Gaining Advantages through Joint Ventures

Transcription

1 Gaining Advantages through Joint Ventures In this White Paper, Founders Investment Banking will examine the use of joint venture (JV) agreements to optimize business strategies in the oilfield. The energy industry is no stranger to joint ventures and other strategic transactions. From classic industry consolidations to joint ventures, carve-outs, and strategic alliances, executives in the industry have been known to systematically explore options to gain competitive advantages. Today s market volatility is likely to prompt oil and gas companies to explore the use of new joint ventures to increase efficiencies, mitigate risk, and overcome capital constraints. A joint venture approach can effectively combine capital and operating capabilities to allow large projects to be undertaken and energy resources to be developed. Further, the collaboration and knowledge transfer among the multi-owner structure is often extremely effective in creating shareholder value over the life of the agreement, which may span years. JVs are a useful way of gaining the benefits of complementary assets and/or capabilities without the same level of economic and political risk associated with a merger or other business acquisition. Below, Figure A identifies a number of drivers behind why JVs have become a well-established feature in the Oil & Gas Industry. Figure A: Reasons for Joint Ventures in the Oil & Gas Industry Capital Constraints Risk Concentration Access to Technology Supply Chain Optimization Projects can be too large for a single company to finance independently Large projects have considerable risk profiles of which no single company may wish to take full exposure Complex projects may demand multiple technologies which require partnerships Optimizing operations by pooling assets and/or complementary services/products, allowing for synergies and cost savings to be realized Geographic Positioning Regulatory Requirements Political Sensitivity Acquisition Risk Pooling assets and/or complementary services/products to develop a marketleading position in a particular geography Some countries require foreign companies to partner with local operators and/or service providers Can help avoid regulatory concerns, including antitrust and national energy security Allows for a test run by working with another organization s capabilities without taking on the capital risk of an acquisition

2 How would the strategy produce maximum value for the asset or project if there were only one company involved Taking the time to understand the strategic rationale of a JV is a critical step in identifying the right partner(s) and increases the probability of a successful outcome. Only when the strategic rationale is understood can JV partners assess their own and other s perceptions of the agreement s potential to create value to determine if objectives are aligned or misaligned. How to Mitigate Risk It is important to remember JVs are not without risk. Though companies often enter into these agreements to reduce risk concentration, managers should understand that partnering with a company will introduce other risks which must be considered, including the loss of proprietary technology/assets, management s focus, and even credibility or reputation. The exact nature of these risks will vary depending on a company s role in the venture and the attributes, capabilities, skills, and other factors that a potential partner brings. Joint ventures are complex agreements which require a high degree of cooperation among multiple parties. Involved parties should be sure to avoid a disproportionate level of investment and/or risk by one group versus another, which would prevent the JV from achieving its anticipated level of value. To mitigate risk and maximize potential opportunity, it is important JV partners properly address four key phases of an agreement in advance of beginning a project. These steps include: Planning Define the strategic rationale and identify all involved partner(s) Formation Build the legal and commercial structure of the agreement Operations Outline and agree to the ongoing operational procedures and management oversight of the joint venture Dissolution Outline and agree to the conclusion of the joint venture, including the end of the project and return of shared assets and personnel

3 JV Planning The first step to creating a joint venture partnership is the process of defining the strategic rationale of the partnership and identifying the partners involved. At the outset, the company will need to identify the assets necessary to undertake a project or business strategy. This will allow a company to vet and select potential partners to determine the compatibility of resources as well as business strategy and culture. It is important these components are not overlooked as JVs often fail because of a breakdown in the relationship between the agreement s partners caused by a lack of trust, differing strategic objectives, and unrealistic or misaligned expectations. The economic impact of the agreement should also be analyzed by its partners to understand the value creation potential of the JV Because the scope of JV agreements vary in complexity, it is critical the boundaries of the arrangement are clearly articulated and understood by all partners. The agreement should define the physical assets, length of time, geographies, markets, and customers the JV partners are aiming to serve. In our experience, this step justifies thoroughness and clarity to help reduce unnecessary disagreements from occurring later in the JV. The economic impact of the agreement should also be analyzed by its partners to understand the value creation potential of the JV. Financial models should examine the potential synergies and key variables of numerous operating scenarios by using a form of sensitivity analysis. Analysis should include variables controlled by the JV partners, such as technologies and cost saving synergies, as well as variables external to the organization, such as oil prices, interest rates, taxes, and government regulations. By thoroughly modeling and considering the financial implications of a range of scenarios, partners will understand the possible economic impact the JV could provide in terms of internal rates of returns (IRR) and returns on invested capital (ROIC). Further, it is our experience that JV partners who model and consider a range of potential upside and downside scenarios increase the probability of success as the initial analysis often facilitates discussions which mitigate risks and establish expectations. JV Formation The contractual terms of an arrangement determine how the associated risks and rewards are shared among partners. Potential partners should consider the degree of proportionality set out in the contract and understand how this might drive the behavior of the involved parties. Given the risk, partners should ensure the contract provides the other entity with an adequate level of influence in those areas deemed as higher risk. Further, JV partners should consult with advisors and legal professionals to ensure contractual arrangements include all necessary clauses, including those regarding location, jurisdiction, tax operating structure, and indemnification. These and other protective mechanisms are used to minimize exposure to the other partners negligence and pre-existing obligations in which there is no involvement. With the current volatility in the oil & gas market, drafting a contract which provides flexibility and accounts for the changes in a dynamic market will be important for the longevity

4 longevity and profitability of JVs. Figure B outlines a number of key items partners should consider and/or include in the formation of the JV. Figure B: Key Items in the Formation of a Joint Venture Define the required governance structure, organization design, decision making hierarchy, and staffing model Focus on attaining the right balance of input from JV management, ownership, and partner(s) Understand the breakpoints for the JV, whether financial or operational, and create mechanisms to track and make changes to help maximize value Ensure a shared view for job execution, including resources and responsibility by partner, as well as what will be measured and rewarded Align the organizational systems, programs, and policies required to support behaviors and actions needed to build and sustain the targeted synergies It is critical JV partners agree on the shared identity, vision, and purpose of the arrangement JV Operations It is critical for JV partners to agree on the shared identity, vision, and purpose of the arrangement. Only then can the new JV s management team structure policies and procedures, and the culture be established and communicated to all levels of the organization. The nuances of each JV will require decisions to be made regarding the overlapping of assets, personnel, and business processes. In situations where the JV is a combination of two vertically integrated organizations, partners must make decisions regarding the potential overlap in areas which functional support (e.g., HR, finance, IT, legal, and procurement), IT infrastructure, office space, supply chain, suppliers, and contractors. When the JV is a new entity, these same areas and functions will need to be developed or provided by the partners. Overlap of assets, personnel, and/or business processes is likely to be less of an issue in situations where the businesses will continue to operate separately from one another. In this case, the JV may simply require the establishment of interface processes while the core processes, systems, and office locations remain unchanged. Independent of initial overlap, active engagement and support of all partners throughout the life of the agreement is key to an effective JV. The continued involvement by all parties may result in each partner taking the lead at different times in the agreement s life. Therefore, it

5 result in each partner taking the lead at different times in the agreement s life. Therefore, it is essential to develop processes which allow the JV to be proactively managed. Below, Figure C highlights three processes commonly found in successful JV partnerships. Figure C: Processes Used in Successful Joint Ventures The continued involvement by all parties may result in each partner taking the lead at different times in the agreement s life Consistently measure business fundamentals to monitor and track the JV, including the continued assessment of the market and the JV s positioning within it Maintain and utilize the contract s flexibility to refresh and revise the agreement, assisting the active and healthy parts of the JV while also mitigating downside risk on the less productive parts Successful Joint Ventures Ensure and promote open communication with involved parties, whereby business performance, environment, necessary corrections, and successes can be discussed to keep the JV aligned Partners will need to establish clear rules for maintaining control over the strategic direction and key operational decisions that will significantly impact the JV. However, partners must strike a balance to allow management the freedom to lead the organization on a day-to-day basis using a non-bureaucratic decision making process. This is a difficult balance which requires a clear and well-understood delegation of authority. It is often helpful if JV partners establish a regular series of oversight meetings with management teams to monitor progress, track performance against strategic goals, as well as review and update the agreedupon strategy. JV Dissolution At some point, most JVs come to a natural conclusion. JV dissolutions may be a planned milestone event when a certain goal has been achieved or it may be a response to circumstances. Either way, it should be an event that has been foreseen, with the options considered and provisions outlined within the JV s legal framework. Managing a JV s dissolution effectively from a business, cultural, and legal perspective, enables all parties to walk away with the gained value and knowledge intact. Effective dissolution is important, so they may leverage this newly attained value and knowledge in the next venture.

6 Founders Investment Banking About Founders Investment Banking is a merger and acquisition advisory firm based in Birmingham, Alabama. Its team s proven expertise and process-based solutions help companies and business owners access capital and prepare for and execute liquidity events to achieve specific financial goals. The firm focuses on oil and gas, healthcare, and industrial clients located across the Southeast, and also has a technology practice with a national presence. In order to provide securities-related services discussed herein, certain principals of Founders are licensed with M&A Securities Group, Inc. or Founder M&A Advisory, LLC, both members FINRA & SiPC. Founders M&A Advisory is a wholly owned subsidiary of Founders. M&A Securities Group and Founders are not affiliated entities. The testimonial presented herein does not guarantee future performance or success. Contact For more information, visit call us at , or contact the general practice team directly by Duane P. Donner, II, Managing Director ddonner@foundersib.com John W. Sullivan, Vice President jsullivan@foundersib.com Andrew J. Summerlin, Senior Analyst asummerlin@foundersib.com Joe H. Brady, III, Director jbrady@foundersib.com John F. Ortstadt, Business Development jortstadt@foundersib.com Vaughn R. McCrary, Analyst vmcrary@foundersib.com