but I think we're going to see more alignment in 2016 because there will be a longer history, 2015 and part of 2016, to see what the impact of the price fall has been. The element of distress is also going to necessitate buyers and sellers reaching an agreement. Buyers have been prepared to wait because they are of the view that things will get cheaper. As we go into 2016 there’s more of a consensus that although prices are going to stay lower for longer, we are nearer the bottom in terms of valuations. That mindset change is going to make a big difference towards the volume of deals.

How is the fund raising environment developing compared to the previous year?

I think banks are prepared to lend to the oilfield services sector. Banks have the same concerns as everyone else in terms of what the future looks like and how potential borrowers give banks visibility on their cash flows. A lot of the decision comes down to the quality of products and customers, and forming a view on the certainty of future performance.

Maybe banks are finding it harder to fund capital and early-stage type operations because they are surrounded by more uncertainty, such as future seismic activity. It does come down to picking the right segment within the oilfield services sector and being able to demonstrate how robust the projections are which companies want to borrow against. That probably is no different from how it has been in the past.

Oil and gas is a sector that’s coming under more scrutiny within banks, particularly as credits within certain segments are not performing strongly within banks’ lending books.

Do you have any advice for companies that are looking to position themselves for eventual takeovers?

Be prepared to be broad in terms of where you think the capital is going to come from because it might not be coming from traditional sources and do as much as you can to demonstrate that your projections for your business are realistic and robust. You don’t necessarily just talk to your biggest few competitors.

It might be people in other parts of the sector, it might be financial investors from other parts of the world, it might be specialist debt investors who come and help recapitalise a company, so being creative and being broad and not just thinking that the likely buyer is a sort of similar minded but slightly bigger oilfield services company.

Jon Clark is EMEIA Leader Oil & Gas Transaction Advisory Services at EY and has focused exclusively on the oil and gas sector since 2000. Jon’s role includes the development and execution of transaction advisory business for an international portfolio of independent and national oil companies and OFS businesses.

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