Energy Valuation Insights The Benefits of a Quality of Earnings Analysis for E&P Companies
As we’ve often highlighted on this blog, transaction activity in the O&G sector has waned in recent years. Rather than utilizing free cash flows to support expansions via acquisitions, companies have emphasized capital discipline, favoring dividend payouts and buybacks.
With this thinning of the buyer market, it is more important than ever for a potential seller to be able to provide potential buyers with a clear picture of the company’s capacity for generating cash flows.
In that light, we thought our readers would appreciate a recent Mercer Capital slide deck on quality of earnings (QofE) analysis.
The purpose of a QofE analysis is to translate historical reported (GAAP) earnings into a relevant picture of earnings and cash flow that is useful in developing credible forward-looking estimates.
This process can be useful for both buyers (who need a clear picture of the earnings stream they’re acquiring) and sellers (who likewise need a clear picture of the earnings stream they’re giving up and may benefit if given credit for many of the common QofE adjustments).
Benefits of a QofE to sellers include:
- Maximizing value by revealing adjusted and future sustainable profitability.
- Promoting command and control of transaction negotiations and deal terms.
- Covering the bases for board members, owners, and the advisory team which optimizes their ability to contribute to the best outcome.
- Helping to communicate the real financial picture to the buyer since financial statements and tax returns are insufficient for sophisticated buyers.
- Leveling the playing field since in one form or another buyers are going to conduct a QofE process; therefore, sellers should do so as well so there are no surprises.
Benefits of a QofE analysis to buyers include:
- Avoiding overpaying for earnings that aren’t sustainable.
- Identifying opportunities for cost savings in your target’s expense base.
- Finding revenue synergies with your existing business.
- Clarifying the real working capital needs of your target.
- Assessing the real capital expenditure needs of your target.
For buyers and sellers, the stakes in a transaction are high. A QofE analysis is an essential step in getting the transaction right.
