Activism at U.S. oil and gas companies has trended at an elevated level since 2016, a couple of years after commodity prices plummeted, with M&A-related demands booming. Between 25 and 29 companies in the sector have received public demands each year since 2016, according to Activist Insight Online, compared to 17 and 21 between 2013 and 2015. Now, one activist is seeking to articulate why investors don’t think management teams should be trusted to fight for survival alone.
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Kimmeridge Says Move Away From Fossil Fuels Is Hurting Business
Kimmeridge Energy Management released a white paper last week describing the U.S. exploration and production (E&P) industry as being "in a time of crisis" fed by sub-$60 oil and a global move away from fossil fuels. Those factors may be unavoidable, but Kimmeridge believes expansionist, debt-laden, and inefficient strategies continue to play too large a role.
Regular readers will be familiar with geologist and former Sanford Bernstein sell-side analyst Ben Dell and his firm Kimmeridge, the owner/operator/investor that has dipped its toe into activism three times over the past couple of proxy seasons. Indeed, only four investors have made public demands at three different oil and gas companies since 2018, according to Activist Insight Online, and Kimmeridge is one of them (the others are SailingStone Capital Partners, Elliott Management, and Fir Tree Partners).
Starting from next year, the self-described private equity firm is planning on having an even bigger impact. Kimmeridge recently hired Wellington Management portfolio manager Mark Viviano as its head of public equities and is reportedly seeking between $500 million and $1 billion for a new fund – Kimmeridge Energy Engagement Partners. That’s ambitious for an industry where as many as one-third of companies are, by Dell’s own admission, uninvestable. Yet it reflects a vision for how the sector digs itself out of the mess that it currently finds itself in.
The Problems Arising From Uneconomic Drilling
Uneconomic drilling is primarily an incentive problem, Dell argues, with low parachute payments, short holding requirements for stock-based compensation and too many relative or revenue-based targets included in bonus payments. "I would say the number one problem with the industry is corporate governance and how management are being paid," Dell told me in an interview this week.
Kimmeridge plans to be a corrective, advocating reduced reinvestment, maximal return of capital to shareholders, and consolidation. In other sectors, that might instantly be deemed short-termist. But in upstream oil & gas, reducing production could be in the interests of both investors and climate activists.
"The reality is, if investors walk away from the sector and they don't vote to change the behavior, we will end up with a sector that spends 100% of Ebitda, that drills uneconomic wells, that flares gas, that uses fresh water, and doesn't adhere to the best possible standards," Dell argues. "If you want to change the sector, you have to engage, and I wholeheartedly believe that ESG does not mean walking away."
(Recently, Elliott Management took the other end of the wedge, suggesting Kansas and Missouri utility Evergy increase its renewable output – the two settled this week).
With an environmental, social, and governance (ESG) agenda focused on reducing waste and improving alignment with shareholders, Kimmeridge may soon be seeking to better its result at PDC Energy, where it won 42% of the vote in a proxy contest last year.
Three months after the fight, PDC acquired neighbor SRC Energy in a low-premium, all-stock deal that could become a model. The number of E&P companies could even shrink from 600-odd to 100, Dell says, although that could take a decade.
"My experience from PDC is that long-only investors in energy, those who are left, understand what needs to be done and want to see it fixed," he continues. "I think people believe that if anyone could turn around the sector from an activism standpoint, it's the team we're putting together."
Twitter, which is reportedly under pressure from Elliott Management to hire a permanent CEO, has been a prospective target for activism for at least four years ("It's a truth almost universally acknowledged that a Twitter shareholder in need of a return is in search of an activist investor." Activist Insight Vulnerability, February 3, 2016). The natural question is, what took so long? In those four years, Twitter turned a $457 million loss into a $1.5 billion profit and nearly doubled its cash (or total assets, if you prefer). The stock price has actually doubled in that timeframe, although it has been a long road back from the $14 low to $35 today. Twitter never delivered on its early promise – it briefly traded at $69 in 2014 – so the intervening years were a series of disappointments. But it remains a reminder that activists in search of a target need a business to turn around before they commit themselves to a campaign.
MG Capital Urges HC2 To Investigate Philip Falcone
Quote of the week comes from MG Capital, which wrote to the audit committee of HC2 this week to urge an investigation of CEO and Chairman Philip Falcone, including "concerning accounting and disclosure issues that may represent either outright fraud or a violation of rules," and in a separate letter to shareholders said it would nominate a six-person slate to replace the entire board. In its letter to shareholders, the 5% stockholder wrote:
"In light of all these historical and recent issues, we feel that HC2 stands at a crossroads this spring. Even if Mr. Falcone enacts some incremental enhancements designed to improve HC2’s short-term prospects, we believe any road forward proposed by him will lead off a cliff. MG Capital is offering an alternative road that we contend will lead to enhanced value creation, superior governance, and the eradication of conflicts and self-dealing."