Amec Foster Wheeler plc agrees £2.225bn takeover by John Wood Group plc

Consolidation within the oil & gas industry is perhaps unsurprising. A difficult number of years and a persistently low oil price mean that merger & acquisition activity is to be expected.

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Monday saw a merger between Amec Foster Wheeler(LSE: AMFW) and Wood Group (LON: WG), which values the former at £2.225bn. Could it prove to be a success in the long run for investors in the merged entity?

Improving outlook

As with any merger, the number, and likelihood, of synergies is a key consideration. In the case of the Amec Foster Wheeler and Wood Group deal, it is estimated by their management teams that £110m in synergies will be delivered per year on a recurring basis. Given that the former's pretax profit for 2017 is expected to be £190m prior to Monday's news, it is clear that the merger is set to bring sizeable improvements to the two companies' financial performance.

Furthermore, the two companies envisage greater revenue opportunities resulting from the merger. This could help to boost their sales at a time when the oil & gas industry looks set to continue to experience a difficult period. In addition, a size and scale advantage over sector peers could provide the merged entity with a competitive advantage, as well as superior defensive characteristics should the price of oil decline.

Valuation

The merger values Amec Foster Wheeler at a 15.3% premium to its closing price on the trading day prior to the announcement. It also represents a 28.7% premium to the prior 30 trading day volume-weighted average price of the company. This may appear generous at first glance, but it actually seems to somewhat undervalue the business. For example, it puts the company's shares on a price-to-earnings (P/E) ratio of just 12.3. Certainly, it is the highest point at which the company has traded since October 2016, but given the long-term outlook for oil it looks as though Wood Group may have obtained a relatively good deal.

That's especially the case since Amec Foster Wheeler was expected to return to rising profitability in 2018. This could have boosted investor sentiment and allowed it to command a higher valuation. However, at the same time, investors in the company will be able to keep their shareholding in the new business. As mentioned, it should offer even better growth potential due to size and scale advantages, as well as the potential synergies.

Sector outlook

Of course, there is no guarantee that the merger will be a success. Synergies are not always delivered as expected, and a merger inevitably creates a degree of uncertainty as integration commences. However, given the uncertain outlook for oil, creating a stronger company which may be more resilient seems to be a sound move. The combined entity may not perform significantly better than the wider industry in the short run, but may prove to be a strong buy for the long term.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.