By Sarah Samir
In quest for larger capital amidst financial instabilities in the global oil and gas industry, companies resort to different mechanisms to acquire necessary funds to expand their businesses. One way to do so is to opt for Initial Public Offerings (IPOs). This global trend has opened a number of state-owned oil and gas firms to the privatization structures and private companies themselves then take this as a first step to increase their pool of acquisitions.
Egypt has also begun walking down this path. Under the umbrella of the strategic national plan designed by the Ministry of Investment and in cooperation with NI Capital of the National Investment Bank, in November 2016, Egypt’s Ministry of Petroleum and Mineral Resources selected and announced eight oil and petrochemical companies for IPOs on the Egyptian Stock Exchange (EGX). The companies will include the Middle East Oil Refinery Company (MIDOR), Egyptian Ethylene and Derivatives Company (ETHYDCO), SidiKerir Petrochemicals Company (Sidpec), Alexandria Mineral Oils Company (AMOC), and Misr Fertilizers Production Company (MOPCO), as well as Engineering for Petroleum & Process Industries (Enppi).
The country is thus confidently following an international trend, according to which hydrocarbons producing countries reform through privatization and oil and gas companies themselves become open to offering their stakes through IPOs. Their ultimate goal is thus to generate stronger financial cushions, diversify their portfolio, decrease implicated risks, and eventually create and guarantee sustainable business face to face with the existing challenges in the global market. Accordingly, an IPO helps in boosting “the transparency of the firm by subjecting it to capital market discipline,” eloquently stated Anil Shivdasani, Merih Sevilir, and Ugur Celikyurt in their article ‘Going Public to Acquire?: The Acquisition Motive in IPOs’. Yet, each and every oil and gas firm has high expectations as to the benefits that such a public conduct may deliver.
Seeing Benefits of IPOs
IPOs can be useful on several levels. “An IPO creates liquidity for the firm’s shares, provides an infusion of capital to fund growth, and allows insiders to cash out,” as Shivdasani, Sevilir, and Celikyurt wrote. Furthermore, an IPO “provides cheaper and ongoing access to capital, facilitates the sale of the company, gives founders the ability to diversify their risk, and allows venture capitalists and other early stage investors to exit their investment.”
Opting for IPOs can enhance companies’ positions in the market by also generating “funding for future cash-based mergers,” noted Armen Hovakimian and Irena Hutton in their paper ‘Merger-Motivated IPOs.’ IPOs have been seen as helping companies in boosting capital for future acquisitions by “relaxing financing constraints that might have impeded a private firm’s ability to acquire attractive targets.”
Furthermore, through access to the public equity market, a firm enhances its ability to access the public debt market. Hence, an IPO further paves the way for “publicly traded stock [to] be directly used as a method of payment in stock-based acquisitions.” This leads to a situation, in which companies manage to establish a firm ground for their sustainable business ahead of tumultuous periods.
Various case studies of hydrocarbons companies showed that IPOs, indeed, generated required capital. In Colorado, Denver-based Extraction Oil & Gas Incorporation “sold 33.3m shares for $633m [in 2016] in an IPO for $19 per share,” as mentioned in Mikaila Adams’ article ‘Oil and Gas Companies Testing Investor Appetite for IPOs.’ Following this move, “the company’s D&C capex budget for 2016 was at $335m and increased 60% to $535m for 2017. Thus, the company had announced plans to add a third drilling rig [in its operating concession already] in the first quarter of 2017, which is earlier than the previously disclosed mid-2017 timing.” Accordingly, the IPO allowed the company to increase its exploration operations and drew a positive image for future projects.
In light of the notion that IPOs can also open a door for new and more profitable acquisitions, James C. Brau and Stanley E. Fawcett had surveyed 336 Chief Financial Officers (CFOs) in 2006 enquiring about the motivation behind IPOs. According to their article ‘Initial Public Offerings: An Analysis of Theory and Practice,’ the authors found that “CFOs identify the creation of public shares for acquisitions as the most important motivation for going public.”
Expanding Business through Fresh Acquisitions
An IPO can, in fact, increase companies’ properties, boost their business and help them grow. Oil and gas companies understandably aim to expand their business, but to do so through IPOs, they need liquidity to be able to purchase stocks. In line with that, the banking sector is to play a crucial role in enabling smooth transitions, especially in situations of such intensity and length as the low-oil-prices environment has brought about since mid-2014. It is therefore that many industry executives still expect the banking sector to recover its trust in oil and gas players, whom they viewed less favorably in the past couple of years. “Banks that lend to the energy sector are still very hesitant to extend credit backed by oil reserves,” as Tom DiChristopher and John W. Schoen wrote in their timely article ‘Oil and Gas Mergers and Acquisitions Are Finally Making a Comeback.’ But as “recovery [in oil and gas acquisitions globally] has so far largely depended on buyers’ ability to tap into equity markets,” there appears to be no better option than for the two sectors to collaborate through the IPO schemes.
Subsequently, and “by expanding the menu of choices for acquisition financing, the public status may not only allow a firm to pursue more acquisitions, but it may also allow it to pursue the types of targets that could be [otherwise] out of reach of private acquirers,” Hovakimian and Huton explained. This means that, without IPOs, “very large targets could be difficult to acquire for cash, as this may require borrowing beyond the potential acquirer’s capacity.” Similarly, “a target’s owners are likely to be more receptive to a stock-based acquisition by a publicly traded firm, because of the liquidity and relative ease of valuation of the public bidder’s stock.” The same proposition applies “for targets where insiders want to maintain some ownership in the combined firm instead of immediately cashing out.”
There are many reasons that can trigger acquisition in any industry. According to Marc Goedhart, Tim Koller, and David Wessels, a company could resort to acquisitions for “improving the performance of the target company, removing excess capacity from an industry, creating market access for products, acquiring skills or technologies more quickly or at lower cost than they could be built in-house, and picking winners early and helping them develop their businesses.” Therefore, an acquisition does not always come with benefits and values merely for the acquirer company, but may bring profit to the acquired company as well, explained the authors in their article ‘The Five Types of Successful Acquisitions.’
In assets acquisitions, “the acquirer only owns the assets without taxes and without liabilities,” while, in shares acquisitions, “the acquirer buys a company’s shares, taxes, liabilities, and trademarks,” Sharkawy&Sarhan’s Associate, Reham Eissa, explained to Egypt Oil&Gas. Thus both assets and shares acquisitions can boost operations and activities associated with companies’ implemented projects. Egypt’s Enppi’s General Manager for Civil Engineering Division, Eng. Galal Soliman, stated to Egypt Oil&Gas that “offering stocks to other firms is beneficial to the company on the technical level.” In addition to these technical benefits, cost reduction comes into the picture as well. Eng. Soliman explained that “for international companies, manpower’s cost is highly expensive, so when a partner is awarded a project that needs around 2,000 [staff], Enppi can supply 1,000 of them at a lower cost,” which is facilitated through acquisition partnerships.
These success stories are, however, not a rule. There is a great chance for the acquisition transactions to fail or to generate lower-than-expected profits. Therefore, when a company is studying acquisition deals it should consider “corporate culture and that of the company [that is to be acquired],” according to Richard Bloch’s article ‘Acquiring Another Company.’ Furthermore, the company should ensure “apprehension among both [its] employees and those of the company [it] acquires” as well as “a potential increased debt on [its] balance sheet if [it is] borrowing money to fund acquisition, which could impact ability to borrow additional funds for other purposes.” Accordingly, the acquiring company can resort to means other than loans in order to ensure the best possible profit out of the acquisition transaction.
The oil and gas industry requires huge funds to perform efficiently and generate required profit amidst cash-demanding environment, which relates most importantly to technological innovations. As Loretta R. Cross stated in the article ‘The Technology Revolution in Oil and Gas,’ “the days of so-called ‘easy’ or conventional oil are dwindling; so the oil and gas industry has focused on developing technological solutions, thereby increasing the world’s producible reserves and creating the ‘new normal’ of exploration and production.” This progress strongly indicates that it is almost essential for oil and gas firms to increase their liquidity in order to be able to acquire new assets, adopt new technologies, and apply new exploration methods to survive. Presenting part of the oil and gas firm in IPOs can help the company to secure the funds it needs for the growth.