Oil M&A and the penguin problem

Bernstein Research have looked at the mergers and acquisitions undertaken by the oil majors in the last decade and have found that most of them failed to add the sort of value that shareholders appreciate.

Lead oil analyst Neil McMahon uses this anonymous quote to illustrate the problem (author’s emphasis):

“If we increase the size of the penguin until it is the same height as a man and then compare the relative brain size, we find that the penguin’s brain is still smaller. But, and this is the point, it is larger than it was!”

It’s a simple matter of ratios: markets prefer to reward increased profitability, cash flow and dividends rather than growth in the overall size of the company.

Unsurprisingly, they suggest that this is why the markets have not rewarded the majors’ acquisitive spending with higher share valuations. What is surprising – perhaps – is the disconnect between the companies’ view of their activities and the actual impact on the bottom line.

Synergies are a popular rationale for acquisitions, but the market tends to view synergies with scepticism, at least in the oil sector:

The only way that acquisition can lead to value enhancement is when the assets in question are below long term market value.  Although many of these deals are supposed to bring with them synergies, these are very hard to measure, and in an inflationary environment it is very hard to tell apart normal cost inflation from slightly lower, but still positive cost inflation, as a result of synergies.  We also note that the only company that has managed to gap away at all from the peer group on ROACE over the last ten years has been ExxonMobil – the company which has undertaken exactly the least acquisitions, but has continually rationalized its asset base to keep it efficient and grown value on a per share basis by buying back large quantities of its own shares.

However, as we have heard on many a conference call, while investors are not particularly impressed in growth for the sake of scale, they are even less impressed by natural shrinkage because the company’s have failed to replace production. The Majors must walk a fine line between overspending on growth projects that the market is unimpressed by, but investing just enough to replace their production preferentially through organic means.

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