Last week I was in Montreal visiting family and while there I was asked the dreaded question that most people in Alberta fear. And no, it wasn’t pipeline or Jason Kenney related.  No, the question du jour was “How’s business? It must be tough in Alberta right now.” Ugh, cue the deer in the headlights expression for me, right? I mean I have a hard enough time telling people what I do, never mind articulating if I’m being successful at it!

 

Seriously, how do you even begin to answer that? It’s a small question, with a massive answer.

 

In many ways, it has been harder to answer these types of questions from my curious Central Canadian friends and family over the last few years than it has been to navigate the economy.

 

And oddly enough, whenever I get asked a question like that, I often find myself getting quite defensive and mistrustful of my interrogator. Seriously, does the person even care or are they just trying to satisfy some morbid curiosity about Alberta? Do they understand what they are asking? Do they have some kind of hidden, anti-pipeline, anti-fossil fuel agenda they are trying to feed with my unsuspecting revelations about the fragile state of the energy economy? Can this individual handle the truth? Who invented liquid soap and why?

 

Then the following nothing-burger pops out of my mouth:

 

Well I guess it’s OK and it is improving. It could be better. But it could always be better. What? Come on man, do better right? How about this:

 

Yes. It’s tough in Alberta. We went through a brutal energy recession exacerbated by over-reaching regulatory paralysis and a dedicated environmental opposition that wants our primary industry to pretty much go away. But tough is what Western Canada and the oil patch does. The energy sector is home to some of the smartest, hardest working, innovative and creative business people I have met. The entrepreneurial culture is a way of life. And the energy sector isn’t going anywhere. It will survive, but it is changing.

 

That’s a bit better, but to fully answer, it is best to avoid all the hind-sighty stuff like what could have been if the price of oil hadn’t deep-sixed in 2014. What’s more interesting is what has changed in our business, both from an execution standpoint but also from a client and assignment standpoint, because it’s been a fascinating, ongoing journey watching this business transformation unfold in real time with real life consequences for our clients, our business and, dare I say it, our families. And I think it’s useful to share this with our readers, because it’s an important perspective as they consider what to do with their businesses. So I’m going to try and I’ll try not to sugar-coat it.

 

First off, any advisor active in this sector will tell you that the years from 2015 through the end of 2017 were some of the most challenging in their careers. Anyone saying something different is selling you a bill of goods.

 

Notwithstanding that, most of the advisors I know have stayed active, albeit at a reduced pace, because the need to transact, raise capital, restructure debt, sell assets, acquire market share, diversify a business or exit doesn’t change because you are in a cyclical downturn. Rather, it is during these times that decisions become far more strategic because the implications and opportunities are magnified. Not all the assignments are fun, some are downright depressing. It is never fun to guide a client into insolvency, but sometimes the softer landing helps. But there is always opportunity.

 

And this is true at Stormont. Since the end of 2014 we have done our fair share of transactions and assignments for clients, ranging from buy-side work to acquisitions and financings to traditional divestitures across a range of industry verticals including occupational health and safety services, oilfield construction and maintenance, surface rentals, downhole tools, engineering, building products and software.

 

And while we continue doing traditional deals in our industry space, it is safe to say that they are different in flavour than they have been and there are a few “truisms” that this new market has taught us.

 

First off, companies are smaller

 

While the impact of the downturn has been hard on the producer side, it has been doubly so on the service company side. The typical private mid-market upstream focused energy services company is genrally two thirds to one half the size they were in the heady days of 2013 and 2014. There are many reasons for this – over-capacity, slashed capex and rate pressure from E&P companies – but it is pretty much universal across the board. This means that where once a typical company size was between $5 million and $15 million in EBITDA (again, private businesses), these same businesses are now seeing trailing EBITDA numbers of $2.5 million to $10 million.

 

This reality has had major implications for M&A and how it should be done in the current market.

 

Deals are harder to close

 

Our experience has definitely taught us that in the current environment deals are much harder to close than in the preceding happy days. In particular there was a stretch between the end of 2015 until the fall of 2016 when there was so much uncertainty in the market, it was pretty much a crap shoot whether you could get a prospective buyer to even return a phone call let alone get a deal across the finish line, regardless of the quality of the business you were representing because the market situation was so fluid.

 

Deals are smaller

 

This goes without saying. If the size of the businesses have changed, it stands to reason that deal size is that much smaller as well. One knock-on effect of this is that big cross-section of buyers has been taken out of play as many private equity funds have size requirements for their deals, in particular platform deals and it is harder to get the attention of larger strategic buyers for smaller deals – they can just buy the assets and build organically. So advisors have been forced to adapt to this reality. In some cases, more than half of the “usual suspects” private equity funds are out, although the market for add-ons to existing platforms has stayed moderately open.

 

So companies are smaller, deals are harder to close and the buyer pool has shrunk. Sounds like a tough market alright, yet we and others persevere and continue to succeed.

 

The client demographic is changing

 

As the downturn lurched through its seven stages of recovery, the nature of our clients and assignments evolved. Where once we were close to 85% sell side or divestiture related, as soon as the green shoots started to sprout, all manner of assignments and clients started to emerge as well.

 

Out of chaos comes the seeds of change. One striking thing we have noticed is the emergence of the next generation of entrepreneurs ready to take on the challenge of the changing energy landscape. It is often said that out of adversity comes success and this is true in spades here. We have done assignments for young, aggressive management teams that have a vision for how they want to grow their businesses and have a runway for success that stretches probably ten years or more into the future. We have also done transactions for successful entrepreneurs who have a niche service line and have recognized both the strength and weakness of that business model and have decided that in order to succeed, they needed to be bigger, faster and have partnered with sophisticated management teams that have a track record of success.

 

At the same time we have also executed transactions in the past few years that reflect a darker reality for the current environment, namely companies that are over-stretched with their lenders, can’t keep ahead of the debt and need to do a transaction and are hoping a corporate deal nets them more than taking the assets to the auction house.

 

A long winded way of saying that our typical customer through and at this end of the downturn is no longer the usual industry veteran looking to exit his business and retire to a small shack in (soon to be unwelcoming to Alberta property owners) Kelowna. Instead, we are increasingly finding ourselves in front of young management teams who are telling us about their seven step plan to global domination. It’s actually a pretty exciting time once you sort through the gloom.

 

Buyer demographic has changed

 

At the same time as our client demographic is changing so too is the buyer demographic. I think the days where you can run a sale “process” and carpet bomb private equity with an opportunity and hit the most obvious strategic buyers with a teaser and expect a hyper-competitive auction to break out are over. Buyers are more cautious, more skeptical and smarter than ever. Private equity funds are seeing multiple competing deals a day and in the oil patch, the gravitational pull of the Permian is immense. Industry agnostic US private equity funds are pretty much thumbing their noses at the sleepy Canadian energy services market and getting anyone to pay attention is really a labour of love, notwithstanding the excellent value proposition that Canada represents.

 

To run a successful process these days, as an advisor you need to spend a remarkable amount of time explaining the opportunity to your strategic buyer network and understanding what their corporate goals are. On the private equity side of the buyer ledger, as an advisor, you need to have solid pre-existing contact into the firms in question and know what they have in their portfolios and where a client company is going to fit. And against all rules of M&A and auctions, you need to be prepared to enter into properly qualified pre-emptive situations when someone grabs the bit – with less buyers, this is a necessary evil.

 

As we’ve watched this shift in the buyer pool develop, we have invested a lot of time and effort into nurturing and expanding our touchpoints into as many of these organizations as possible. In any given week, we probably spend up to 20% of our time talking to prospective buyers about what their priorities are, outside of specific opportunities.

 

Multiples don’t matter as much

 

This may seem counter-intuitive, but in a world where many companies have seen their EBITDA cut in half or more, most energy service businesses are underperforming their asset base and/or their potential. This means if you want to buy “company x”, you need to be prepared to pay at least fair market value for tangible and intangible assets plus a bit of goodwill and if the trailing EBITDA shows you with a multiple of 10 to 12 times, well you suck it up and pay it. The flip side of this is a laser focus by buyers on the forward curve – what work is in the bag, in the pipeline and in the hope chest and what does that mean for cash flow. This is where maybe the multiple comes back into the realm of reality. It’s less a “what have you done for me lately” and more of a “what can you do for me tomorrow” market.

 

Government policy has made it harder to do deals

 

Yes. And no. Since 2014 there have been a number of policy changes that have made the oil patch a more complicated place to do business. I am thinking of carbon taxes, emissions rules, royalty changes, tax increases… But ultimately most of these have been absorbed and adapted to by the sector. Where government has gotten in the way is in, you guessed it, inaction and inability to encourage more offtake and infrastructure investment. This, as any regular reader of the blog will know, is one of the key areas needing to be addressed to help the energy sector really grab gears. But in the meantime, we soldier on!

 

Way more attention to asset management, production and delivery

 

When people think of the oil patch, they think drilling rigs, frac crews and those giant trucks that populate the mineable areas of the oil sands. But that is just a small part of the massive and complex infrastructure that exists to deliver plentiful and affordable energy to Canadians across the country every day. A more critical aspect of that is maintaining existing production levels and ensuring the integrity of the pipeline delivery network that exists across Western Canada. For this reason, we executed a pivot in our business in late 2014 from being predominantly upstream focused to a more balanced up/mid/downstream approach. Many of our clients over the past few years make their living building, maintaining and decommissioning the vast network of pipeline and processing facilities that exist across our country. We would estimate that after health and safety services, this area has been a particular focus for us accounting for a significant portion of our client base.

 

Technology

 

Technology and innovation has always mattered in the oil patch. We are dealing with hard to find molecules of fossil fuels that are located miles underground and require tremendous ingenuity to extract and bring to the surface. Every technique, tool and process available to get that to happen faster and more efficiently is critical. We saw this over the last few years even though arguably efficiency was also a function of price-cutting. That said, going forward the application of new, more efficient processes, better tools, artificial intelligence, big data, block chain – all of these are coming to the fore in the patch as former employees of E&P firms and engineering firms and other innovators come up with better and more effective ways to execute the same task.

 

We are seeing this in our client base with many companies presenting new ways to optimize production or drilling efficiency. We even see the application of technology in our own approach to transactions, as we are able to leverage rich content from service providers that allow us to do our jobs more effectively and compete head to head with larger firms possessing infinitely more resources.

 

The US is where it’s at

 

Yes. And no. We hear it every day. We read about it. We obsess about it. We need two new news networks – the Trump channel and the Permian channel. The United States is seeing an inordinate amount of activity relative to Canada and is attracting a ton of capital. Many of our clients in the past few years are looking for that wedge entry point into the US market. Heck, we’re looking at it too. Not because we don’t like Canada or our clients don’t like Canada – there is a lot of opportunity here. But life is short and companies exist to make money and there is currently lots to be made in the US. The flip side is that the US oil patch is a very expensive place to do business – multiples are orders of magnitude higher than in Canada and the market is huge and parochial. Go figure. For our clients, it’s a numbers game. For us, the border doesn’t matter.

 

Closing thoughts

 

So, it was a weird question and I gave a long winded evasive answer. Maybe a bit of an advertorial, so sorry about that, but this is what we do, what we’ve observed and how we’ve adapted. We are a specialized energy service focused company and we have stayed true to that through the whole industry downturn and recovery and made a very conscious decision to stick to our expertise and avoid the temptation of chasing our tails in other industries. It involved tightening our belts for a while but we are better and stronger for it.

 

So yes, it has been a tough few years. Less so for us than for our clients. We are able to work in pretty much any market and aren’t particularly concerned with how hard it is, or what the deal size is. Instead, we are instead focused on what’s best for our clients and helping them achieve their transaction goals, whether it is a graceful exit from their business, a transformative acquisition or something as simple as the chance to live to fight another day.

 

What does the future hold? We truly believe that the next few years represent a significant opportunity in M&A, for firms to transform themselves through acquisition into the world beaters that we know Canadian firms can be and are of the view that it’s a continental market and to succeed you need to be on both sides of the border if possible. And we are excited to be part of that process, however it unfolds. We are getting engaged on new and interesting mandates on an accelerating basis. We are looking to the future as the current cycle unfolds and determining what steps we need to take to build our business not for today, but for next year and the years after that.

 

How’s business? Good. Growing. Has it been tough in Alberta? Damn right is has, but it’s made us all tougher, stronger and smarter. Watch out.

 

Prices as at March 9, 2018 (March 2, 2018)

• The price of oil rose then fell during the week on positive economic news and then a not so bullish storage report.
  • Storage posted an increase
  • Production was up marginally
  • The rig count in the US was mixed
• After a smaller than expected withdrawal, natural gas remained in the doldrums – expect continued volatility…

 

• WTI Crude: $62.04 ($61.40)
• Nymex Gas: $2.730 ($2.711)
• US/Canadian Dollar: $0.7804 ($ 0.7760)

Highlights

• As at March 2, 2018, US crude oil supplies were at 425.9 million barrels, an increase of 2.4 million barrels from the previous week and 102.5 million barrels below last year.
  • The number of days oil supply in storage was 26.7 behind last year’s 34.2.
  • Production was up for the week by 86,000 barrels a day at 10.369 million barrels per day. Production last year at the same time was 9.088 million barrels per day. The change in production this week came from a marginal increase in Alaska deliveries and a increase in Lower 48 production.
  • Imports rose from 7.282 million barrels a day to 8.003 compared to 8.150 million barrels per day last year.
  • Exports from the US rose to 1.498 million barrels a day from 1.445 last week and 0.897 a year ago
  • Canadian exports to the US were 3.442 million barrels a day, up from 3.219
  • Refinery inputs were up during the week at 15.935 million barrels a day
• As at March 2, 2018, US natural gas in storage was 1.625 billion cubic feet (Bcf), which is 16% lower than the 5-year average and about 30% less than last year’s level, following an implied net withdrawal of 57 Bcf during the report week
  • Overall U.S. natural gas consumption was up 2% during the report week, influenced by weather
  • Production for the week was flat. Imports from Canada were up 8% compared to the week before. Exports to Mexico were flat.
  • LNG exports totalled 25.0 Bcf including one vessel carrying 3.5 Bcf of gas from the newly commissioned LNG facility in Cove Point Maryland.
• As of March 6 the Canadian rig count was 285 – 201 Alberta, 8 BC, 66 Saskatchewan, 6 Manitoba and 2 elsewhere. Rig count for the same period last year was about 270.
• US Onshore Oil rig count at March 9, 2018 was at 796, down 4 from the week prior.
  • Peak rig count was October 10, 2014 at 1,609
• Natural gas rigs drilling in the United States was up 7 at 188.
  • 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 down 1 at 13
  • Offshore rig count at January 1, 2015 was 55

• US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 70%/30%

 

Drillbits

• President Trump signed his new steel and aluminum tariff law on Thursday. For the time being Canada and Mexico are exempt unless we screw up the NAFTA negotiations or Trudeau wears the wrong socks. It’s all very fluid
• In a startling development, a US shale player was overheard at CERA Week stating that they expected to be Free Cash Flow positive in the second half of 2018. For the first time in 18 years. Well done. I guess.
• Speaking of CERA week, this is the annual confab of oil and gas movers and shakers from across the globe, held in Houston and breathlessly covered by expense account journalists and oil hanger-ons. As usual, my invitation… lost in the mail
• The Alberta government announced via its speech from ther throne to open the 2018 legislative session that it would consider restricting oil and product shipments to the BC Interior and Coast if the BC government continues to obstruct the TransMountain pipeline expansion. Take that, I guess. But tell me, how is penalizing your own industry an effective way to combat another jurisdiction… Oh wait, Trump, tariffs… I get it now.
• Australia’s Woodside Petroleum has dropped plans to build a liquefied natural gas export plant at Grassy Point on Canada’s west coast,choosing to focus on another Canadian LNG project, Kitimat, run by Chevron Corp. In a related development, Chevron is looking to sell a minority share of its interest in the Kitimat LNG project. Please, can someone just go ahead and build one of these things already?
• Trump Watch: Stormy Daniels. Kim Jong Un. Stormy Daniels. Kim Jong Un. Mueller. Ugh.