As oil prices remain stagnant, many companies are seeking to offload non-core assets in an effort to survive the downturn. As a potential buyer, there are increasing opportunities to acquire portfolio assets at a discount. In this pricing environment, there are additional considerations any would-be buyer should plan for as part of its acquisition model.
UNDERSTANDING LIEN PRIORITY Buying from a Distressed Seller
When reviewing buying opportunities, be sure to evaluate the financial health of the seller as part of your pre-due diligence. Identify whether the potential seller may file for bankruptcy within the next two years. If you are concerned that a bankruptcy filing may be in the seller’s future, you should ensure the transaction is at arms length and would be considered fair and reasonable to an outsider who may have an interest in seller’s assets (such as a creditor). Work with legal counsel to mitigate your risk during the negotiation period. Carefully value your assets, and understand the Seller’s financial health before proceeding with a buyer’s due diligence of the assets.
UNDERSTANDING DEVELOPMENT COMMITMENTS
Future Capital Requirements
Prior to entering into a purchase agreement, perform a cursory check to see whether the potential seller is behind on payments due under development agreements, if production payments are current, and if leases have been allowed to expire. Specifically ask the seller to disclose this information. Have the seller include all lease expiration dates on lease exhibits, and provide a list of development agreements showing their remaining carry costs, participation costs and expiration dates, if any. During buyer’s due diligence have your land team pay special attention to the financial implications of expiring acreage, and the carry and participation costs associated with seller development agreements. Using this information, your business development team can assess the future capital requirements for the next several years needed to maintain the assets.
PROTECT YOUR INVESTMENT Status of Ongoing Obligations
In the current environment, many sellers seeking to offload assets may not have drilled or paid anything within the last year or perhaps longer. During buyer’s due diligence it is important to review seller’s files including contracts, leases and payment records to ascertain if the seller is in breach of any of its obligations which may subject the buyer to additional financial exposure, litigation or even loss of the acquisition assets.
IDENTIFY YOUR RISK Perform a Cursory Due Diligence
Before entering into a purchase agreement we recommend performing a cursory level due diligence to assess the added risk, as discussed above, of buying assets in this pricing environment. Identify any “fatal flaws” that would be deal breakers or require a significant price adjustment. We strongly recommend getting your land advisors involved at the onset of this cursory due diligence phase to help mitigate your risk.
Cursory Due Diligence Checklist
Assess the risk of a seller bankruptcy within the next two years.
Ensure assets are valued fairly to similarly situated assets.
Ask seller to disclose all development agreements and other similar agreements, in which they have existing and future monetary obligations.
Determine whether seller is behind in a significant number of partner payments, drilling obligations, rental payments or royalty payments.
Review seller leasehold acreage expirations to see how much acreage is subject to extension payments.
Research the seller’s main partners’ financial filings and activities over the past 6 months and identify partners who may file bankruptcy in the near future.
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