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5 REASONS WHY ENERGY CEOS SHOULD BE TALKING TO INVESTMENT BANKERS
DAN HAMMAKER, AXIAL, NEW YORK CITY
WITH OIL PRICES HANGING in the balance, talks of deals are likely unwelcome by many CEOs. There is still interest from the deal community, however, from strategic buyers flexing their strong cash positions to consolidate the smaller players to private equity firms taking advantage of the current price environment. Some industry specialists have also warned that if oil prices continue to stay low for too long, mid-sized companies may be forced to take on huge levels of debt. As a result, the energy industry is expected to go through a period of restructuring and the question is not "if" but when.
Even so, many CEOs do not feel they are in a place to make a decision about the future of the company and as such, feel there is no reason to talk with bankers who may be inquiring. The truth is there has never been a better time to develop these relationships.
Having relationships with investment bankers, regardless of whether a company is considering a transaction, grants a CEO access to the information needed to grow and maximize the value of the business. Given uncertain market conditions, leveraging this relationship may be necessary sooner than one may think.
There are five vital reasons energy CEOs should be developing relationships with and engaging in conversations with investment bankers now more than ever.
1. UNDERSTANDING VALUATION
Particularly in a fluctuating environment, it's important to understand how buyers come to a company's valuation.
There are two common ways to look at the value of a company, and CEOs should be aware of tthe differences. Enterprise Value (EV) can be thought of as what a business is worth based mostly on its common stock price, which is often derived in large part from the health of the balance sheet. Fair Market Value (FMV) considers market conditions and buyer demand in addition to EV.
Unlike FMV, CEOs can control the company's EV. That number not only illuminates the overall health of the business, but it can also reveal the strength of KPIs (key performance indicators) that drive valuation. If a CEO seeks to maximize the value of the company, knowing valuation KPIs is not optional - lacking that knowledge risks failing to address problems at the company before they cause irreparable harm to its EV.
Since the primary component of EV is the value of a company's common stock, its figure tends to be grounded in whatever has been paid for a business in the past. FMV, however, is more forward looking - it seeks to depict what a future offer should be. Rarely can EV exceed FMV, but often a buyer will attempt to catch a CEO off-guard with an offer between EV and FMV. CEOs who don't know FMV risk accepting a spontaneous offer that is too low, or passing on a deal that shouldn't be refused.
2. UNDERSTANDING INDUSTRY MULTIPLE COMPS
The EBITDA multiple has become the industry standard for FMV measurement. Since companies in the same size-bracket should expect to face similar market conditions and buyer demand, they tend to share EBITDA multiples as well. CEOs that are aware of multiples commanded by energy companies both larger and smaller than their own are better able to calculate their own growth strategy.
Consider, for instance, a CEO who is looking to grow. The CEO might see new opportunities for expansion, but that expansion is unattainable without a capital outlay. No matter - the CEO will just take out a loan or raise equity. On the other hand, because larger companies can command higher multiples, that CEO might first consider an acquisition. A small competitor can be purchased at a low multiple, vaulting the company's size into the bracket where multiples are higher. The CEO could then leverage the new market influence for better terms on a loan or a higher price on equity, either of which allows the CEO, in theory, to invest more and accelerate growth trajectory. Such a strategy cannot be conceived without first knowing multiples above and below the status quo.
3. ASSESSING GROWTH RATES
As EBITDA multiples and FMV imply, valuations exist relative to the market. As a result, though a CEO might be growing the company, the company could effectively be shrinking if the competition is growing faster.
Thus, to grow is not enough - a CEO must find ways to accelerate the company's growth rate past that of the competition. Investment banks, with their steady transaction involvement, have a strong grasp of how fast companies of different sizes in the energy industry are growing. The savvy CEO can use this to benchmark the company's current performance against that of the competition and establish goals for the future accordingly.
4. STAYING ON TOP OF INTEREST RATES
A line of credit is a standard tool in the CEO kit used to smooth seasonal valleys in revenue, finance minor repairs, and cover incidental expenses. However, as in the previous example regarding the CEO looking to grow, sometimes a simple credit facility won't match the investment necessary to take full advantage of a company's full growth potential.
An investment banker can help a CEO understand which credit option will maximize opportunity while minimizing losses in financial flexibility. When considering the many forms debt can take - from junior capital to senior debt, mezzanine to A/R financing - knowing the differences in terms and rates can get complicated quickly. Investment banks can offer not only a sense for what type of debt best fits a CEO's needs, they can likely bring to the table a number of providers interested in having a conversation.
5. COMING TO A 5-YEAR VALUATION TARGET
For CEOs not ready to make a move, but interested in planning for the future, knowing what a company could be worth down the line is an important metric. Using information gathered about the current worth of the business and the rate at which it should grow, most investment bankers can provide a five-year valuation target. What's important to note here is that investment bankers also bring energy industry projections that add color to otherwise standard future predictions. These insights include market expectations, buyer behavior, seller indications, and more.
A CEO's goal is always to maximize the value of the company. To do so, the CEO must supplement internal prowess with an understanding of what's going on externally. It is worthwhile talking to energy investment bankers because of their expertise in energy markets.
ABOUT THE AUTHOR
Dan Hammaker is a product marketing manager at Axial, an online network for deal professionals and CEOs, where he helps CEOs and executives of private companies understand their options for growing and maximizing the value of their businesses.