There is an Old Roman Adage – Caveat Emptor: Buyer Beware.
This is the principle that the buyer is responsible for checking the goods before a purchase is made. Given the seller always knows more than the buyer (in this case venture capital firms or investors), the deck is stacked – and not in the buyer’s favour.
For sellers, you have a duty of care. Both parties can lose significant value in the deal, but there is also a potential win-win. An orderly transition is the critical success factor – and the key to the energy transition in the industry.
In the heat of a downturn, with sellers eager to offload an asset and buyers eager to snap up an asset at a bargain – mistakes are often made. It doesn’t have to be this way. An ‘orderly transition’ can be a critical success factor.
Case in point: A Shell site divestment CEO, Ken Rivers, coined the phrase ‘orderly transition’. “I continue to be struck by how some new owners who are fully conversant with financial risk and assessment, can be almost blind with respect to their inherent refinery risks.” On the other side, he said, “I see many operators not appreciating fully the management of change required as owners flip – especially in the overall coherence of their management systems.”
These turbulent times are characterised by unprofitable assets, slowdowns in production, significant staff layoffs, and loss of the collective experience. Downsizing, divestments, consolidations, mergers and acquisitions are an inevitable business consequence in a challenged downstream oil industry. Once the Covid-19 pandemic is under control, it is expected that the merger and acquisition activities globally will accelerate significantly.
Whether you are a buyer or a seller going through an asset transfer right now, how well do you think you are prepared for an orderly handover? Have you thoroughly assessed your readiness and ability to manage potential risks and opportunities? Is your house in order? Are there sufficient internal, experienced resources readily available?
The Asian Downstream Experience
In many ways, Asian assets are uniquely positioned to benefit from an orderly transition. There is strong demand growth in the region, which has led to significant investments in assets over the last decade. The impact of the accelerating energy transition will impact Asian markets less than in Europe. China is still the dominant player in the region, which is expected to continue.
Significant regional players will continue to be clustered in Singapore, Korea, and Malaysia. They have the potential to continue to grow and connect heretofore fragmented markets.
Continuing a long tradition, national oil companies continue to play a strong role in investment decisions – often with joint ventures with IOCs and crude suppliers.
Adjusting to Change
There’s no doubt the financial and economic impact of the crisis has caused shifts in divestment perspectives. Whether you are a large IOC or a small independent, preparation needs to start now for both buyers and sellers alike.
Although there have been some big deals recently, M&A activities in some areas of the business have plunged to the lowest level since 2013. However, many are predicting a likely bounce back in the second half of 2021. Business strategies, including the respective product and asset portfolios, must be reviewed. As a consequence, often divestments are needed to cover financial losses incurred during the pandemic. Furthermore, in view of the low interest rates, there is now cash available to fund M&A deals.
In a recent paper based on divestment’s “Orderly Transition” EY noted that post COVID-19, when it comes to rebalancing portfolios as a result of the crisis, executives need to plan now for what happens next and understand the preparation necessary. There is evidence that taking bold action now could pay off later. The most resilient and successful companies will be those that have shown discipline and focus on their transformation.
The whole M&A process and the orderly transfer of ownership is imperative to sustaining the overall business value for all parties. Yet, it is all too often overlooked. An M&A manager’s job description seldom includes ‘orderly transition’ and his/her involvement stops once the deal is signed. An orderly transition requires a systematic approach and to be built in contractual obligations and commitments at the earliest possible stage (pre-due diligence) to ensure a successful implementation.
How to Save $100M
Events that occur during the considerable challenges of transition can culminate in $100+M of both financial and reputational loss. Yet this is entirely preventable.
Below are examples of some of the key root causes to avoid:
- Refinery transactions within JV structures – multiple stakeholders increase complexity.
- Bureaucratic regulatory approvals.
- Local partners (often a regulatory requirement) with limited funding potentially delay the transaction.
- One company’s announcement on asset divestment can directly and indirectly put pressures on other players in the market to dump assets, creating market chaos.
- Privatization of state assets presents major transactional challenges.
- Post-merger integration checklists focus on the integration of the company and not the sustainability of the operational performance.
- Companies don’t get the fundamentals (‘must dos’) right first, losing valuable time.
- The hand-over methodology must be well proven and fully developed.
- Lack of robust management systems.
- Loss of staff motivation after announcement.
The seller of the asset could easily pay heavily for not de-risking the asset transfer through a lower asset valuation by the new owner. Furthermore, all the potential benefits of new asset ownership may not be realized. Both parties should be focused on an orderly transition process. This supports the necessary regulatory approvals and equity requirements, as well as debt funding of the deal. The mitigation costs are minor compared to transaction risk.
A thorough deal implementation process is required, especially after the transaction, to ensure the total potential value is realised.
Staying Safe, Reliable and Profitable During a Transition
Currently, with so much internal and external chaos, it is easy to neglect the essentials for an orderly transfer. However, the sustainability of safe, reliable, and profitable operations during transition is imperative to capturing the anticipated business value.
The key challenges are to:
- Identify underlying business risks and opportunities, both rational and emotional.
- Specify the degree of integration required to secure the benefits.
- Identify those impacted (customers, acquired and existing staff, suppliers, regulators, management, etc.), as well as cultural aspects and the resistance to change.
- Ensure a secure and viable platform for business growth.
- Secure the expected cash flow from existing and new assets in a changing business environment.
- Improve the overall business performance, avoiding implementation pitfalls.
A comprehensive and systematic process is required to:
- Define the deal strategic intent (investor, financial, and business logic), deal, design AND implementation requirements, with clear critical success factors.
- Align stakeholders to the strategic logic for value creation and capture.
- Develop a high-level implementation plan, which defines ‘mission critical’ activities.
- Provide a network of functional and diverse “on-demand” experts, who can quickly and effectively remove barriers to implementation.
- Ensure comprehensive data collection, for fact-based decision making.
- Specify data requirements, so there is a “single source of the truth”.
- Develop the financial model(s).
- Provide financial sensitivity studies.
- Exploit synergies and upsides (e.g. master planning).
- Prepare a quantifiable risk assessment, with mitigation steps and action parties.
- A more proactive business performance.
A more proactive Business Improvement Performance process can help to better understand the impacts on:
- Current and future business models
- Changing market environment
- Service providers
- Governments and regulators
An orderly transition in the transfer of assets is crucial to securing value for all parties. A proactive, planned and systematic management approach, using experienced resources, will effectively de-risk the asset transfer process, at a relatively minor cost to both seller and buyer, and prevent on average $100+M of both financial and reputational loss.
Who can afford to pave the way towards an energy transition with a disorderly transition?
This article was written by Paul Newman, Client Director and Jörn Falbe, Practice Lead for Manufacturing Excellence at Petrogenium.