Mergers and Acquisitions Deals Effectiveness: Evidence from the Oil and Gas Industry
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1. INTRODUCTION 4
2. LITERATURE REVIEW 7
2.1. Theoretical review of mergers and acquisitions 7
2.2. Empirical review of M&A deals effectiveness evaluation 9
2.3. Theoretical review of real options 13
3. METHODOLOGY 19
3.1. Criteria and sampling 20
3.2. Discounted Cash Flow valuation 21
3.3. Real Options and Cox-Ross-Rubinstein option pricing model 25
4. MARKET AND FIRMS DESCRIPTION 29
4.1. Market description 29
4.2. Wintershall Holding Gmbh description 31
4.3. DEA Deutsche Erdoel AG description 31
4.4. Wintershall DEA AG description 31
5. VALUATION PROCESS AND RESULTS 33
5.1. Wintershall Holding Gmbh valuation 33
5.2. DEA Deutsche Erdoel AG valuation 37
5.3. Real option valuation 39
5.4. Wintershall DEA AG valuation 43
6. RESULTS DISCUSSION 47
6.1. Comparative analysis of the results and inferences 47
6.2. Theoretical and practical implications 49
6.3. Limitations of the paper and future research suggestions 50
7. CONCLUSION 52
REFERENCES 54
APPENDICES 58
2. LITERATURE REVIEW 7
2.1. Theoretical review of mergers and acquisitions 7
2.2. Empirical review of M&A deals effectiveness evaluation 9
2.3. Theoretical review of real options 13
3. METHODOLOGY 19
3.1. Criteria and sampling 20
3.2. Discounted Cash Flow valuation 21
3.3. Real Options and Cox-Ross-Rubinstein option pricing model 25
4. MARKET AND FIRMS DESCRIPTION 29
4.1. Market description 29
4.2. Wintershall Holding Gmbh description 31
4.3. DEA Deutsche Erdoel AG description 31
4.4. Wintershall DEA AG description 31
5. VALUATION PROCESS AND RESULTS 33
5.1. Wintershall Holding Gmbh valuation 33
5.2. DEA Deutsche Erdoel AG valuation 37
5.3. Real option valuation 39
5.4. Wintershall DEA AG valuation 43
6. RESULTS DISCUSSION 47
6.1. Comparative analysis of the results and inferences 47
6.2. Theoretical and practical implications 49
6.3. Limitations of the paper and future research suggestions 50
7. CONCLUSION 52
REFERENCES 54
APPENDICES 58
This paper is devoted to the problem of measuring the effectiveness of mergers and acquisitions (M&A) deals in the oil and gas industry and to the development of a more reliable way to evaluate that effectiveness. Mergers and acquisitions usually have strategic value for firms, which highlights the importance of the correct measurements, since they lay the ground for decision making. However, there are a number of issues that may arise in the process of evaluation and may hinder it or lead to false results. Sometimes it might be difficult to clearly define goals of the M&A deals, which are crucial for assessment of the effectiveness, sometimes it might be difficult to measure the success of a deal and attribute it completely to the M&A activity due to some external factors (e.g., market conditions, regulatory environment, etc.) that can affect the firm’s performance. It may also be the case that valuators may use inappropriate tools or simply not enough tools (e.g., use one approach) for assessing the effectiveness of the deal. For example, using discounted cash flow model alone may undervalue the potential of high-risk investments, while using real options alone may not consider the residual value of assets from the previous abandoned projects.
The relevance of this problem and this paper is dictated by the fact that measurement of the effectiveness (presented as synergy measurement - which is explained the next chapters) of an M&A deal is still an issue, because firms sometimes fail to estimate the value of the synergy correctly (McKinsey, 2020). Moreover, the paper is focused solely on the oil and gas industry, and there are several reasons for that. Firstly, although it is true that oil and gas industry receives more attention from the media and represents a significant share of the global M&A market, however researchers have paid much less attention to M&A deals in the oil and gas industry (Hsu et al., 2017). Moreover, Ozgur and Wirl (2020) admitted that to their knowledge, academic reviews of M&A studies in oil & gas industries are rare. Secondly, according to Deloitte’s 2019 oil, gas, and chemicals industry outlook, it was expected that the importance of new infrastructure would increase as a result of increased production and insufficiency of current infrastructure to handle the volumes. Considering the fact that planning and constructing new infrastructure have always been a very long process, new tactical M&A deals could be expected. Moreover, according to Deloitte’s 2023 oil and gas industry outlook, new policies are expected to accelerate the clean energy transition and natural gas plays a new role in this transition. The energy policy in the US and Europe has pivoted in 2022 due to the Russian-Ukrainian conflict. Now, instead of getting rid of the natural gas, countries decided to reduce emissions from natural gas while developing cleaner alternatives. This fact combined with the fact that the US agreed to increase LNG exports to Europe through 2030 increases the necessity of natural gas investments, including investments into related infrastructure. In addition, Deloitte has revealed several trends for the coming year. The first trend is the increase in acquisitions in natural gas assets and resilient midstream infrastructure. The second trend is the increase in joint ventures and alliances to commercialize new clean energy technologies. The third trend is reduction of operational emissions through acquisition of assets with a strong ESG1 profile. And the last trend is mitigation of inflationary pressures across the oilfield services sector through vertical integration. All these facts highlight the increasing relevance of M&A activities in the oil and gas industry, and hence the evaluation of M&A deals effectiveness in this industry. Finally, Kulik and Savina (2020) expressed in their paper the necessity for further analysis of other M&A deals in the oil and gas industry done specifically by using the methodology explained in this paper to confirm their conclusions.
The relevance of this problem and this paper is dictated by the fact that measurement of the effectiveness (presented as synergy measurement - which is explained the next chapters) of an M&A deal is still an issue, because firms sometimes fail to estimate the value of the synergy correctly (McKinsey, 2020). Moreover, the paper is focused solely on the oil and gas industry, and there are several reasons for that. Firstly, although it is true that oil and gas industry receives more attention from the media and represents a significant share of the global M&A market, however researchers have paid much less attention to M&A deals in the oil and gas industry (Hsu et al., 2017). Moreover, Ozgur and Wirl (2020) admitted that to their knowledge, academic reviews of M&A studies in oil & gas industries are rare. Secondly, according to Deloitte’s 2019 oil, gas, and chemicals industry outlook, it was expected that the importance of new infrastructure would increase as a result of increased production and insufficiency of current infrastructure to handle the volumes. Considering the fact that planning and constructing new infrastructure have always been a very long process, new tactical M&A deals could be expected. Moreover, according to Deloitte’s 2023 oil and gas industry outlook, new policies are expected to accelerate the clean energy transition and natural gas plays a new role in this transition. The energy policy in the US and Europe has pivoted in 2022 due to the Russian-Ukrainian conflict. Now, instead of getting rid of the natural gas, countries decided to reduce emissions from natural gas while developing cleaner alternatives. This fact combined with the fact that the US agreed to increase LNG exports to Europe through 2030 increases the necessity of natural gas investments, including investments into related infrastructure. In addition, Deloitte has revealed several trends for the coming year. The first trend is the increase in acquisitions in natural gas assets and resilient midstream infrastructure. The second trend is the increase in joint ventures and alliances to commercialize new clean energy technologies. The third trend is reduction of operational emissions through acquisition of assets with a strong ESG1 profile. And the last trend is mitigation of inflationary pressures across the oilfield services sector through vertical integration. All these facts highlight the increasing relevance of M&A activities in the oil and gas industry, and hence the evaluation of M&A deals effectiveness in this industry. Finally, Kulik and Savina (2020) expressed in their paper the necessity for further analysis of other M&A deals in the oil and gas industry done specifically by using the methodology explained in this paper to confirm their conclusions.
This paper was aimed at developing a more precise methodology for evaluating the effectiveness of M&A deals in the oil and gas industry. To reach the intended goal, a number of various research in the fields of M&A deals effectiveness evaluation and synergy evaluation have been analyzed. As a result, a two-model valuation approach has been introduced, which is a methodology for assessing the effectiveness of M&A deals in the oil and gas industry which combines the discounted cash flow model with a real option and gives more plausible results compared to the one-model valuation approach, which implies using solely the discounted cash flow model. To prove this point, both approaches have been used on the case of the M&A deal of Wintershall Holding and DEA Deutsche Erdoel, which led to subsequent formation of Wintershall DEA, to calculate the effectiveness of the deal in terms of created synergies. The results have shown that when using the one-model valuation approach the sum of values of the firms before the merger, namely Wintershall Holding and DEA Deutsche Erdoel, is greater than the value of the merged firm, Wintershall DEA, implying that the deal led to value destruction instead of creation. However, when using the two-model valuation approach the value of the merged firm, Wintershall DEA, is greater than the sum of values of the firms before the M&A deal, namely Wintershall Holding and DEA Deutsche Erdoel. That is due to the managerial flexibility being considered, which does not happen when using the one-model valuation approach. Moreover, the value of created synergy exceeded the expectations of the new firm, indicating that the M&A deal was effective. Considering the fact that Wintershall DEA themselves reported that the merger was successful, because already by the end of 2019 (in only 5-6 months after the merger), the firm managed to produce synergies worth more than €100 million, which was more than expected, it may be indeed claimed that the two-model valuation approach produces more plausible and more reliable results compared to the one-model valuation approach.