Mergers and acquisitions (M&A) are a key tool in a company’s value creation toolbox. Despite a highly turbulent macroeconomic environment over the past decade, M&A activity in the oil and gas sector has continued, albeit at lower levels than prior years.1 Now, a new M&A wave is expected, driven by record cash flow in the exploration and production (E&P) sector, among other factors.2
In this next wave, differentiated value creation will likely underpin M&A success, and set M&A winners apart. Many upstream firms view acquisitions as a “bread and butter” activity that they do well. However, more than 50 percent of deals in the E&P sector don’t create value for shareholders.3 Many deals are limited to a focus on reducing general and administrative (G&A) expenses and ignore any operational synergies that may exist. There is a lost opportunity here for firms to raise their synergy aspirations and look beyond G&A, as M&A deals pursued for operational synergies typically outperform those based on G&A savings. In addition, the choice to publicly announce synergy targets can impact the total return to shareholders (TRS). By making clever decisions, companies can reap the most from their deals.
In this article, we explore two steps that upstream companies could take to maximize value from their deals and build resiliency ahead of the next cycle.
Most deals don’t create value
Over the past 12 years, there have been roughly 750 upstream deals with a transaction value of at least $100 million.4 Although most deals were less than $1 billion in size, deals greater than $1 billion have contributed the largest portion of transaction value since 2016 (Exhibit 1).
Taking a closer look, most deals greater than $1 billion in size haven’t created value—but the best deals have created outsized returns for their shareholders (Exhibit 2).5
What could be the make-or-break factor determining deal success? Multiple components are at play, such as pre-deal diligence, asset-performance uncertainties, outlooks for oil and gas prices, and transaction management.6 But in all cases, the ability to accrue differentiated value creation is a key factor determining merger success and may determine the winners in the next cycle.
One plus one equals three: Maximize value by moving beyond G&A
All too often, upstream deals have limited their synergy goals to the low-hanging fruit of G&A reductions. Our experience shows, however, that operational synergies are almost always larger than G&A savings—often by a factor of three or more.
The most successful mergers are usually those that adopt a transformative approach to value capture, systematically pursuing synergies across financial categories and functions, including operations. Upstream companies can open the aperture across revenue and production, operating costs, and capital efficiency in addition to G&A, using the merger as a “moment in time” to catalyze performance improvement across both entities.
Pursuing operational and production synergies with rigor equal to (or greater than) G&A cost synergies also has an important change-management dynamic. While reducing headcount and other expenses is usually viewed as a necessary evil that often generates negative emotion, developing additional revenue through operational excellence can drive energy and excitement and offer teams a point of pride to rally around. Operational synergies have the added benefit of being a buffer in case G&A synergies are harder to obtain than expected.
Our work has highlighted that successful mergers approach operational synergies from three main angles (Exhibit 3).7
Leading companies often ask the following questions when considering M&A:
- What are the direct operational synergies to be extracted, either from an overlap (or adjacency in footprint) or from an expanded size and scale?
- How can we leverage the best-of-the-best capabilities from each organization, using both data and capabilities to scale opportunities across portfolios?
- How can new opportunities be catalyzed in this unique moment to realize step changes in performance?
Firms that strive to become world-class serial dealmakers may engineer answers to these questions into a repeatable “deal machine,” which they continually improve while proactively strengthening the muscle memory of how to run it.
Publicly announce synergy goals
To announce, or not to announce, that is the question. Once synergies have been planned and targeted, they can be announced—internally or externally. At a minimum, targets, or goals, can be clearly communicated internally, with discreet goals set for each part of the combined business. This mobilizes the entire organization to drive performance, while offering a clear rationale for decision makers to anchor the many tough calls that will likely be required during the integration process.
But announcing targets externally can increase the chance that deals create value (Exhibit 4). While there is a negligible link between communicating additional information about the deal and the initial market reaction, announcing cost-synergy expectations may be tied to significant long-term outperformance over peers. Our analysis of 776 deals across sectors showed that companies that announced synergy targets outperformed those that did not by an incremental 7 percent TRS over a median of two years.
Publicly announcing targets can contribute to putting healthy pressure on the executives and support teams who will have their compensation linked to meeting targets. As the onus is on the company to deliver, this can encourage executive teams to tackle the difficult decisions included in initial synergy estimates instead of opting for an easier route. To ensure delivery, publicly announced targets are typically supported by internal targets that are up to 200 percent higher, even in the case of value leakage.8 Public announcements also allow investors to understand where the synergies are coming from, instead of the deal being a black box.
After the deal, some organizations may be tempted to adjust the synergy goals used in approval to better match the actual delivery. To counter this behavior, top CEOs may require their teams to place a record of synergy objectives in a figurative time-locked safe with the initial opening set for the first executive lookback on deal success. There will likely be both positive and negative variances against the goal, but only by knowing where gaps exist can teams fine-tune estimation and delivery methods to continually improve.
In the next wave of upstream M&A, differentiated value creation may be a key factor underpinning merger success. By pursuing operational synergies beyond G&A and publicly announcing synergy targets, companies can maximize the value from their mergers—and accelerate their growth and performance.