Ah Labour Day. That annual celebration of the righteousness of the downtrodden worker, the brave collectives and essential workers, putting it all on the line day after day in order to enrich the greedy capitalist fat cats who live for exploiting the masses.
Or at least that’s the way it started. Now Labour Day is just the last long weekend of the summer, the flashing beacon that your time sitting around on your duff at the lake has come to end and that it is time to go back to work and back to school and that, especially here in Calgary, the weather is going to turn. It’s an annual tradition, pandemic or not.
Which leads me to my own Labour Day tradition, which is to offer up a bit of a market preset and to spend a little time discussing one of my favourite subjects after my family, NFL football.
That’s right folks – are you ready for some football? Because I sure am. Are you ready for some M&A?? I sure am ready for that as well
The NFL season kicks off this Thursday, featuring the Super Bowl Champion Kansas City Chiefs against the Houston Texans, live from Kansas City. Amid the mayhem of street protests, COVID, BLM, Trump v Biden, devastated economies, racial unrest, Antifa, Boogaloos and Nancy Pelosi’s hair cut, the most popular league in the world is coming back in a game featuring two of its most transcendent stars in black quarterbacks DeShaun Watson and Patty Mahomes. Not to mention the anticipation as to what players and the league are going to do with anthems, flags, kneeling and positions on racial injustice.
I don’t know about you, but to me this is the very definition of “must watch” TV and the ratings will be through the roof, likely challenging Super Bowl, if not Donald Trump press conference levels.
I will give you some predictions, but before that, ho-hum. M&A. Look, it’s what I do, I have to talk about it.
Fortunately, there are some deals in the service sector that are worthy of chatter and miracle of miracles, they don’t involve insolvencies! Yet.
In the first deal, Schlumberger sold its One Stim business to Liberty Oilfield Services in exchange for a 37% equity interest in Liberty. This non-cash deal marks another step in Schlumberger’s exit from the North American (mainly US) upstream frac’ing world and tells you all you need to know about Schlumberger’s perspective on where the market in the United States is headed. Halliburton is now the sole remaining service major with a significant fleet in North America and even they have said they are looking overseas. Liberty shares powered ahead more than 40% after the deal, especially after they said they were going to mothball 1 million horsepower of frac’ing equipment, basically the former Weatherfiord fleet that Schlumberger had bought a few years earlier for… $430 million.
In other exciting Frac’ing and deal news, this time with a Canadian flavour, the saga of CalFrac continues to play out between two competing shareholder groups – the directors and management who are trying to execute a classic restructuring that will see note-holders take a haircut and become majority equity holders in the Company and the Wilks Brothers, who are significant investors in the Company and are proposing a deal they claim can protect or even enhance value for current shareholders and also deal with Calfrac’s enormous wall of debt. Proxies, insults and press releases are flying and the saga will end with the shareholder vote in short order, but this once dominant company, laid low by the energy price storm and demand collapse could actually live to fight another day regardless as a, hopefully, leaner and meaner competitor to the newly enhanced Liberty, provided, you know, the market recovers a bit more…
So the M&A world, getting interesting, slowly but surely. This is not a “sit still” environment, even if you are required in many cases to “sit at home”.
Last year at this time, it seemed like we were well on our way to an energy recovery and the center held as long as it could before being undone by the pandemic and the absurd price war between Saudi Arabia and Russia.
As the summer has passed, we have seen consistent draws from storage and remarkable production discipline from OPEC+++++. From a Canadian perspective, TransMountain continues to be built, this time by a government that has unlimited money (how about them apples?) and differentials have stabilized. We aren’t shipping as much as we usually do, but without blowing our brains out on capex, our major industry participants are doing “OK”, as long as you realize that in the current market, the definition of OK means surviving without a bailout.
So, where are we at now? Well, true to the last 5 years, we are walking the edge of the precipice, but for Canadian oil and gas, it’s hard not to think that the worst may be behind us and (lightning bolt just missed me) better days may be ahead. How far ahead remains to be seen, but the smart players are already getting ready for it.
I mean think of it, we have weathered pretty much every sling and arrow that can come our way, right? The only way things could get worse is if Joe Biden decided to adopt the Bernie Sanders energy plan (he wants to put energy CEOs in jail) or if Justin Trudeau actually started to pay attention to the energy sector as everyone seems to want and starts interfering.
Allow me to be the first to say this – neither of those two things will happen.
So back to Labour Day. Why is this the time to look at the M&A landscape instead of, say New Year’s?
It’s mainly because here in Calgaryland, Labour Day is transition time. Weather wise, Labour Day can bring a snowfall, or a thunderstorm or a 29 degree sun splash. I checked the weather BTW and we are actually forecast to get all three. Yikes!
What is also a given as we come out of the Labour Day weekend – even in COVID times – is that the proverbial back to school/back to work switch gets thrown and Calgary’s business community gets busy again in preparation for a hoped for “better than last year” drilling season, since like any true energy industry participant, we are nothing if not optimists.
It happens every year around this time like clockwork. Kids back to school, the leaves turn (trust me – it’s Calgary), budgets for 2021 start getting set and the pace of M&A heats up, regardless of stage in the commodity cycle, the commodity price, pandemic status, mask mandate or length of Trudeau’s hair. The only difference is whether the focus is upstream, midstream or downstream and which particular subsectors will be leading the charge. It happens with us at Stormont as well. After spending much of the last five and a half months sitting at home in various states of casual attire doing Zoom and Teams calls, both Dave and I were physically in the office, at the same time, for four consecutive days this week and next week will be the same. Time to get back at it. The sector clearly isn’t sitting still and neither should we.
As we discuss with clients in the energy services space, there are certain ideal times of year when deals get more attention in the market or start getting done. These times are just after Labour Day but before American Thanksgiving, just after Christmas and before March and then, for Western Canada, post spring break up. Sometimes you get a pandemic that screws things up for one year, but people adapt and carry on.
For a variety of reasons, these times of year work, driven mainly by the service sector activity cycle but also by the buyer demographic and energy company capital budget timing.
In the context of the current market, new drilling activity is going to be muted so the upstream sector, at least on the oil side, isn’t going to set the world on fire (which of course would be a bad thing and is a terrible fossil fuel metaphor).
In the current market, I like to think of it as a great realignment and repositioning. As I’ve said previously, good companies will always attract quality buyers and that is true no matter what the economic environment. There is just too much capital and the industry is too important for the M&A market to go away. In many ways this is an ideal time for smart buyers to start doing deals as we are close enough to a resolved egress environment to allow well-financed and patient buyers to pick up businesses with a lot of runway ahead of them.
As to the opportunity, there has been on the one hand a fairly significant culling of the industry and on the other a buildup of capital, most importantly private equity, looking for a home. As the industry has contracted and margins compressed, the weaker players by necessity have fallen by the wayside and the survivors have retooled their business models and moved their businesses forward. Into this breach step buyers looking to consolidate industry segments, build asset bases, acquire customers and otherwise position themselves for the next cycle, driven in large part by the larger infrastructure projects that are actually happening – LNG Canada, Trans Mountain Expansion and Line 3.
Against this are the prices of oil and natural gas, which appear to have, if nothing else, stabilized at current levels, allowing E&P’s to deploy internally generated cash flow into the WCSB to keep production numbers at least steady, if not growing slightly in key regions and allowing some service sector participants to get back to work.
In addition, infrastructure continues to be a dominant theme in Canada’s energy sector, as major midstream and downstream projects continue to move forward, processing picks up and the renewables boom in Alberta (yes, you read that right) continues to gather steam.
I’m not predicting anything close to a return to heady, frothy, 2016 crazy times (and if you know the industry, you will understand how low that bar is and how tongue in cheek the comment is meant to be), but a gradual re-inflation of the industry is certainly in order, led by gold standard, efficient Canadian operators.
On the upstream side, industry subsectors that have been the most beaten up during the downturn are often the ones to see the first levels of interest – mainly companies that provide front end services such as engineering, planning, infrastructure services like road and right of way clearing, smart rentals and most anything site service related such as safety, security and medical services.
On the midstream side, along with the mega projects currently underway, we expect an ongoing influx of dollars into pipeline and processing infrastructure whether it is new-build or maintenance, turnaround and integrity related. The thesis on investing and maintaining critical infrastructure will always hold even if the market is about to get whole lot more competitive.
As far as who the buyers are, we anticipate a mix between Canadian strategic buyers including mid-market players and opportunistic private equity funds looking to support these mid-market players and pursue their own particular investment theses. We also anticipate that more US based buyers will be wanting to kick the tires in Canada, as they assess the damage to the US shale industry.
So, we are as always cautiously optimistic on the M&A front, both from a business cycle and seasonal perspective, the evidence being our own client base and actual market evidence as well as a general feeling that with these projects coming on stream, many owners and management teams will prefer to have their companies built and oriented towards growth long before any commodity travels down a tube.
One big risk we are tracking that is COVID related is capital mobility.
As it currently stands, not a day goes by that one of us doesn’t get an email or call from a US-based private equity fund letting us know they are open for business and actively looking for deals in Canada. Which is great. But from a practical perspective, if we send them a deal they will want to visit the company and a 14-day quarantine doesn’t work for assessing investment.
Forced to choose between a company in Calgary and one in Denver, a Chicago based PE fund is going to pick the Denver based opportunity every time if the quarantines remain in place, because it’s easier.
It sounds trite, but the cumulative impact of that decision tree alone on multiples, foreign direct investment and expansion of our industry will be significant if not addressed soon, our capital markets are just too intertwined. This is why I believe that travel restrictions are going to start easing sooner rather than later (like, enough with the 2022 nonsense) and quarantine rules relaxed. Mandatory fast result saliva testing for anyone flying should be an airline and regulatory priority – whoever cracks this nut wins the day.
I may be overstating this and we have several deals in the market where the buyers are all saying the right thing, but I have never met a buyer who didn’t want to do a site visit.
Governments – please pay attention to this. A massive percentage of all M&A is private equity driven and most of that capital is located outside of Canada. Just saying.
Now, on to the NFL.
This 1035th NFL season is going to be epic. I feel it. (It’s that many seasons, right?) Lots of exciting young stars, emerging teams, holdouts galore, surprise retirements and team altering injuries, trades and suspensions. The pre-season was, thankfully, not a thing due to COVID. Layer in a healthy dose of patriotism, racial tension, flag waving, kneeling and a still-unsigned Colin Kapernick and as I said earlier, bring it on!
So…
This year, much like Calgary weather, the NFL is completely unpredictable. What the NFL does to address racial issues is going to get as much play on talk radio if not more than the games so the league and the players must get it right. They haven’t tipped their hand yet, but I think they will get it right. They have to.
Game wise, the evil empire is broken. Cam Newton is the starting QB for New England. Tom Brady and his cast of Avengers are all in Tampa Bay of all places.
Kansas City is the Super Bowl Champion and Cincinnati and Miami both have game changing rookie QBs. The Aaron Rodgers era in Green Bay is coming to an end, likely this year. Drew Brees is back for one more shot. Baltimore and their electric QB Lamar Jackson will be there til the end.
Even Buffalo looks good!
So what do I see?
All predictions are of course subject to the vagaries of testing, but assuming symmetric health, the Super Bowl this year will be New Orleans vs Baltimore. And the Ravens will win.
Unless of course a couple of teams catch lightning in a bottle. And we get an epic New England vs Tampa Bay grudge match. And Cam wins the MVP. Could happen!
There, I called it. Without watching so much as a snap.
Have a lazy weekend. Get to work in earnest on Tuesday!
