Vito:
Hello and welcome to Strategic Alternatives, the RBC Capital Markets Podcast. We're here to uncover new ways to raise capital, drive growth, and create value in an ever-changing world with insights and outlooks from the RBC Capital Markets team. I'm Vito Sperduto, Head of RBC Capital Markets US, and today I'm joined by Tim Perry, Vice Chairman of Global Energy, and Nick Woodruff, Managing Director within our Global Energy team. Tim and Nick, I'm excited to hear your perspectives. Let's dive in. Welcome to the podcast.
Tim:
Great. Thanks, Vito.
Nick:
Thanks, Vito.
Tim:
Glad to be here. Looking forward to it.
Vito:
So maybe let me just give a little bit of background on Tim and Nick just because they bring a wealth of experience here, both in terms of years in the industry and then also just a plethora of experience on our leading energy platform. Tim joined us last August as Vice Chairman of Global Energy after spending over 25 years at Credit Suisse, where he was Co-Head of the Global Energy and Transition Group. He's based in Houston and primarily focuses on upstream E&P and royalty companies. And then Nick has been on the Energy team here in Houston for over 11 years and has been one of the leading advisors in the space from a corporate M&A perspective, but also from an acquisition and divestiture perspective where we have one of the leading industry practices, and certainly has created a number of joint ventures over the last decade.
I think there's a wealth of information in terms of what's been going on in the sector and really looking forward to today's discussion. And especially guys, as we sit here a little less than a month out from our Global Energy Power and Infrastructure Conference, which is June 4th and fifth here in New York City. Certainly that's going to be a great event. We always have a plethora of clients both in terms of corporates but also in terms of investors who show up for the day.
Maybe just to kind of set the backdrop a little bit and think about what we're seeing out there, I think by a lot of measures, everybody takes a look at the volume of announced transactions across the globe. Where we sit today in the second week of May, global M&A volumes are up about 30% in terms of announced volume and US M&A volumes are up almost 50% as we look at it. Now, as the three of us know, these are against fairly easy comparisons given that the first half of last year was probably one of the slowest periods we've seen.
And then the other thing I'd point out before I hand it to you guys is one of the things we saw in energy at the end of '23 and certainly as we've come into this year, a lot of the green shoots in terms of M&A deals that were happening. The energy sector was leading the way and we saw some great corporate transactions and I know you guys were busy with a number of them, but maybe Tim, why don't I turn it to you first and talk to us a little bit about what's driving this wave of energy consolidation? You've got this great perspective in terms of multiple decades in the space, but tell us a little bit about what you're seeing today.
Tim:
Well, great. Thank you, Vito. You're right, probably many of the listeners out there may have seen a lot more energy transactions and maybe are just more attuned to that. But in reality, it is true. We're seeing record M&A that we've really never seen. Frankly, the last time we saw this M&A was a generation ago, around 2000 when you saw transactions between the majors like ExxonMobil merge for example. But now it's different reasons than it was back then and what's going on right now. Number one is we're really, and have been for the last 25 years, in the midst of the Shale Revolution. And now going on here in the 20th year or so, what you're seeing with respect to the Shale Revolution, it's on the later innings if you will. As a result, there's a real desire for tier one inventory and there's not that much of it left. Not near as much as there was 5 or 10 years ago.
One of the real drivers here is to obtain that inventory. And some of the inventory, particularly on the US onshore companies, competes with any oil or gas reserves in the world, so that's a real driver. The second thing, what we're hearing from institutional investors is frankly they want fewer energy companies that the larger companies tend to trade at higher multiples. They have more liquidity and they trade at multiples one and a half to even two times higher than mid caps and even higher than that, small caps. If you look at accretion dilution analysis, larger companies can usually do accretive deals of buying smaller companies. That's another driver too that the math works, Vito.
Vito:
Yeah, that's pretty interesting to hear. Nick, in your experience, obviously we've seen some large blockbuster deals like Exxon-Pioneer in the space. As you think about this consolidation wave, and Tim mentioned we're sort of in the mid to start of the later innings potentially, like the fifth or sixth inning, although I always like extra innings myself, as we think about the consolidation wave, do you think that there's more to be done as players look to Exxon-Pioneer and say, "Okay, we're seeing that large combination happen. What do I need to do for my business?" Give us your perspective.
Nick:
That's a great question, Vito. What I'd like to say first off is the material growth phase is largely over in our sector. Oil grew from around 5 million barrels of US production to 13 million barrels, so over doubled production capacity. And gas doubled from 60 to almost 110 BCF per day of production and equity came in on an annual basis greater than $30 billion. Tim was a huge contributor of that and his CS days and that really fueled the growth. Now we're in a low to no growth business model and operators and public companies are chasing cost of supply and access to capital. Those two premises are really driving the consolidation wave that we're seeing, like you referenced Exxon, Pioneer, Chevron trying to chase some international assets with Hess. You've got other guys in the gas world like Chesapeake and Southwestern combining together and creating a bigger and a better business. It was interesting trying to access more reserves, more resource, some of the producers are trying to vertically integrate and reduce the cost structure within.
Vito:
And maybe Nick, sticking with you for a second as we think about valuations out there, one of the things I always counsel clients on is how to think about public market values relative to the private market and what might be had in terms of a change of control transaction. Certainly in your space we've seen a lot more consolidation or mergers versus acquisitions. And so as you think about where equities are today versus the market, how do you think about the energy sector? How is it from a valuation perspective and is that a metric that a lot of your clients are looking to try to understand what they do next?
Nick:
Certainly when we're doing private deals, we talk about speed, value and certainty to close, and that's what our clients traditionally are laser focused in on. When you're talking a corporate deal, it opens up the spectrum to significantly more degrees of freedom and variables such as value, relative ownership, implied premium, governance, and then setting the right management team to realize the pro-forma synergies and then board DNA and makeup. This is something that's really critical to understand.
I was with a C-suite on the road last week and we were comparing and contrasting public M&A versus private opportunities and they dropped an interesting statistic on private opportunities in quality areas and quality companies seem to be around 3 to $5 million per undeveloped location, and that's a metric that some of the folks look at. Whenever we're comparing that to some select public opportunities, it's 1 to $2 million per development location. So the perceived approach and perceived public discount is greater than a private transaction. That's always in the art of the beholder on what we're looking at as well.
When we compare opportunities in the landscape of where we're in that fifth or sixth inning that you were referencing, I'll give you some interesting statistics. In 2019, we had 11 E&P companies that were greater than $10 billion and had a combined makeup of 280 billion market cap. Today there's 13 combined companies with that same threshold of $10 billion and make up $500 billion of market cap. So fewer companies, bigger market caps. And then below that, 48 public companies in 2019 versus 30 today. There's less companies out there and then you have to find the right DNA, the right makeup, the right asset configuration to extract long-term value.
Vito:
Those are some interesting statistics. By the way, for the audience's benefit, what you should keep in mind here is that the team within our Global Energy practice is advising on about 30 upstream or midstream transactions per year, which is basically the most of anyone on Wall Street. And so in terms of the dialogue here, they're speaking from probably the most robust set of experience possible. Tim, as a fellow gray hair, since the audience can't see our... Although we have heads of hair, so that's great, you've got some perspective over time. How do you think about where values are today relative to history? You've certainly experienced quite a bit, but are we overvalued, undervalued, fairly valued, still to be determined? How do you think about it?
Tim:
Sure, thanks Vito. You're right, I've had gray hair and unfortunately for many years, but at least you're right. I still have it, so hope that will continue. In any case, although this job sometimes gives me lots of gray hair, all joking aside, listen, the valuations of the sector frankly seem very reasonable and it's pretty interesting. One thing I'll put about just as a perspective, right now energy as a percent of the S&P 500 is right around 4 to 5%. If you go back 10, 12 years ago, it was in the low to mid teens reaching a high of around 15% of the S&P 500. Another way to look at it, which is pretty amazing. If you look at the overall valuation to forward EBITDA ratio, right now the overall for this sector is right around five to six times that compares to the overall S&P 500 in the mid to high teens. It's about one third of that.
And then also if you look at the yields right now for the sector overall, it's in the low double digits, call it 12 to 14% for many companies, whereas S&P 500 is about half that. It's very, very cheap relative to the S&P 500. What's happened is we've seen really consistently over the last several years that the demand forecast for oil and natural gas have changed pretty dramatically on a global basis. This is causing some people to, it all comes back, their commodities, realign their commodity forecast and rather than the decline for oil that's starting to flatten out quite a bit. And then on natural gas as a significant power source, we're seeing natural gas expectations in the US expand pretty significantly. I know we'll probably talk about this more detail later in the podcast, but the view of AI and also LNG is really changing the demand forecast for natural gas. It feels like the energy sector right now is very cheap on valuations.
Vito:
Yeah, it's interesting. If anybody who watches financial news networks, they're all focused on first, the FAANG stocks, then the Magnificent Seven, and they certainly have driven a lot of the market highs that have occurred in '23 and '24. But we're starting to see the performance of some of those companies, whether it's the Teslas of the world or others start to moderate a bit as we're going into the year. I think investors and corporates alike are taking a closer look at the energy sector and seeing some value there. I think that's a great way to put it.
I think what our audience always enjoys hearing is some of the advice you're giving at the board level. And so when we talk to the C-suite and we talk to the boards, sort of some of themes you like to talk about and make sure that they have a good grasp. And by the way, I would share with you all, we talked a lot on prior podcast episodes about the Conference Board's CEO Confidence index. On a scale of 0 to 100, 50% or above is a confident forward outlook on the part of CEOs. It's almost 200 CEOs globally that are taking the survey. I always look at it as a great measure of activity. As I've said in the past, when you have the highest levels of CEO confidence, those happen to be the quarters where we have the highest level of announced M&A volume.
One of the interesting things is that the last two quarters, so the first quarter of the year and then the second quarter of '24, where the CEO confidence index was just announced about a week ago, have been at 53 and 54 respectively on the measure. As they term it, "CEOs are cautiously optimistic." I think they feel good about their businesses, but they look at the external factors, and those factors are probably driving the greatest levels of concerns for them. In the US and in other places globally, it's the upcoming elections and the uncertainty around those elections. At year-end, I think it's the highest level of political elections globally that we've ever had in one year.
And then certainly impacting your sector. When we look globally, the geopolitical instability and the potential expansion of global conflicts is a concern. I know that directly impacts your sector more than most, but tell us a little bit about how you're guiding boards and with some of that perspective in mind. Also as we get into it guys, maybe how are you seeing the alignment between CEOs and their boards? Are they on the same page? Is one thinking more aggressively than the other? I think those would be pretty interesting things to hear. I don't know who wants to start off on that. [inaudible 00:17:03]
Nick:
I think the board themes and topics change whenever we're sitting in front of them and C-suites on a somewhat frequent basis. And several years ago it used to be, how do I get leverage down in a low commodity price environment? We had to create joint ventures and different structures to accomplish that, as well as asset sales. We pivoted to return to capital and different boards had different views, whether it was a fixed and variable or the debates or share buybacks. Now we've pivoted in most of the conversations and topics Tim and I are sitting in front of boards and C-suites on is, how do we build a durable business with a reinvestment rate that competes in the marketplace in years three, four, and five? Everyone's staring at a near term development set that is known. You have to go procure pipe and different products in the marketplace. And you've got hedges, so you've got a return effectively locked in for the next 12 to 24 months.
And years three, four, and five is, how do we improve our business? How do we compete in the market? How do we gain and improve our reinvestment rate through allocation of capital, whether it's through a merger into better assets or whether it's through an acquisition on a smaller scale and up tiering inventory? That's the biggest topic that I'm seeing in the market and at boards right now.
Tim:
I guess a couple of comments I would make is how things have changed. First of all, I do think CEOs are very aligned with boards. Indeed, in most of the transactions that Nick and I have been involved with recently, the CEOs are the ones that are really driving the transaction. It's not the lead director or one of the directors or the chairman or chairwoman. It really is the CEO and they get the issues in terms of having consolidation. That being said, I think as we always advise boards, you always should look at the status quo and is this the right time to do it? Is this the right partner? You don't have to do the deal.
But one of the things, what we do tell boards is first of all, where we sit today, and this is particularly on the oil side, is that you have a commodity that for a long period of time has really been kind of in this 65 to 85 range. And that's a really good range to do transactions. The reason is, it's frankly not too low. It's not $50 oil, it's not $40 oil where people feel it's tough to sell out at that type of price. At the same time, we're not sitting there with oil at 100 or 125. If you look back on history in terms of transactions, recent history, and even going quite far back at those times when oil gets either real high or real low, very, very difficult to make transactions work in the sector that's either public or private transactions. All we talk about boards, is this the right partner?
We have incredible regulatory challenges in this industry going forward. We already talked about inventory and particularly tier one inventory starting to get in less and less supply. Will you be a better company for your shareholders as a larger organization? And if you feel that way, now generally is a pretty good time to think about transaction given where the commodity sits. Now obviously you have to look exchange ratios in the particular instance, but those are some of the macro themes that we have a lot of discussions with boards about, putting this particular deal, not that you have to do it, but in relevance of a lot of factors over time.
Vito:
Yeah, Tim and Nick, and Tim especially, I love that perspective. One of the reasons this podcast is called Strategic Alternatives is because when I try to describe what we do for clients, it's really helping them understand the strategic alternatives that are available to them and how they compare it to the status quo just so that our boards and CEOs can be well-informed when they go to make a specific decision. It might not be the deal that is one of those alternatives, could be something else, but again, they can make a decision and do it in an efficient, informed fashion, so love hearing that. And the perspective on transactions happening when you have a balance from a price perspective in terms of commodities and not when you're at the extremes, that's pretty interesting. That's something I had not thought of personally, and that's a pretty interesting way to think about it.
Nick:
Vito, let me add one component onto that and I'll coin it as the Goldilocks era. The zone is 60 to 80 for oil and 3 to $4 for natural gas. That's where we can get in the money, development drilling, and sellers feel like they're getting value for their undeveloped potential. We also need to compare and contrast that to the near term strip versus the five-year strip and how we are in contango or backwardation in the curve. That's really important. Whenever oil was at $120 a barrel and we were $50 backward aided, we saw that buyers were unwilling to pay premiums for cash flows that they could hedge into the market because we usually find that producers are generally optimistic and don't like to hedge when prices are high and put in hedges when prices are low. So understanding that spread between the near term strip and the five-year in addition to where we're at on the prompt is very important on when we enter into a transaction.
Vito:
And Nick, that's a great way to think about it, especially as we think about transactions and when they're the most successful. It's really when it's two companies coming together with the appropriate fit and making sure that... There's so many other things besides price, but making sure that there's a real cultural fit and that all the constituents, all the stakeholders are thought about, so great to hear that. So look, I think we've covered a lot in this first segment and I want to wrap it up on that before we come back and hit some more detailed topics including the regulatory environment. Tim, Nick, thank you so much and we'll talk to you momentarily in our second segment.
Tim:
Looking forward to it.
Nick:
Thank you.