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Rick Black, Dennard Lascar Associates LLC executive vice president; Samir Kayande, RS Energy Group director; Michael Casey, Goldman Sachs managing director and head of midstream; and J. Michael Chambers, partner with Latham & Watkins LLP. (Source: Hart Energy)
DALLAS—As the midstream continues to grow so will the need to find financing to complete the buildout.
But the critical question is: What kind of financing will be needed to make the buildout happen? RS Energy Group Director Samir Kayande, Dennard Lascar Associates LLC Executive Vice President Rick Black, Goldman Sachs head of midstream and Managing Director Michael Casey, and Latham & Watkins LLP partner J. Michael Chambers weighed in on that question and more during the roundtable discussion: What Firms Need to Finance The Buildout at the Midstream Finance Conference on Oct. 23.
This business is run by engineers and accountants, so how do they respond to people who are typically in a very different line of work? What do they need to do when they go to Wall Street?
Black: Companies need to have a good narrative about their story and be able to sell it. Oftentimes when we get involved with a company that is starting to go public—obviously the ramp up to an IPO—the bankers really steer the ship in a lot of ways and legal is a very important piece of that. But sometimes they overlook the fact they need someone to help them from the communications standpoint. Not only as they go through the deal—which the IPO is a deal—but then beyond that the bankers fall away and then the company is out there in the public markets and they need to know how to perform like a public company.
So there are a lot of behind-the-scenes pieces that they need to be able to be prepared for from their resources and their team to getting their books closed, having their planning and all of those type of things. Then there are a lot of other ancillary things: getting your website up, being prepared to do your earnings release. What goes in that? What do you say on your conference calls?
And understanding the markets because private equity is going to have one perspective and then once you go out, you become public, you are going to have a group of investors and that group is going to change over time. So it’s really seeking out the proper investors for your company. And from a company perspective it’s getting used to being a public company from the cadence. It’s considerably different. From my experience, it takes four or five quarters for a company to really feel comfort in that stride, getting things produced, things prepared and going out and presenting to investors.
What do you feel investors are looking for when they consider a Midstream prospect? What makes or breaks a deal for them?
Kayande: It’s a communication strategy but it’s also a business strategy, as well. When your risks are very similar to upstream and it turns out now that their investor profile is very similar to the upstream investor, as well. The same questions that an upstream investor would have about a business apply to the midstream business.
Here are the questions: What are the resources? What is the quality—if you are in the Delaware Basin, there are companies out there that will say there are 15 zones in the Delaware. Yes there are 15 zones but not all of them are available under every piece of service acreage. So how many zones can we really underwrite for this particular opportunity if it goes public or our firm actually specializes in the pre-IPO reports because we are not a bank, so we can write about anything we choose.
These are the kinds of questions that investors are always asking E&P companies about. These are also questions that are going to be appropriate for the midstream, as well.
Obviously the midstream and the oil and gas sector as a whole have been Wall Street darlings of late so in your opinion what can management do to break out of the pack to convince investors that your firm’s different, your shares should be in the portfolios as opposed to your competitors?
Casey: Let’s take a step back and talk about what the industry needs to do and after a very bumpy couple of years in terms of the fundamentals we saw with commodity prices albeit that’s recovered now with the number of distribution cuts. I think what we need to see is a period of stability and consistency for investors to find the space to be investible—a period of no distribution cuts, a period of time where the businesses reflect the underlying fundamentals that they are seeing, which is what’s going on on the upstream side.
So I think if we get … a number of quarters behind us, that will be the catalyst that ultimately we believe brings retail dollars back in the MLP space but also gets broader institutional participation in the midstream and MLP sector.
When you then narrow down to specifically what can companies do there are a couple of things structurally—the housekeeping around the IBR structure, that’s a big thematic that we continue to see. Every week it seems that you see a transaction where a company is simplifying their structure. That’s something we believe will be a condition for investors as they look to put dollars to work. They are going to be looking for companies that have taken those steps to simplify the structure.
Then finally, a move toward the self-financing business model. What equity investors want is for companies not to need to come see them. They want businesses that are self-financed through managing coverage ratio and distribution policy, companies that are able to effectively self-finance their capital programs.
As an attorney what do you see as the big issues in depth and equity offerings for a midstream enterprise?
Chambers: First of all, there is not a lot of equity financing going on, at least in terms of IPOs although we do have a couple of brave souls trying to do it in the first quarter. Debt financing, there are a lot of deals getting done. A good example is, I think, midstream is building an NGL crude line from Permian to Corpus. From a lender’s perspective one of the biggest things they are looking at is the combination of your acreage dedications and NBCs. That was a bit of a challenge for upstream. They have a lot of strategic partners there but a lot of it is acreage.
What are the minefields for a company going public as it relates to filings with the SEC?
Chambers: There is always a trip-up on having the financials ready, having the team put together, dedicating the time to it. I would say the typical IPO process has gotten much quicker than it was when I started this job. Now if the market is right and you hit a window you can sort of get in and out in maybe four months, maybe six if you are unlucky. I wouldn’t say it’s a hot button issue but maybe some of you are familiar with seeing more on the E&P companies doing an upsize structure. The SEC after a year or two of seeing these is starting to ask more questions about it, making it more difficult for us to keep the structures in place. The good news is if we can just get the market to cooperate someone seems to have sent a memo to the SEC to say let’s get these companies through quicker. So the comment process is much shorter these days.
How do midstream capital deals differ from upstream deals?
Kayande: The cash flow profile is very different. Really this isn’t news to anyone but a fundamental difference is that, in theory, the midstream should be less reliant on the single performance of a single reserve. It’s more debt-like. Midstream business is primarily an acreage dedication with a lot of volumes coming from a single asset. This is really more of a financing structure than it is necessarily a fully operationalized new business whereas it would be if you have a multiplicity of clients that you are providing service to. If they are your customer then it becomes more of a financial transaction. So from that standpoint it looks a lot more like an E&P bond deal because what you are doing effectively.
Can you share any horror stories or successes for IPOs?
Black: Lots of humorous stories and incidences that go on as you can imagine when a team crisscrosses the country for a week or two weeks meeting with investors all over the place. One thing happened unfortunately on a recent one is don’t have the road show end in California when you are going to ring the bell the next day in New York. That makes for a very tired and woozy management team.
How does management pick and choose where to tell their story? You can’t do them all so what kind of criteria should they be using when they are out there to pick where they are going to talk and who they are going to meet with?
Black: It’s going to be different for each company and obviously the sale-side coverage and analysts who write research reports and put out estimates and readings, you are probably going to want to go to their conferences. Beyond doing a number of road shows, there are a number of different industry conferences that are microcap-focused or certain geographies and things like that. I would say having a communications person in there early to get some of the workload particularly off of the CFO and planning out, ‘what does this first year look like? What does the first 18 months look like?’
At the end of the day, investors are going to have a couple of criteria. One of them is they have to meet management at some point. They just have to meet them. So think of that, making yourself available and going to conferences on the road and to do a lot of introductory phone calls. Then the second thing beyond meetings is the reputational risks. Particularly out of the gate you really want to stick to all of the right requirements and you want to look and feel like a public company. You don’t want to have little communications mess-ups or press release mess-ups or anything like that that will start to ding the reputation because it’s all starting from scratch. Even companies that have been successful for 30 or 40 years as private companies once you become public nobody cares. They only care about what you do as a public company.
Kayande: As a user of financial statements and presentations, one thing that drives me bananas is knowing that a piece of information is missing. And I never assume it’s missing because they forgot. It’s missing because they don’t want me to see it. It will be noticed and it will be found but it’s something that is amazing to me, the number of management teams that try to control how that message comes out by being up front with it.
How can firms reach foreign investors who are attracted to U.S. energy assets? Is there a way to reach them without the road shows to Edinburg and Brussels?
Casey: When you are out selling equity in the market in the context of a public offering it’s something that we do look at from time to time whether they are accounts in London or other areas that would have interest in owning an MLP. There are additional legal requirements to sell into those markets. Our experience has been that generally that exercise doesn’t yield a lot in terms of incremental demand. Occasionally there is a fund that has a very specific interest in a company, we figure that out.
Where we have seen greater interest in from some of the private investment funds. There are a number of infrastructure funds organized in Europe that are looking at deploying capital into the U.S. market. They raise funds, that’s a big part of their story as to where their next fund is going to be invested so they are opening up offices here and very aggressively looking to deploy capital.
The challenges is they don’t necessary have the history and experience and so when they jump in to looking at something it’s a bit of a baptism by fire to jump into something that granular and detail where you are looking at well economics, etc. supporting the midstream business but we do think those will be key participants over time.
What do you see happening the financial markets in 2019 and 2020 that will look different as we continue the Midstream buildout?
Casey: One of the things we have observed is everyone is managing their distribution policy and think about capital perms very carefully. They are not having the access to the financing market at least on the equity side. So historically where you might have seen $20 billion of year of equity capital formation between 2013 and 2014 that was moderated and is expected to continue to be moderate for quite a bit. Making analyst forecasts for next year and beyond look something like $5 billion or less because capital has just become more challenging to come by.
Kayande: There have been a lot of investors both upstream and midstream that have been burned growth capex being maintenance capex in disguise. How that gap gets bridged is with more information. This is what we can count on or this is higher risk. What we saw this year, especially on the E&P side, is those companies that beat production and raised capex were punished very heavily.
Contact Terrance Harris at tharris@hartenergy.com
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