So here we sit a week or so removed from the US election and you know what? I feel kind of liberated. Not a voting-result based monkey off my back, just relief that I don’t have to spend as much time getting distracted by another country’s crazy politics, at least until January, when the transition happens, or if I suddenly develop an interest in Italian politics (ay, caramba!). Besides, as a private equity buddy reminded me the other day, the blog was maybe getting a little too political in nature, so herewith, back to business!

Actually that comment was pretty timely, because it is time to get back to task at hand which is putting the pieces back together here in Alberta and figuring out what the market will look like going forward. While there are green shoots, the road to recovery is going to be long, and this has implications for many business owners who have already weathered one too many business cycles (and by this, I mean everyone, because this one cycle was more than most can take).

At any rate, on Wednesday, I had the pleasure of participating on a panel with some of my peers from the advisory, private equity, legal and corporate community at a conference related to succession for business owners. Our particular panel was discussing the various liquidity options available to owner/managers of mid-market businesses including family succession, Management Buy-Outs (MBO), recapitalizations, IPO’s, and Strategic and Private Equity Sales as well as the option of selling assets at auction. This was of course a great theoretical discussion, sprinkled with real world examples of deals both good and bad, value maximization tips and all of that good stuff.

During the Q&A part of the panel discussion, there was a question from the audience specifically about the oil field services space in Alberta and whether the current market was an appropriate time to sell or whether owners should wait for a recovery. As the energy services expert, I took the bait. While I did admittedly dodge the question a bit by saying that if the time is right for an owner to seek liquidity and they have an outcome and timeline they feel they need to achieve, they shouldn’t make themselves slave to a particular market, the reality is that it is in markets like this that the liquidity discussion, timing and how deals are structured can become even more important, because when cash values are depressed, the options tend to be more limited.

Anyway, the basic premise behind my answer is as follows:

If you are an entrepreneur that was looking to exit in 2014 for any other reason than trying to time the market, but wasn’t able to achieve a successful outcome, those reasons are probably still there today. In our experience, the main reasons successful entrepreneurs decide to exit a business is because they are either done with the business and its risks or it has grown to a size or the operating environment has changed such that they feel they need to derisk their investment or bring in a partner to help run the show, or both.

If either of those were true at the peak of the market, it’s usually the case at the bottom of the market too, if not more so.

In addition, whether you are an owner looking to retire or a mid-career entrepreneur looking to derisk, these processes take time. And in an industry with an on-average 7 year cycle peak to peak (I could have said trough to trough, but I’m an optimist), time is the enemy as is the shape of the recovery.

So if you are an oilfield service company owner, first off, you know and understand the cycle. You have been through a few, you know the highs and the lows. And you know that this cycle has been two plus years down, which means you have about five years on average to hit the next peak. And if you have made the decision to exit the business or bring in a partner, you probably want to have that done while the business is on the upswing rather than be negotiating a deal when the market is tipping over.

If you look at how to time a private transaction and how long it takes to achieve a full exit, it’s at least a three year process. Why so long? Because the owner is part of the goodwill of the business. The clean exit almost never happens, unless you are a 100% passive owner to begin with or decide to go the asset liquidation route. In all other circumstances, the seller will either be required to stay contractually as a manager or be compelled to stay by the presence of contingent consideration.

Even where a strategic is your likely partner, the time it takes to get organized and into the market properly is typically up to three months from when the decision to sell is made. Then, assuming a robust market for the company, it is probably 6 months to close, in the current market likely longer. So right off the bat, you have used up a year.

If you sell to a strategic, it gets more straightforward after that, with more than likely a one to two year management contract with perhaps some bonus or contingent payments tied to it and a five year non-compete. So: sale to a strategic – 2 to 3 years to be fully “out”.

With a private equity sale, it’s more complicated. This is because a private equity group will buy a majority interest in the company, the vendor will roll equity and the two together will seek an opportunity to sell out of the business – with an average hold of about 5 years. If in that period the entrepreneur hasn’t put in place a credible management team to replace themselves, guess where a lot of the goodwill in the company still resides – that’s right, management. So the operating partner will often be required to re-up with the business, the timing of which will depend on whether the exit was via IPO, sale to a strategic, a private equity backed strategic or a larger private equity group – starting the whole process over again.

A sale to a private equity backed strategic probably fits somewhere in the middle.

With that in mind, it is easy to see how a simple question of wanting to exit or de-risk from a business quickly goes from a “I’ll sell to Company A and be golfing by Christmas” to a three to five to seven year or longer proposition.

This is of course is the long winded reason I said if you have made the decision to exit or partner already, then that decision is independent of the business or commodity cycle, because time matters.

So what is happening in the market now?

We are of the view that we are in the midst of a gradual re-inflation of the Canadian oil-patch. Capital budgets are cautiously expanding, activity levels are up and companies are hiring. This process has actually been underway since the spring, but it’s been hard to believe given the volatility. But to borrow from and paraphrase what my friend Andrew the lawyer told me during a different cycle – “people in this town don’t realize the downturn started nine months ago”, and the same is true in reverse. When the market turns, sometimes it’s those closest to it that miss the signs, especially the weak ones.

But those signs are there and not just from an operator’s perspective. As I’ve detailed previously on the M&A side, we have been receiving an accelerating number of calls regarding opportunities in our market. These are from generalist private equity groups looking to balance portfolios to specialist funds looking to exploit a thesis as well as firms that have a platform company, a limited amount of time to add to that platform and a boatload of capital. As well, the strategics are starting to wake from their decline induced hibernation to see what is out there and how they can realign their product offerings to exist in the new, cost-conscious E&P world.

Since we are also of the view that the recovery will be gradual and that the demand growth for equipment and services will be subdued, we believe that this market recovery will be marked by companies needing to be bigger to participate and that scale, breadth and depth of offerings matter. This is because all the pricing power now resides in E&P companies reluctant to see costs inflating and procurement groups driven by a belief that single source delivers a more economical result than multiple vendors a situation likely to persist until a capacity deficit develops again, which we believe is far off. In this environment, the larger service companies can spread loss-leader service lines across a broad range of different margin products while smaller players increasingly find themselves on the outside looking in.

It is into this “bigger is better” strategic market and the “aggregator” private equity market that mid-market owners should be looking and where M&A activity is likely to be busiest. Put another way, if you are a niche, mid-market energy service company asking me whether you should transact now or wait for the recovery to take hold, my comment back is that unless your time horizon to full liquidity is more than one commodity cycle and you have the financial resources and desire to manage a slow growth recovery, there are opportunities and ways to transact now that you might want to take advantage of.

Are companies going to get the same value as they would have gotten in 2014? Of course not. If you want that value, you are going to have to wait and how long is anyone’s guess. What you need to do is , ask yourself, how long will it take me to grow my cash flow back to 2014 levels and if the answer is any longer than 2 years, you need to ask yourself if it’s worth carrying that risk all on your own or is there a way to risk-share and still get upside. Lots of companies are now going the latter route. We are seeing transactions now being done on a share swap basis with limited cash changing hands, implicitly acknowledging that valuations are low, there is some shared upside but companies are stronger together (there – I spoiled it with politics). Smart companies are partnering to get stronger, smart private equity groups are aggregating strategic sectors to position for the recovery and they have the capital to wait out the slow part.

As stated in previous editions, the M&A market is never dead. There are always deals being done. And business succession and the search for liquidity is an ongoing process, it never goes away, no matter whether rig utilization is 20% or 80% or the price of oil is $25 or $75. A prudent business owner should be open to any discussion on liquidity, risk sharing and growing or strengthening his business no matter the point in the cycle because no one can predict when the peak or trough is going to happen, just like no one can predict when someone will want to or need to sell their business.

That’s what I wanted to say on Wednesday in answer to that question.

Prices as at November 18, 2016 (November 11, 2016)

• The price of oil ended the week up on mixed  signals as the continued US dollar rally battled OPEC sentiment to establish a foothold. Expect more volatility until the end of month OPEC meeting.
  • Storage posted a modest and expected increase
  • Production fell by a rounding error
  • The rig count in the US and Canda continues to grow
• Natural gas was up during the week on choppy and uncertain news

• WTI Crude: $45.69 ($43.41)
• Nymex Gas: $2.843 ($2.619)
• US/Canadian Dollar: $0.7406 ($ 0.7383)

Highlights

• As at November 11, 2016, US crude oil supplies were at 490.3 million barrels, an increase of 5.3 million barrels from the previous week and 35.2 million barrels ahead of last year.A build up in storage at this time of year is not unexpected
  • The number of days oil supply in storage was 31.2, ahead of last year’s 30.8.
  • Production was down for the week at 8.681 million barrels per day. Production last year at the same time was 9.182 million barrels per day. The change in production this week came from marginal decreases in Alaska deliveries and lower 48 production.
  • Imports jumped from 7.442 million barrels a day to 8.423, compared to 6.968 million barrels per day last year.
  • Refinery inputs were up during the week at 16.126 million barrels a day
• As at November 11, 2016, US natural gas in storage was 4,047 billion cubic feet (Bcf), which is 6% above the 5-year average and about 1% higher than last year’s level, following an implied net injection of 30 Bcf during the report week.This level isa new all-time high.
  • Overall U.S. natural gas consumption was up 3% during the week as flat power demand was offset by increases in industrial and residential demand.
  • Production for the week was flat and imports from Canada fell by 4% from the week before
• As of November 14, the Canadian rig count was at 165 (25% utilization), 108 Alberta (24%), 17 BC (22%), 36 Saskatchewan (31%), 3 Manitoba (20%)). Utilization for the same period last year was about 25%.
• US Onshore Oil rig count at November 18 was at 471, up 19 from the week prior.
  • Rig count at January 1, 2015 was 1,482
• Natural gas rigs drilling in the United States was up 1 at 116.
  • Rig count at January 1, 2015 was 328
• US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 55%/45%
• Offshore rig count was up 2 at 23
  • Offshore rig count at January 1, 2015 was 55

Drillbits

• Selected earnings reports for Q3 – it’s a mixed bag!
  • Tourmaline reported Cash Flow for the quarter of $185.5 million vs $197.1 in the same quarter last year. The Company also announced its capital program for 2017 of $1.35 billion.
  • Enerplus reported Funds from Operations of $80.1 million versus $120.8 million in the same quarter last year. The company also announced a $400 million capital program for 2017
• Spartan Energy Corp.has entered into an agreement with ARC Resources Ltd. to acquire strategic assets in southeast Saskatchewan for cash consideration of $700 million.
• Husky Energy says shifting ground is to blame for a pipeline burst in July that leaked crude oil into the North Saskatchewan River and jeopardized the drinking water of thousands downstream.
• Apparently Warren Buffett has sold all his Suncor shares and has loaded up on airline shares. While I am not convinced the trade was coordinated, if it was, it is a major bet on a price decline for oil by a smarter man than me. That said, not sure I’m buying it.
• The U.S. Geological Survey has announced that the Wolfcamp shale in the Permian contains technically recoverable reserves of 20 billion barrels of crude, which makes it the largest onshore unconventional oil discovery in history. Not specified is either the price these reserves become recoverable at or the technology required to exploit them
• The herky-jerky, stutter step momentum continues amongst OPEC as the November 30 meeting in Vienna draws inexorably closer.
• Saudi Arabia is preparing to publish data on its oil reserves, a closely guarded state secret that it has not updated since the 1980s. This disclosure is likely being driven by the upcoming Aramco IPO. Analysts are practically drooling in anticipation of being able to see this data
• Libyan oil output continues to rise and currently sits at 600,000 bpd, up from 200,000 a few motnhs ago.
• Drumpf Watch: The Donald is making appointments, scheduling meetings and doing other stuff needed to get his Cabinet and team ready for assuming his lowest paying and least enjoyable role – look, I can say it right? This is not most billionaire’s idea of a cozy retirement. At any rate, the lack of organization, chaos and fumbling going on in the Drumpf transition team might be considered cute, charming and Beverley Hillbilly’ish if not for the gang of crazies getting put up for key roles, the influence of family and the complete and utter disregard for convention, ethics and compromise.