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Oil’s Slide Hasn’t Capped Energy M&A Gusher

27 October 2015 in Trading Ideas

As the price of oil approaches its fourth month below $60 a barrel, you might think the commodity’s slump would throw a wrench into the sector’s merger activity.

You’d be wrong.

Case in point: Just last Monday, Duke Energy (NYSE:DUK) said it would buy Piedmont Natural Gas Company, Inc. (NYSE:PNY) for $4.9 billion.

As the Wall Street Journal noted, the deal between the two Charlotte-based companies marks the second time this year that an electric utility will buy a gas-distribution company already operating on its home turf. In August, Southern Co. (NYSE:SO) agreed to buy AGL Resources Inc. (NYSE:GAS) for $8 billion; both companies are based in Atlanta.1

But geography wasn’t the only interesting tidbit – so was price. The Journal reported that Duke’s all-cash acquisition price of $60 a share for Piedmont amounted to a 40% premium to that stock’s closing price on Friday. Similarly, Southern’s $66-a-share buyout of AGL represented a 38% premium for that company.

According to the Journal, Duke and Southern are willing to pay high premiums because the regulated gas companies offer reliable returns and a way to capitalize on the glut of natural gas. US utilities anticipate only modest growth in electricity sales in the next few years, but gas demand is expected to be robust.

That demand will be particularly strong in eastern regions where new natural gas pipelines are under construction, which will allow gas to replace coal and heating oil for power production and residential uses.

As big as the Duke/Piedmont merger is, however, it’s merely one deal in what has been an epic year in energy sector deals.

According to the Journal, there have been $323 billion in announced or proposed oil-and-gas mergers so far this year, the highest dollar amount on record for a similar period by nearly $100 billion. Oil and gas is the third-most-active sector for M&A this year.2

A handful of mega-mergers has been responsible for most of the surge. Last week, Energy Transfer Equity LP (NYSE:ETE) said it would buy pipeline Williams Companies Inc. (NYSE:WMB) for roughly $32.6 billion, in the year’s 10th-largest deal overall.

In August, Schlumberger Limited (NYSE:SLB) the world’s largest oil-field-service company, announced that it would buy smaller rival Cameron International Corporation (NYSE:CAM) for $12.7 billion.

Meanwhile, the year’s largest deal in any industry is Royal Dutch Shell PLC’s (NYSE:RDS.A) roughly $70 billion pending agreement to buy BG Group.

Big deals have continued despite a nearly 60% decline in oil prices since early last year that has seen weaker companies scramble for options.

When companies are under pressure, the value of the cost and other synergies that come from combining with rivals increases, Jay Horine, head of North American energy investment banking at JPMorgan Chase, told the Journal.

There also is a natural desire to get larger during such periods because bigger companies typically outperform smaller peers when times are tough.

Yet just like the overall merger market, the total number of oil-and-gas deals has fallen as many unstable companies don’t enjoy the option of selling themselves or making acquisitions as the course of oil prices remains unpredictable. That has created an unbridgeable gap in many cases between buyers afraid of further declines and sellers mindful of the prospect of a sharp recovery.

However, the ground should become more fertile for acquiring weaker companies when crude prices stabilize—even at the current level of about $45 a barrel, according to bankers cited by the Journal.

“Opportunities for self-help are going to run out, so the benefits from smart, strategic transactions will increase,” said Dan Ward, co-head of Deutsche Bank’s global natural resources group. Strong players looking to boost efficiency could usher in another golden era for energy M&A like in the late 1990s, when landmark deals like combination of Exxon and Mobil were struck, he said.

That backdrop could continue to boost shares in stocks of companies that are likely acquisition targets.

The Energy Takeout Targets motif has gained 5.7% in the past month. During that same period, the S&P 500 has increased 7.2%.

Over the last 12 months, the S&P 500 has risen 5.4%; the motif is down 41%.

1 Rebecca Smith, “Duke Energy to Buy Piedmont Natural Gas for $4.9 Billion,” wsj.com, Oct. 26, 2015.

2 Dana Cimilluca, “Energy M&A Surges Despite Oil Slump,” wsj.com, Sept. 30, 2015.