Description

Thesis Summary

Thanks to a historically high discount on its private assets of 63% that constitutes a welcome margin of safety, Riverstone Energy (RSE LN) not only offers long exposure to WTI and to the “higher energy prices for longer” trade that many people missed this year, but also represents a rare “value” vehicle to ride the decarbonisation technologies sector as the fund pivots away from a legacy portfolio heavy on conventional energy (mainly North American shale) towards energy transition assets.

One crucial leg of my thesis is that the track record of its manager is unduly tarred. Governance and capital allocation and alignment of interests actually improved sharply since 2019, following, as we have to acknowledge, a rather disastrous period of complacency, with sometimes overly concentrated shale bets, and a few diworsification mistakes.

Everything pondered, as someone who, with a bit of luck on the timing maybe, managed to trade RSE as a proxy oil play with success throughout its whole turbulent history, I believe Riverstone as a manager thoroughly deserves a more nuanced assessment of its performance since launch of this vehicle in late 2013. The revised management agreement and modified investment policy initiated after the threat of a wind down (discontinuation was put to vote) during 2019 made a lot of sense to me and are now reaping undeniably positive results. If one encompasses the whole tenure, and in spite of the inauspicious timing of their launch, I would think Riverstone’s track record shows substantial outperformance over most public and private peers and industry benchmarks.   

A constant stream of realisations and public listings, which is remarkable given the appalling context of the industry, the power of a mammoth buyback policy, the strategic pivot likely to attract fresh bids, also contribute to form a good case to invest at this stage of the cycle, even after the massive rerating since 2020.

Key quantitative take-aways:

True discount on private assets is fat at 63%, higher than the 42% facial discount. It could even increase in Q1 2023 when Hammerhead, which accounts for 20% of NAV, gets public.

Reasons for mispricing

Today’s hybrid portfolio mix, and obviously the truly epic bear market of the oil & gas sector since Riverstone Energy  IPOed at the top of the previous commodity cycle in 2013 when WTI at $100, help to explain why RSE LN  is an orphaned security, with inadequate liquidity  and a lack of analyst coverage. Still I find it quite surprising it has not been written up on the VIC before by the Closed-End-Funds aficionados, with the notable exception of CDEV – one of their key investments, now called Permian Resources after a recent merger.

Background: how RSE fared during a commodity bear market for the ages

When it IPOed in October 2013 at the height of commodity prices, on the London Stock Exchange, Riverstone CEF looked like a compelling proposal for energy investors. It enabled to get liquid public-market exposure to the deal-making nous of private equity firm Riverstone Holdings, which since its incorporation in 2000 by David M. Leuschen and Pierre Lapeyre, Jr, both ex Godman IB veterans, had reached the status of the world’s largest private equity investor in energy companies.  The senior executive team was widely considered as fierce negotiators, capable of tapping their Goldman connections to recruit deal makers and find juicy investment opportunities. Riverstone’s mandate was fairly wide, as it conducted buyout and growth capital investments in the exploration and production, midstream, credit, oilfield services, power and renewable sectors of the global energy industry. Riverstone had already committed over $30 billion to more than 120 investments in North America, Latin America, Europe, Mexico, Africa and Asia. In particular, the firm was proving a prolific financier of the U.S. shale-drilling boom.

The cornerstone investors comprised big names like Louis Bacon, founder of Moore Capital Management and proper institutions with deep experience on the sector like Alaska Permanent Fund Corp; the board was chaired by Sir Robert Wilson, the former chairman of BG Group (now Royal Dutch Shell) and Rio Tinto;  Lord Browne, the former chief executive of BP was on the board alongside Jim Hackett, former CEO of Anadarko Petroleum, a true fracking legend. The team assembled read like a who’s who of the top executives  of fracking pioneers and oil & gas senior rainmakers, such that the 1.5% management fee plus somewhat biassed (low-hurdle) performance fees  looked like a cheap ransom to pay to secure such prime stewardship.

The destruction of value for oil & gas investors, the historic bear market that ensued is well documented and I shall not dwell too much on it. Not only did oil prices quickly collapse from $100 in late 2013 to a low of $26 in 2016, but the China-US trade wars and Covid lockdown that followed, in a context of financing deserting the space due to mounting ESG constraints and heavy losses, dramatic compression of multiples especially for smaller E&P players, and idiosyncratic issues in Canada shale (shortage of pipeline and other infrastructure, political bottlenecks, did conjugate to form colossal headwinds for Riverstone.  Write-downs on private investments, public marks getting crushed, all lead to heavy NAV declines, compounded by a widening of the discount with investor sentiment at all-time lows.

Yet, looking under the hood, there were some mitigating factors that seemed to be overlooked. Even though RSE had committed when WTI was 100, it still had considerable cash resources being deployed at a slower pace than anticipated, resulting in the RSE portfolio being invested at a weighted average oil price of approximately $51.  Besides, the ample firepower enabled them to capture a fair amount of great opportunistic deals at truly distressed valuations especially in Western Canada and the Permian.  Another technical mitigating factor was the systematic re-investment of the performance fees into RSE shares at market.  To this day Riverstone employees still account for 8% of the register.

RSE investment strategy expanded to also focus on the other sectors across the energy value chain including energy services and power, but ultimately a wind-down vote provision (based on failures of Invested Capital Target Return and share price) was triggered in 2019 and led, quite forcefully, to structural changes for the better to restore lost shareholder confidence.

First, the Investment Manager accelerated the strategic pivot to reposition the Company's focus away from oil and gas investments in the exploration and production sector and to increase its focus on renewable, decarbonisation and selective infrastructure investments. A smart move with a view to attract fresh capital and a new breed of investors and reverse the outflows faced by the industry; as evidence, I would  highlight that  in 2020, the SP Global clean Energy index grew by  138%, whereas the SP Oil & Gas  EP Index fell by 37%.

Second, even though no change was made to the 1.5% fixed fee, additional conditions were installed for accrual and distribution of any performance allocation: 1) a portfolio level cost benchmark requiring the portfolio's unrealised and realised value to be above cost, upon an investment realisation; 2) a an 8 per cent annual cumulative hurdle rate calculated from the date of investment to the date of realisation; 3) a full realisation of an investment.

Third, it was decided that a distribution of 20 percent of net profits attributable to each fully realised line would be available for distribution to the Company's Shareholders, whether by dividend or share repurchases. The share buyback that followed is quite spectacular: between 2020 and 2022, a third of the shares outstanding were retired at mammoth discount to NAV: brutally efficient to enhance NAV per share.

The table below aims to illustrate this turbulent history.

It looks to me NAV per share has greatly outperformed the SP Oil & Gas Index. I would go as far as to say that faced with those incredible set of challenges, Riverstone significantly outperformed its benchmarks.

The portfolio today

RSE’s pivot is quite advanced with transition assets representing a third of the portfolio.

Thanks to a steady pace of realizations and public listings, private investments now only amount to two thirds (2/3) of the mix.  Note than when Hammerhead will get listed in Q1 2023, this private portion will drop to less than half of the portfolio.

 https://www.reuters.com/markets/us/hammerhead-plans-rare-us-listing-canadian-gas-producer-over-1-bln-spac-deal-2022-09-26/

Conclusion and Price Target

Even without any sanguine bullish view on oil, I would think RSE is a fairly convex proposal. By Q1 2023, cash and public lines will amount to half of its NAV. Plug a discount of 40% on the private holdings, which seems reasonably conservative as the pivot continues and less and less of this  bucket  is conventional, and you can justify a price target 35% above current.

Catalyst

Hammerhead IPO in Q1 2023; continued Share BuyBack: rotation of share register from legacy fossil investors towards ESG mandates; possible wind down vote in late 2022