For many investors, it will come as no surprise that Genel Energy (LSE: GENL), Afren (LSE: AFR) and Gulf Keystone Petroleum (LSE: GKP) are once again the subject of takeover rumours.
However, it would appear that this time around the rumours have some real substance. Indeed, a combination of sector-low valuations and rising levels of free cash flow have formed a perfect environment to do deals.
Free cash flow
According to City analysts, historic trends show that big oil’s appetite for acquisitions tends to reach fever pitch, around a year after oil majors start to generate excess cash. Unfortunately, big oil has been spending more than it can afford on exploration and development during the past few years, so cash has been a scarce commodity.
But now, free cash flow has started to grow again, sparking chatter that big oil could be about to embark on an acquisition spree. For big oil, the depressed valuations of Iraq-focused oil producers could be too hard to pass up.
Depressed valuation
Afren’s valuation is one of the lowest in the oil sector right now. After being hit by a tidal wave of bad news, investors have given the company the cold shoulder.
Still, at present levels some City analysts believe that the company is trading around one third below its core net assets value, an impressive discount.
That said, it’s unlikely that any offer will be made for Afren until the company is able to sort out its management crisis and boost production. Auditor KPMG has been hired to work alongside legal advisers Wilkie Farr & Gallagher on a widening probe regarding unauthorised payments made by Afren’s chief executive and chief operating officer.
Afren has also cut production guidance within the past few weeks, from 40,000 barrels of oil equivalent per day, to 32,000 – 36,000 boed.
Returning to work
While Afren is in crisis management mode, Genel and Gulf Keystone are making progress.
Gulf Keystone confirmed a production rate of approximately 20,000 boed during June and expects to double this production by the end of the year. That would give the company a higher output than Afren, although Gulf Keystone’s market capitalisation is still around 40% less than that of its larger peer.
Genel, meanwhile, is expanding out of Iraq and is analysts’ favourite takeover target. Led by Tony Hayward, the former chief executive of BP, Genel is currently in the middle of a high-impact exploration program offshore Morocco. The company’s oil production hit 63,000 boed during the first half, up 50% year on year. The firm’s current cash balance is $973m, including $500m of recently-issued debt.
A risky business
Buying a company based on its takeover prospects is never a sensible bet. Still, Genel, Afren and Gulf Keystone all have their attractive qualities and could fit well into your portfolio.