Due Diligence and Valuation of Unconventional Oil & Gas Assets for Acquisition Bidding

Abstract Acquisitions & Divestitures ("A&D") professionals routinely adjust the valuation parameters, on the basis of asset type being evaluated, to determine an acquisition price that is conservative yet competitive for use in a bid. A study of over seventy three A&D transactions over a two year period enabled us (the author’s team) to compare the valuation parameters for unconventional asset acquisitions vis-à-vis those for conventional asset acquisitions. Transaction data indicates that valuation metrics, particularly on a production multiple basis, for the acquisition of unconventional assets are significantly higher vis-à-vis those for the acquisition of conventional assets. The use of higher valuation multiples implies that the A&D market expects an unconventional asset to have lower risks and/or better growth prospects in relation to a conventional asset. SPEE Monograph 3makesit clear that an unconventional asset – a term often used in A&D markets to describe a continuous hydrocarbon reservoir of low permeability which exists over a large geographic area and requires extensive stimulation to produce at commercial rates – does not always have fewer risks and/or more growth prospects. Therefore, the acquisition of an unconventional asset at overly aggressive valuation could potentially lead to underperformance and adverse financial consequences for the buyer. The high valuation multiple for Halcón Resources Corporation’s ("Halcón") acquisition of its Woodbine unconventional play in Texas, which so far has not met expectations, provides a glaring, well-documented example of underperformance with adverse financial consequences in recent history. We believe buyers should use high valuation multiples with confidence only for those unconventional asset transactions which involve"resource play reservoirs" as defined in SPEE Monograph 3.1 Using a cash flow based analytical framework outlined in the paper, we argue it is highly likely that a resource play reservoir would offer lower risks and/or better growth prospectsvis-à-vis a conventional asset, all else being equal. Hence, in relation to the acquisition of a conventional asset, the valuation multiples for the acquisition of a resource play reservoir – a subset of unconventional asset deals – should indeed be higher. For the remainder of unconventional asset deals, the practice of valuation at high multiples could lead to perilous financial consequences. The paper concludes with our recommendations for due diligence and deal structuring with respect to an unconventional asset acquisition. We identify due diligence items which include the determination of whether or not an unconventional asset exhibits the technical characteristics of a resource play reservoir. Unfortunately, such determination requires extensive well data. Early in the exploration process, it may not be possible to determine if an unconventional asset has the technical characteristics of a resource play reservoir due to the lack of adequate well count and data. For such early stage unconventional asset acquisitions, we discuss certain deal structuring techniques which could potentially make bids more competitive and less risky.