Executive Q&A: Brotherhood Of Minerals

[Editor's note: A version of this story appears in the November 2019 edition of Oil and Gas Investor. Subscribe to the magazine here.]

The popularity of minerals investing has blossomed over the past few years as oil and gas equities have trended downward, but the principals of Red Stone Resources LLC first ventured into the space as unconventional shale plays were heating up. Sanjit Bhattacharya, as a young real estate developer in Lawton, Okla., made his first personal investments in the Bakken Shale in 2007. He was later joined by his brother Shan, a software developer, when Red Stone formally launched in 2012.

Neither had a background in oil and gas.

Each attended Cameron University in Lawton, where their father taught finance, and who also trained his sons in the art of investing. Sanjit began investing in real estate at 19 and while going to school. He received his business degree and sought an entrepreneurial path via his already established real estate development venture.

Shan’s computer science degree took him on a path that included factory automation and robotics for Goodyear, missile systems with the Department of Defense and Lockheed Martin Corp., and safety and security software for British firm LDRA.

Both were destined for a much different path.

The company that would become Red Stone grew out of Sanjit’s personal minerals portfolio. He recycled profits from sales of minerals interests in the Bakken and Fayetteville shales into new investments, including an early entry into the Scoop/Stack play. Shan left his software career in 2017 to partner with his brother full time.

Today, the still-privately held company, based in Edmond, Okla., holds some 20,000 net mineral acres across four basins: the Anadarko, Appalachia, Haynesville and the Permian, its newest basin entry as of 2017. The firm employs 30 people with regional offices in Oklahoma City, Pittsburgh, Dallas and Marshall, Texas.

Oil and Gas Investor: You both had careers outside of oil and gas, and no educational nor family background in the industry. What was the impetus for the starting up a mineral acquisition company?

Sanjit: I saw the amount of wealth created in the oil and gas space, especially in Oklahoma, which is such an oil-centric community. And I had some friends in the space that had done very well. It piqued my interest. I had the real estate platform and corporate finance background, so how could I use that skill set and transition to another industry that has equal or greater risk adjusted rate of returns?

There is a significant arbitrage between minerals and upstream E&P. There’s really no capex in minerals. There’s a saying, you know, that once you spend money on the min­erals, it’s the last check you’ll ever write. If you are dealing with nonop and you’re with the wrong operators, you can get drilled to death. It’s a lot more risk as well. So it seemed like a good fit for us.

And it’s a highly scalable business. The size of the minerals market is $500 billion-plus. If you look at public companies in the mineral space, there is less than $10 billion in market capitalization, so it’s barely 2% of the market right now.

Shan: We weren’t energy guys as a family, but we were finance guys. From a very young age, our father opened up the Wall Street Journal and helped us analyze companies. We would take our lawn mowing money and buy stocks. He instilled in us the value of finding good investments and doing that kind of analysis up front and building a capital base. That was really fun for me.

Sanjit learned how to save his capital better than I did. In his teens and early 20s, he start­ed doing well for himself; he learned the val­ue of capital early and built his dry powder.

Sanjit: The oil and gas space is a very capital intensive industry. There are a lot of deals out there, and a lot of people don’t have the cap­ital to acquire assets. And we did. So that’s what really got us in this space.

Investor: How did you take the leap? Did you both quit your other jobs before starting?

Sanjit: No, no, no. We made some invest­ments in some overrides in the Bakken Shale in Mountrail County and bought some assets in southeastern Oklahoma in ’07 when uncon­ventional drilling was picking up.

“All of this is cloud-based. So even though our teams are based in different locations, we’re all hooked together and can access this information in real time and be responsive.”
—Shan Bhattacharya

Investor: Did you start with outside capital or just personal investments?

Sanjit: It was just personal money that I’d saved up.

Investor: How much did you get started with?

Sanjit: I started with $1 million in savings.

Investor: And now? Any private equity or oth­er investors?

Sanjit: Red Stone is right now funded com­pletely based on the family balance sheet.

Investor: Does that limit what you can do?

Sanjit: There are some pros and cons with that. We’ve been able to aggregate a signif­icant number of acres and, with rotation of capital, really scale our platform. Being in­ternally funded makes our decision-making process a lot faster and nimbler both on the buy and sell side. It helps our organic buying, and we can be opportunistic on the sell side as well, which provides us a lot of flexibility.

Investor: So how big of a deal can you do right now?

Sanjit: Earlier this year we closed a transac­tion for around $10 million, and we recently closed another transaction for $4 million. But our average size deals are sub-$1 million.

Shan: We prefer those smaller deals because they allow us to source directly from the land owner. We believe that we can buy smart and stay disciplined and with boots on the ground. That gets us value early in the process when we buy, so when we put these larger packages together, the arbitrage is significant.

Investor: Who are you typically acquiring from—individuals or other mineral companies?

Sanjit: Our focus is buying on the ground, or­ganic buying with our multibasin platform. Our strategic advantage is the organic relation­ships that we have with land owners. We’ve done thousands of deals, as small as 5 acres to 2,000.

Investor: What would you say is your strategy for building your mineral-focused company?

Sanjit: We have a very strict and repeatable underwriting process and guidelines. We do a deep dive from a technical basis with the engineers and geos that we have in house. Once all the boxes have been checked from a technical basis, we look at where we can scale in an area. And not by just a few acres but thousands of acres of high-quality rock with best-in-class operators.

The basins we take a look at also have the best-in-class operators with the right amount of capex. You can always have good rock, but if they don’t have the money to actually fully drill out those areas, then returns can be affect­ed. We’re highly cognizant of that.

Shan: We’re not the only organization with this particular approach, but we pride ourselves with our intensity and laser-like focus on exe­cution. Our acquisition team members quickly do due diligence when the deals show up—our engineers, geologists, attorneys and finance team—are right there to jump on these deals as they come in. So we can be much more respon­sive and very targeted.

And it’s not just execution, but adding tech­nology, to make sure we have a transparent, traceable, nimble process and then rinse and repeat as fast and as many times as we can to maximize our pricing advantages.

Investor: Has the space become more competi­tive? How is that affecting your strategy?

Sanjit: The space has become a lot more compet­itive compared to five years ago. There’s been a lot of institutional money coming in, private-eq­uity portfolio companies, hedge funds, pension funds, insurance companies, family offices and a lot of smaller companies as well. However, we’ve used some strategic advantages.

Investor: Such as?

Sanjit: Because we’re fully integrated, we seem to be able to be very nimble and fast. We have engineers and geologists in house. We use our technical teams to identify the core rock, then use our aggregation buyers that are in house to buy the minerals. We also have an in-house business development team to sell those minerals if we need to. We use in-house attorneys, of which we have five, to run our title. We’re able to streamline this process in a much more efficient manner where we’re able to give answers to our mineral owners and close a lot quicker.

Shan: On the buy front, to stay sharper and stay ahead of the crowd, we have a digital tap­estry across our entire organization. We have a robust CRM system for all of our buyers, marketing automation for targeted mail outs, phone calls and emails with our own software that cleanses the data so we can get through to landowners in more efficient manner.

We’ve built a proprietary mineral inventory database system that tracks all of our assets and all the associated activity, leasing, drilling units, all tied to it. And we can pull analytics from that to make sure that we track our inven­tory wells and strategically plan exits.

In addition to that, we subscribe to a lot of third-party data providers. We pull all of that data in, cleanse it and put it in a system in the cloud that does quantitative analysis and ana­lytics. We push that data out with visualization platforms like Spotfire and various types of maps to serve all the stakeholders within the company.

All of this is cloud-based. So even though our teams are based in different locations, we’re all hooked together and can access this information in real time and be responsive. So when Sanjit and I go on vacation, we can just crack open the laptop and jump into any deal and look at any map. We can annoy our wives for a few minutes while we get a deal closed and then be right back to them.

Investor: So you’ve used your software exper­tise to give Red Stone a strategic advantage in the buyer’s market?

Shan: That’s my mandate, to find a way to use technology to leapfrog the paper way of doing business. The entire space is evolving, so we have to evolve faster to be in the upper 10%, 5% of performers in our space. It’s not just software but building an organization and linking it all together to internal systems, then applying hardcore data algorithms to pan for gold in all that data. It’s not just a think tank in a closet; rather, it’s something that’s living, tangible and that’s implemented day to day.

Investor: I noticed you have a data analyst on staff. Why is that role important to a mineral buyer?

Shan: That’s worked out well for us. There’s so much data out here on every well and its production, all the revenue that comes in, all the updated activity that’s going on con­stantly. As the outside world is continuously changing, we have to parse and pool togeth­er all that data, stitch it together and make it readily available to serve every part of the organization.

Our data science and software team built out that infrastructure. And once the infra­structure is there, then you have the oppor­tunity to discover and implement the killer apps. You can model out time to development across every asset, every basin, every opera­tor, every bench, and integrate that into eval­uating individual deals as they come through.

And you can render any subset of that data with any particular layer across different kinds of visualization interfaces, and slice and dice that data on the fly.

Sanjit: We analyze historical data on time to development, for instance, from the time op­erators permit to the time they put a rig on it to the time they drill it and complete it. That helps us analyze what we can pay for deals we are evaluating. Some operators go from permit to completed wells in four months where oth­ers may take 10 or 11 months, and that makes a big difference in internal rate of return over the course of three or four years.

Investor: As a mineral holder, you have no control over the development pace and thus presumably your income. How do you strate­gize around this?

Sanjit: The two risks are the lack of control over the development and the speed of de­velopment, right? We can’t tell the operators, ‘Hey, go drill on my acreage.’ But if you buy under good rock and under the best-in-class operators with large enough capex dedicated to that particular area, then the probability of your acres getting drilled is much higher.

The other thing we do to mitigate that risk is line-of-sight development. We try to buy minerals that at least have a permit on it that gives us an indication that this is going to get drilled soon.

Investor: Are you saying that you don’t even make an offer until a permit has been filed for a particular region?

Sanjit: That’s never 100%, but again, if we do buy minerals that are not under the rig or per­mit, they’re going to be in the absolute Tier 1 area under the absolute best operators, and we don’t deviate from that.

Investor: Theoretically that sounds like a good plan, but everybody else would be doing that as well. Are these mineral acres really avail­able? Are you having to spend higher than everybody else to get them?

Sanjit: Because of the technical expertise, added technology and our deep organic relationships on the ground, that helps us get to those acres faster. Don’t get me wrong, it’s still a race, but we win a pretty good share of those races.

Shan: When that deal hits our table, it goes into the system, and we act on it quickly. We think faster than the average guy in our space. If there’s a family member that’s looking at five different offers that are closing in 30 to 45 days, and we can close them in five or 10, they tend to go with us.

And often that offer is hand delivered. Some­body shows up to a house, sits down and has a cup of coffee with them putting a face to the name. It’s not just a letter in the mail.

“If you buy under good rock and under the best-in-class operators with large enough capex dedicated to that particular area, then the probability of your acres getting drilled is much higher.”
—Sanjit Bhattacharya

Investor: Public companies have more of an urgency to get cash flow coming in house, but a private company does not have the same mo­tivation. Are you willing to reach further down the path of development to get better pricing and be patient?

Sanjit: That’s a different line of sight. We have a certain percentage of our assets that we’re comfortable with where it’s a medium line of sight, and we price it accordingly.

Investor: Are you concerned about E&Ps re­ducing capex and rig count falling? What do you do in that situation?

Sanjit: We stay as focused as we can to keep buying the best rock. As the rig count falls, operators will focus on the absolute best rock, so the rigs actually start coming together and more in focus in certain areas. As prices drop and rigs drop, only the best of the best gets drilled. And if your minerals are there, and it still doesn’t have a rig on it, the chances of you getting drilled increases, because Tier 2 and Tier 3 areas go away, and only the Tier 1 gets focused on.

Investor: Do you have any aspirations to ex­pand to other basins?

Sanjit: We’re currently focused on these basins, and right now we’re sticking to our knitting on these four. But that being said, never say no. We’re opportunistic. We know the Eagle Ford and the Powder River, and we got started in the Bakken. If we see a seismic shift of rigs and capital going to a different basin, we have the technical expertise to dive into it and make a run at it.

Investor: What’s ultimately your goal? Do you have an exit strategy or is this a long-term hold?

Sanjit: We buy, we aggregate and then we sell, as long as it meets our underwriting thesis. Having said that, we are close to an inflection point: At the right time, we would be open to consider a capital partner as long as there is alignment and good chemistry. The capital partner would need to believe in our vision, strategy and team, and help us scale and grow even faster than what we have been able to ac­complish on our own.

Shan: Sometimes when I ask Sanjit if he ever wants to just sit on a beach and relax, he says, ‘What’s the fun in that?’ We enjoy this, so the machinery keeps improving and evolving, and we enjoy coming to work every day and doing the business. So even as we make exits in our assets, we acquire others to take their place. We have no plans for a corporate exit in the near future.