Over the last few years, technology has become increasingly more prominent in the extraction and production of oil and natural gas. Oilfield service and drilling providers have worked to develop greater technological advancements that have made E&P activities more efficient and cost-effective. This has had an impact on the types of assets that are valued in purchase price allocations for financial reporting purposes under Accounting Standards Codification 805, Business Combinations (“ASC 805”).
When performing a purchase price allocation for an acquisition in the oilfield services or drilling space, contractual and non-contractual customer relationships have typically been the primary intangible asset being acquired. However, Opportune has recently seen that more often, acquisitions are taking place in which either internally-developed technology or in-process research and development (IPR&D) is the driver behind the transaction. As a result, these assets are considered the primary assets being acquired, and as such the appropriate valuation of these assets is receiving greater attention.
Typically, the multi-period excess earnings method—a form of discounted cash flow analysis—is utilized to estimate the value of the primary intangible asset being acquired in a purchase price allocation. When valuing customer relationship assets under this method, a key input is the assumed customer attrition rate; documentation and support for this particular input has recently received greater scrutiny from auditors and regulatory bodies, including the PCAOB (Public Company Accounting Oversight Board). However, when performing a valuation of technology-based intangible assets, more variables can be introduced into the excess earnings analysis, and care should be taken to provide adequate support for these various inputs.
Key inputs in the valuation of technology-based intangibles and IPR&D include:
Annual obsolescence factor
Total R&D spend necessary to bring the IPR&D to commercialization
Estimated maintenance R&D spend
Time expected to bring the IPR&D to commercialization
E&P companies and their service providers have made fiscal discipline a top priority, even as commodity prices have increased during the first few months of 2018. This means that investments in cost-saving technology can be expected to continue. Just as customer-based asset valuations have recently received greater regulatory scrutiny, and as technology has become more commonplace in the energy industry, companies and valuation providers could expect technology valuations to become more of an exam and enforcement focus in the coming years. Companies making technology-based acquisitions should be prepared with defensible, supportable valuation analyses that can stand up to audit rigor.