Crude Observations

What’s happening deal wise anyway?

For the past several weeks, we have spent time on this blog discussing the state of the energy industry, making fun of various levels of government and postulating on what a post-pandemic world might look like. And don’t get me wrong, it has been a lot of fun because when I do the serious stuff it’s mostly dry and not as engaging as I think it should be.


But sadly, this blog can’t always be fun – sometimes it actually needs to be about “work” and “markets” since, as my partner reminds me, it’s our job even though how we do that job has been altered by the rise of working from home, the presence of office cats, essential workers, mass unemployment, capital formation issues, re-openings and other pandemic related modifications or recalibration of our collective working lives.


As luck would have it, our office was never technically “closed”. We are a small shop, with a small office footprint and plenty of social distancing capacity with doors etc. We made a conscious decision to work from home to be with and protect our families from potential community infection. Besides, with videoconferencing it is easier to be “in-person” with clients, capital sources and prospects than ever before and with everyone using the same technology and no one judging whether you have a bookcase, a cat or a motorcycle in the background.


Of course, as time passes and we move from week 12 into week 213, I find myself increasingly drawn back out into the real world such that I did in fact spend two days in the office this past week. It was actually quite energizing to be there.


I hosted my Zoom coffee at the office and the participants appeared to be relieved to have a different background to look at. Dave and I sat in the boardroom (social distance protocol #1: opposite corners of the table – 4 feet equidistant from the phone) and had several calls with clients and contacts. It all felt normal while of course still being pretty far from normal. Sanitizing spray at every turn, a zoom call with client where we sat in our respective offices – I think you get the picture.


So work continues as it did while we were all at home full-time. Some people in essential services have actually never left their place of work – something that we tend to overlook. People who work in the field or in industrial settings or maintain infrastructure haven’t really missed a beat while the professional white-collar class like ourselves as well as accountants and lawyers continue to have the luxury to self-isolate.


So the world of work continues while at the same time has been turned somewhat upside-down and inside out by the pandemic and how we have had to adapt to it. Look, this isn’t some kind of “new business reality” blog, because as I made clear the last several weeks, I don’t really buy that. But, in all fairness, the pandemic and its knock-on effects can’t help but impact the M&A market.


We are in fact increasingly fielding questions from clients and would be clients about the state of the M&A market for private businesses and what getting a deal done both during and post pandemic is going to look like.


For many people, the automatic assumption is that the M&A market is for intents and purposes closed and while this may be true for certain companies or certain industry subsegments, the reality is that markets never “close” and that out of the chaos that is this pandemic, opportunity and fortune awaits – as does in equal measure the chance of failure.


But all that aside – what does the M&A market look like? How will deals get done in the current environment? Are there sectors that are in favour? Are there sectors (energy) that aren’t? When should go to market? Will I get the price I’m looking for?


All excellent questions which I will try to address as I continue to ramble.


First off, the short answer to the first question – what does the M&A market look like. It looks pretty much what it looked like before, and unlike anything you have ever seen.


Expanding on that, I would have to say that deals will still get done but they are going to take longer, structures are going to have be more creative and return expectations all around are going to have to be recalibrated.


On the process side of things, as an M&A advisor, we run a file now much like we ran it before. We typically engage a client remotely, meeting in person perhaps once or twice but with new technology this is less an issue. Targetted approaches to strategic and financial buyers are all done electronically and most datarooms are virtual. We can all handle the process online so that part of the execution is going to be easily managed. Deals will get done.


What’s going to be hard is getting the deal the attention it needs. We believe it is going to be an exceptionally busy market in the coming years as the economy and industries recalibrate.


Let me explain what I mean by that by putting it in the context of the energy services space.


As the price war unfolded and capex budgets got slashed many companies in the energy services space saw dramatic impacts to their bottom line and, as these past few months have gone by, many have experienced existential threats that they have never had before. Too many to count have taken their equipment to auction, others have simply closed their doors.


The survivors will emerge and carry the day in an altered market as activity levels pick up and prices recover.


Those that are well-capitalized or had low debt levels will seize the opportunity to consolidate market share. Those that have had it with the cyclicality will put their companies up for sale. Hungry entrepreneurs looking to execute on the latest seven step plan to global domination will also be on the hunt for assets and corporate acquisitions. The market will be full of companies looking to do something including both the walking dead and the diamonds in the rough.


The issue of course is how do companies looking to sell find the right buyers – those with the vision and drive to build something of lasting value. And how do those buyers know that they are buying a good business and not just over-paying an owner who was otherwise circling the drain.


In a market where there is so much distress, sorting out all the options in front of you as a buyer is a major challenge, never mind being the seller of a viable business trying to get the attention you need in a sea of economic devastation.


And that’s just the energy sector which in Canada is 10% of the economy. Extrapolate that out to the other 90%, regardless of relative performance.


Now take that noise, multiply it by 15 and roll it into the United States market.


Getting attention for your deal or company is going to be challenge because there will be so many others out there competing with you. Doesn’t mean it can’t be done, it’s just going to need more work.


Oh, and everyone will need capital.


Where does that come from? Certainly not from banks, instead it most likely going to come from private equity.


That’s not really that different. Over the last decade, the main driver for M&A activity has been the private equity market, where trillions of dollars have been invested in private companies ranging in size from sub $2 million in EBITDA to mega-investments with hundreds of millions in cash flow.


There is a well-worn path of US PE coming to Canada and vice versa. It is rare to meet a business owner who at some point hasn’t had a conversation with a PE fund somewhere. They are ubiquitous.


What’s different now is if you are a seller trying to attract attention or a buyer trying to raise cash to execute an acquisition strategy, how do you get the attention of these companies in a world where tens of thousands of companies are competing for the same dollar. Two years ago, private equity found you. For the foreseeable future, you will increasingly have to go find it.


There are more than 4000 private equity firms in North America with more than 90,000 portfolio companies. Collectively they have close to $1 trillion in “dry powder”.


They are all open for business and recognize that this is a historic buying opportunity, but they also have major problems in their portfolios which takes away from the time they can allocate to going out and finding deals.


So if you are a seller or a buyer, to succeed in this M&A market and access the capital required to close on your project, you need to figure out a way to stand out so that when your opportunity hits the desk of some PE guy, they have a reason to look at it.


Similarly, on the strategic side (whether independent or private equity owned), many companies will be looking to expand, but out of a downturn it is much easier to accomplish this organically than through acquisition. This is because even in a healthy industry, it is likely that competitors are going under or are otherwise distracted, allowing a well-capitalized company to build market share via the auction route. So again, to be an acquisition target, you still need to tell a compelling story and stand out from the rest.


So how do you stand out?


In an environment where deal flow is going to be so high, you need to be able to immediately grab attention with a clear value proposition. Whether it’s an industry consolidation, emerging technology, a recession-proof service line, it is critical to understand your story and present it in a compelling and targeted way to a properly qualified list of targets to get the conversation going. If you can articulate the economic opportunity compellingly and upfront, that is a significant part of the battle.


Make sure management is front and centre. This is something that we find many companies overlook and during the frothier M&A markets get less attention than it should. But as capital gets tighter or you are in a more competitive market, bench strength matters. Private equity funds will be paying increasing attention to management teams that are going to be stewarding their capital, assessing bench strength and trying to figure out who can manage through a downturn.


Further to the preceding, it will be more important than ever to understand your financial reality, have realistic forecasts where that is even possible in this evolving market and have a firm grasp on where profitability comes from, key margins and what an optimized capital structure for your business should look like. Presenting the financial information in a structured and credible form will allow the capital source to quickly execute a financial analysis and remove that obstacle from the assessment process.


Don’t overthink the valuation or the multiple. Conversely don’t just take the first offer that comes along beca8use it seems expedient. Look, this is true in any market, but in one as uncertain as this one, multiples could be all over the map. No one is going to value you on the basis of 2019 and similarly, if you are one of the few industries growing through this, understand you will only get the premium for that if that growth is sustainable. Similarly, anyone who seeks to apply an opportunistic 2020 COVID type discount to a business that should be able to snap back should be sent packing.


We expect that valuations for good businesses will continue to be fair for their current economic environment but to get there, vendors and purchasers will need to be prepared for creative deal options. This is going to be mainly driven by the debt markets which may not be willing to stretch as far they have traditionally given the huge exposures they have to both corporate and personal defaults. Don’t be surprised to see full equity swap transactions and the use of earn-outs and vendor financing to get around big valuation gaps. This will be especially true in recovering sectors where cash management is critical.


Don’t try to manage timing – go to market when you are ready not when you think the market is ready. Timing the market rarely works. The repercussions of this shutdown are going to be measured in years – waiting it out could add 5 years to a succession plan. On the other side of the transaction, buyers will expect to get deals but the reality is that to encourage targets to transact now, they will have to sweeten the pot.


Finally, this may sound completely self-serving (and it is), but hire an advisor. They will be the key to getting your deal on the radar of the most likely buyers/investors. It’s their job to sift through the multitude of opportunities out there and help your deal get to the top of the pile. With the amount of deal flow that PE firms are going to see, advisor led mandates will get more attention because they will have properly prepared marketing material, organize the financial story and will also clearly define the process. Advisor led mandates have higher success rates and generally lead to better outcomes, particularly on the sell side. In a market that is going to be as crowded as it is shaping up to be, having that edge really matters.


Office Cat


Office Cat communicated his displeasure that I went to the office two days this week. We are currently not speaking.


Stormont Capital Crude Coffee


We had the eighth edition of this last Tuesday at the regular time and it was another great conversation.


The main topic was learning about Classroom Champions ( a Calgary based not-for-profit the delivers mentorship and social/emotional learning curriculum to schools across North America.


Then we talked politics.


This week I promise to track down another interesting guest who isn’t me, although I reserve the right to blather away about stuff I want to talk about.


Prices as at June 12, 2020

  • Oil
    • Oil storage was… way up. (oddly this was unexpected – does no one read the news?)
    • Production was down
    • OPEC+++++ extended cuts
  • Natural Gas
    • Storage was up, historically very high; consumption down; production flat; exports flat.
  • WTI Crude: $36.53 ($39.06)
  • Western Canada Select: $26.13 ($31.19)
  • AECO Spot: $1.875 ($1.891)
  • NYMEX Gas: $1.806 ($1.850)
  • US/Canadian Dollar: $0.7350 ($0.7405)



  • As at June 5, 2020, US crude oil supplies were at 538.1 million barrels, an increase of 5.7 million barrels from the previous week and a increase of 52.6 million barrels from last year.
    • The number of days oil supply in storage is 40.9 compared to 28.8 last year at this time.
    • Production was down 100k for the week at 11.100 million barrels per day. Production last year at the same time was 12.300 million barrels per day.
    • Imports rose to 6.864 million barrels from 6.179 million barrels per day compared to 7.611 million barrels per day last year.
    • Crude exports from the US fell to 2.439 million barrels per day from 2.764 million barrels per day last week compared to 3.122 million barrels per day a year ago
    • Canadian exports to the US rose to 2.949 million barrels a day from 2.860 million barrels per day last week
    • Refinery inputs increased during the current week to 13.484 million barrels per day
  • As at June 5, 2020, US natural gas in storage was 2,807 billion cubic feet (Bcf), which is 18% above the 5-year average and about 36% higher than last year’s level, following an implied net injection of 93 Bcf during the report week
    • Overall U.S. natural gas consumption rose 3.1% during the report week.
    • Production was down 0.2% for the week. Imports from Canada fell 7.5% from the week before. Exports to Mexico were up 8.2% on COVID re-opening
    • LNG exports totaled 18 Bcf
  • As of June 12, 2020, the Canadian rig count increased 0 to 21 (AB – 11; BC – 6; SK – 2; MB – 0; Other – 2). Rig count for the same period last year was 58.
  • US Onshore Oil rig count at June 12, 2020 is at 199, down 7 from the week prior.
    • Peak rig count was October 10, 2014 at 1,609
  • Natural gas rigs drilling in the United States is up 2 at 78
    • Peak rig count before the downturn was November 11, 2014 at 356 (note the actual peak gas rig count was 1,606 on August 29, 2008)
  • Offshore rig count was flat at 13.
    • Offshore peak rig count at January 1, 2015 was 55

US split of Oil vs Gas rigs is 86%/14%, in Canada the split is 66%/34%


Trump Watch: Rallies to resume!

Kenney Watch (new!): Sure passing a lot of bills.

Trudeau Watch (for balance): NY Times thinks we are watching his hair grow

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