2022 was an uneven year. It started well, as the post-covid recovery fuelled economic optimism and a high oil price buoyed the oil and gas sector activity which is especially significant for the North-East; but it ended with a chill over private equity activity, following the "fiscal event" of the Kwarteng-Truss budget.
So, in a year of two halves, what can we learn from last year's M&A trends?
The energy sector remained a hot spot and the energy transition is real
Rekindled industrial and domestic demand for energy, together with supply-side shocks, super-charged profits for the oil and gas majors. This resulted in transactional activity which had not been seen locally since the 2015/16 oil price downturn. It also provided renewed confidence to the energy services sector, which had hereunto been embattled by a combination of low margins and anti-fossil fuel sentiment. As longer-term services contracts fall due for renewal, these companies have the opportunity to increase prices and margins and use those profits to diversity into less carbon-intensive revenue streams. Some of that diversification comes from M&A activity.
We have seen Exploration and Production companies explore options to use the government's INTOG scheme to incentivise the development of offshore wind farms alongside existing installations, and the allure of finding a game-changing technology start-up to acquire remains.
Private equity is still (broadly) moving away from oil and gas
For most of the last two years at least, the discussion about Private Equity (PE) in oil and gas services has been about how to exit. At the extreme end of the spectrum, this has led to predictions of undiversified oil and gas services companies having nil terminal value in a time horizon within our working generation. However, during 2022, the conversations have become more nuanced. The war in Ukraine illustrated the issue of domestic energy security and the rising energy prices in the UK during an austere winter laid bare the strength of demand.
One recent poll put the preference for producing hydrocarbons domestically at 87% among Scots. The apparent softening of public attitudes towards oil and gas did not translate into any great deal appetite in 2022, but certain specialist funds are still active. More generally on PE, we saw a chill descend during Q3 which has yet to lift, especially in relation to real estate and infrastructure investments, which are troubled by the macro-recessionary environment, inflation and high interest rates.
Technology, technology and more technology
The degree to which all modern businesses are underpinned by technology is obvious. Both PE and trade deals in the software and broader IT services sectors therefore remained strong for the first half of 2022, with healthy multiples – especially for companies that had a software-as-a-service offering. The stickiness of these recurring revenues remains very attractive to investors and acquirers. In other streams of technology, the familiar issues of obtaining risk capital for development funding and long lead times remains. There was cause for optimism in two key sectors in which Scotland can play an important part in the technology development ecosystem – fintech and cleantech. The former more active in the central belt around the banking and finance legacy hub of Edinburgh; and the latter increasingly around the impressive work of the Net Zero Technology Centre in Aberdeen.
Regulatory and staffing burdens
There are a number of sectors that are feeling the twin pressures of increased regulation and staffing shortages – including food and drink, hospitality and care. This is driving smaller operators in particular to consider their options, resulting in both consolidation and, sadly, some businesses to scale back their operations or even close down.
The key word is 'de-risk'
As a response to the above economics, there were a number of individual trends in transactions last year, which can be grouped together as 'de-risking'. This included extended due diligence and less willingness by buyers to accept the risk of issues uncovered; the use of earn-outs to reduce the upfront consideration payable and share the risk of underlying business performance with the sellers and the consideration of warranty and indemnity insurance to transfer future risks.
Looking ahead, I would many of the trends we saw last year continue in 2023 – at least in the short term as recession looms. But with exchange rates encouraging foreign investment in the UK, the Aberdeen market would appear better placed than elsewhere in the UK to sustain deal activity throughout that period and beyond.
This article originally featured in The Press and Journal in February 2023
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