Executive Q&A: Of Capital And Consolidation

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

The offices of Tudor, Pickering, Holt & Co. feature a 49th story unobstructed, panoramic view of Houston’s Buffalo Bayou Park stretching upstream into the distance of the lush west side. TPH, as it is colloquially known, is an investment bank, advisory firm and provider of research, sales and trading services to institutional investors. Maynard Holt, CEO, strides into the corner lounge and settles on a couch before announcing, “They made me wear a tie.”

While the capital markets remain quiet, the Houston-based firm has stayed active on several fronts. One area in particular is minerals, where it recently advised Viper Energy Partners in a dropdown from parent company Diamondback Energy Inc., was a senior co-manager for mineral-focused special purpose acquisition company Switchback Energy Acquisition in its $300 million IPO and advised Desert Royalty Co. in its combination with Kimmeridge Energy Management Co. to form Desert Peak Minerals.

“Minerals are hot,” he said, ticking off recent engagements. “People still want basic oil and gas exposure, and you can get exposed to the top line in these mineral deals. Individuals and institutions are drawn to that.”

This summer, TPH also served as co-manager to Rattler Midstream LP’s $665 million IPO and advised artificial intelligence provider Tachyus on its $15 million funding round, two energy sectors that still attract investor interest. And though A&D is tepid, the company represented privately held Spur Energy Partners in September in its $925 million acquisition of Concho Resources Inc.’s Northwest Shelf assets, a bloom of a deal in a desert of dealmaking.

TPH’s other transactions this year include two midstream sales (Eureka Midstream Holdings LLC and Whitewater Midstream), assisting Murphy Oil Corp. on its strategic exit from Malaysia and a $6 billion MLP simplification transaction for AmeriGas. In the area of upstream consolidation, it advised Energen Corp., RSP Permian Inc. and Wildhorse Resource Development Corp. in their mergers with Diamondback Energy Inc., Concho Resources Inc. and Chesapeake Energy Corp., respectively.

“It’s really just a supply/demand thing. It’s not the end of the age of oil. It is not the end of fossil fuels. It’s just we’ve found so much.”

Of particular interest, in August, the bank represented Occidental Petroleum Corp. in its $1.5 billion joint venture (JV) with Colombian producer Ecopetrol SA in the Midland Basin, a deal that harkens back to the early days of shale when JVs were rampant and went almost unnoticed as Oxy closed its megamerger with Anadarko Petroleum Corp.

“You can still make good cash-on-cash returns with the drillbit,” Holt said, “and this was undrilled acreage. Ecopetrol had the strategic interest, and Oxy had the properties.”

And the last time the JV structure was popular, he noted, capital markets were shut down as well. “The industry is going to find new ways to capitalize itself.”

With a view that oil and gas companies are struggling to source capital presently, Oil and Gas Investor visited with Holt in early September to gauge his thoughts on current issues and the financial state of the industry.

Investor: Oil and gas stocks are in the red year-over-year and most dramatically so—is it time to panic?

Holt: No, let’s don’t try to overcomplicate it. Sometimes we can get all fussed about climate change, electric vehicles, encroaching regulation, but the reality is we just have too much oil and we have too much gas. And we have too much oil and too much gas because we’re darn good at finding it and getting it out of the ground. The success of the industry has become one of its worst enemies.

“Right now it’s a buyer’s market for oil and gas properties. … There is longterm buy-and-hold money re-emerging because [investors] recognize these values don’t make sense.”

What’s happened now is it’s just really hard to find anybody that thinks oil or natural gas are going up much anytime soon. And if they do go up, the view is we could quickly get more oil or gas if we needed it. So the ability to invest in oil and gas by saying, ‘I think oil and/or gas are going up (and staying up), and now I’ve got to pick a stock.’ You can’t do that anymore.

The other way you used to zero in on stocks was a company might be drilling some new well or delineating a new play. So even if you didn’t think prices were going up, these guys were suddenly going to announce more resource with the latest well results and that meant you could multiply it out over a bunch of potential drill sites. We’re not really doing that anymore either. If anything, investors today are worried there could be less resource than what conventional wisdom says.

So investing in a stock because you think oil or gas is going to go up or because you think suddenly they’re going to find a whole bunch more, that’s not what we’re doing anymore. One of the best-performing stocks this year is Hess (Corp.) and it’s because of Guyana (offshore oil discoveries), but it is a really rare thing anymore to have stocks like that. So that makes oil and gas investing hard; which of these companies should I really own?

The other thing that makes this hard is the oil and gas industry, if it was a restaurant, we’ve put so much on the menu. There are so many companies to choose from that it gets hard to sort them out. So you’ve got a huge selection at the same time that the basic or simple logic of why you should own it has been taken away. If you’re a smaller company below $10 billion market cap, it’s kind of hard right now to get attention from institutional investors.

And so it looks and it feels bad, and CEOs and boards are like, wow, this is not fun and don’t necessarily see something that’s going to change it dramatically near term. So that’s frustrating. But I think it’s really just a supply/demand thing and we shouldn’t overcomplicate it. It’s not the end of the age of oil. It is not the end of fossil fuels. It’s just we’ve found so much.

Investor: Is there a silver lining in there somewhere?

Holt: If you were being positive just on the oil macro, in particular, everything we’re doing right now is pulling money out of the business. Public investors aren’t giving you more money. Private equity is very selectively putting more money to work. Some people are not going to invest because of whatever reason, such as ESG [environmental, social and governance] or environmental. But you add all this up, money’s coming out of the business. And what happens when we do that? You’re setting up for an oil price rebound in the next few years.

Investor: So is this an unprecedented market environment?

Holt: I think so. This one has a lot of things in it that I would dare to say maybe others have not. Obviously, it has a supply/demand situation, but it also has an abundance of energy companies to choose from, like we didn’t have in 1986, to pick a time.

It has this feeling where your average investor is saying, ‘I don’t know if I need to do this anymore.’ If you think back to the middle of June ’14 through to last fall, there have been about five times when oil price got a lift and looked like it was going to go back to something pretty good. And it pulled money into the sector and then all those people lost money because it fell again. So we’ve had five times where the market’s been burned. And last fall was really rough. We got to $76 in early October 2018, and then we ended the year around $46. It was punishing.

Also, the U.S. independents used to be just price takers, and when it came to oil, and there was no way these guys could affect the oil price, right? In that way, it was a safer business. But now they contribute so much to production and to sentiment that they have a lot to do with price. And so it’s just a very, very different business right now.

The last one is the thinking around climate, the development of alternatives, and this little chorus of ‘is this industry even around in 20, 30 or 40 years?’ That’s a new thing to have thrown into the mix. You hear that comment in New York and Boston a lot, not to mention Europe. That’s an important part of the sentiment equation. That’s just the mentality that exists.

But when you take a step back and look at the dynamics of the world, the fuels that supply global power and what their market shares really are, the population growth that’s coming and the fact that we’re underinvesting in oil right now, boy, that’s just got to mean that oil has another pretty strong day.

I would never bet against any kind of technology, but that includes technologies we have going in oil and gas too. A decade or more out it’s all about technology, but in the next five years I think oil has another good run.

Investor: With the energy sector representing about 5% of the S&P 500 currently, do you think it can find new buyers through the balance of this year or next year?

Holt: It’s probably going to be hard to find new buyers in real volume. You can make good money in oil and gas; you can make good cash-on-cash returns. But the whole world is really fussy about yield right now—where can you get good yield?

The problem right now is that a lot of people have lost a lot of money. But if the industry shows it can make money for people, whether it’s in a stock or a direct asset investment, I think people will come back to that. They’re just hesitant to do so because they’ve been burned. I do think in a yield-hungry world, energy could be a very attractive place for capital to come.

Interestingly, our research guys have been talking for a while now about the dawn of the “super private,” which would be capitalized differently than a public company or from a private-equity company. It would take money directly from institutions or family offices and wealthy individuals and will run the business in a way that’s more like a family owned private. They don’t spend a dollar unless it’s going to make more than a dollar.

It is expensive to be public and comes with its own share of other obligations. That the industry might become increasingly in the hands of long-term private owners is quite possible. That’s something that we’re watching and thinking through.

A fascinating deal that I think is representative of that is Hilcorp (Energy Co.) buying BP (Plc) out of Alaska. That’s a really large $5 billion-plus deal. Wow. There’s a one-time absolute legacy asset that’s going to be in the hands of a big private company. Hilcorp would have clear capabilities to do what’s needed to make the assets perform. They bought Conoco out of the San Juan Basin for $3-plus billion, and now they’ve bought this for over $5 billion.

So with the combination of private, long-dated equity with maybe public bonds, there’s probably a different way to do this than the way we’ve been doing it, and that’s probably where we’re headed.

Investor: Could you elaborate?

Holt: Forever in our business people would say, ‘Should I go public or should I sell the company?’ We would always answer, ‘It depends on what you are trying to do.’ If you’re trying to get liquidity for your shareholders, you should sell the company. If you’re trying to finance the company, that’s why you’d go public. The reason why is they were providing you capital. But they’re no longer providing you capital. The deal has broken down for a vast majority of the companies. Only an elite group is still drawing strong interest.

You hear a lot about investors losing interest in energy companies, but energy companies are losing interest in investors too. It’s a relationship.

If you had an asset you wanted to buy, you would be drawn to capital that is interested in cash dividend returns, where fundamentally they’re interested in just dividends. That’s the money you would go after. You wouldn’t go after money that says, ‘Hey, we need to sell it or IPO pretty soon,’ because that doesn’t sound good. And you wouldn’t go after public money that’s going to give you a terrible valuation, and there’s a limited pool of it.

The one way in which the industry could push more assets into the hands of private capital is more and more buyers emerge that are backed by that capital. CPP (the Canada Pension Plan) is kind of doing the Hilcorp model. CPP has money in a number of places, like Crestone Peak Resources, Encino Energy and a number of Canadian companies. That’s big, long-dated capital.

Investor: But they’re not an E&P.

Holt: They back them. They can be the capital to make those super privates. That’s the way in which we might get more and more private money into the space.

Investor: So you’re seeing a trend not toward private-equity-backed companies as acquirers, but true privates?

Holt: People are recognizing the opportunity because this is a stunning thing. Right now, it’s a buyer’s market for oil and gas properties. Public companies are not buying, and they were always a traditional big source of capital. The private-equity guys are being really judicious.

We’re just seeing more capital returning and saying, ‘I recognize the opportunity, I want to buy it and I want to hold it.’ That can be minerals, that could be properties, so far it’s not stocks. But there is long-term buy-and-hold money re-emerging because they recognize these values don’t make sense.

Investor: Are we still in an era where you can get big returns for opportunistic deals?

Holt: What’s striking is not the opportunity to make a 10 bagger, but the opportunity to make a double with very little risk. I understand why we’re here—everybody has fatigue—but it’s definitely an oversold market. Very oversold.

Investor: Some people suggest that mergers are not an option, but are necessary, for small- to mid-cap names to survive. Do you agree? If so, how much M&A is necessary?

Holt: I’m not someone who has always been crazy about M&A, because historically, there’s probably a good chunk of M&A that hasn’t worked out well. But my recent view, particularly in the shale era, is if you’re merging similar flavors, there is a lot of expense that you can eliminate, with efficiencies of scale, large contiguous acreage blocks and a lot of synergies. M&A actually can create some real value.

And particularly if it gets more assets into the hands of the most capable managers. If we’re consolidating assets into the hands of the better managers, that’s going to create value.

But M&A is not an auction business. It’s not just a business of who offered the most. It’s a business of which combination is going to create the company with the best team, the best culture, the most synergies and the highest probability of delivering real value over a longer period of time. M&A is really about company building right now.

As a board, you’ve got to think about which management team is going to deliver. It’s not just what the premium is. We believe that one-day premiums, particularly in stock deals, don’t tell the whole story. I think we’re starting to develop the formula, which is the pro forma company is just better than either of its two contributor companies. The new balance sheet and cash-flow profile are better, and nobody on either side got an undue amount of the pro forma company.

Investor: Do you think M&A is a necessary growing pain for the industry?

Holt: I think we’re going to have to go through it. If you said, what’s the scenario where things started turning around pretty good, you, of course, solve the China problem and then you would start having some really smart M&A. Investors would be drawn to that and say that could be a good space to be in if I pick the right horse. And so if you got improvement in the macro and you got some positive M&A that creates real value, I think the space could get another look.

“M&A is really about company building right now. As a board, you’ve got to think about which management team is going to deliver. It’s not just what the premium is.”

A client told me the other day we have too much of every flavor. I think he is right.

Investor: Is there a minimum enterprise value that you think is required to make an E&P viable these days?

Holt: We keep talking about that you need to be $10 billion or more to feel like you’re in the game, on the menu. Honestly, there’s a ton of companies below $10 billion, but you do need to be that size, unfortunately, to get a serious look in upstream. You can get a look between $5- and $10 billion if you are really good, but size matters right now.

Investor: Do you think consolidation is going to materially change the landscape to get to that $10 billion valuation?

Holt: It could. If you think out five years, what is the chance that we have even 80% of the number of companies we have now? That feels pretty small. The conditions are ripe for it and there are some good deals to be done.

Investor: Is there a place in today’s world for a small independent?

Holt: I think so. As you get bigger, smaller things start becoming ‘not material.’ You just focus on a lot of big things. As you get bigger, honestly, the other odd thing that happens is your ability to take risk goes up, but your willingness somehow seems to go down.

So the small entrepreneurial company that grabs ahold of something that no one else is paying attention to and is willing to take risk even though they don’t have a huge balance sheet, I think there’s always going to be a role for that company. We got the whole shale revolution because of those companies. Without these entrepreneurs, we’d be in big trouble because we’ve got to have that innovative spirit.

Investor: If you were given $500 million in capital today, what would you do with that?

Holt: Three things. One, I’d go buy mature oil assets, PDP, to own it for the long haul. Two, I’d wade into the high-yield market, and I’d selectively buy some of that poorly trading debt. That looks like opportunity too. And opportunity three is I would invest in any company that had some size that helps oil and gas get cleaner and more efficient.

That’s the wave of the future. Oil and gas is going to get cleaner and more profitable. We have no choice. Things like electric frack fleets are fascinating. We are seeing companies all the time that have innovative software, unique chemicals, that do great things with natural gas so you don’t have to flare it, methane detection through cameras, hydrogen and the list goes on.

It’s almost impossible to say what the world looks like in 10 years given our ability to innovate and improve. Would anyone 10 years ago have predicted that the U.S. was going to become the largest hydrocarbon producer in the world? We’re excited about the possibilities.

Some people want to say oil and gas are like buggy whips, but they’re not like buggy whips, they’re like semiconductors. We just got so good at making it that we flooded the market. Don’t call us yesterday’s news. We’re a tech behemoth that overdid it.