Description

Summary

Riverstone Energy Ltd (RSE), a London-listed investment trust domiciled in Guernsey, was established by Riverstone Holdings in 2013 to focus on investments in global energy companies. Initially heavy on conventional energy, RSE shifted its strategy post-2020 towards energy transition and decarbonization.

As of 31 March 2024, RSE's portfolio included notable holdings such as Permian Resources and Crescent Point Energy, with a mix of listed and unlisted assets, focusing increasingly on decarbonization projects. RSE’s recent price per share of ~900 GBp per share, represents a 33% discount to headline NAV, with 74% of NAV in cash or liquid public positions. The discount to public investments is about 14%, and the implied discount to private assets is 111%. The stock is likely undervalued due include small market capitalization, UK listing, closed-end fund status, and the complex mix of conventional and decarbonization assets. Despite historical issues with performance fees, the revised management agreement in 2019 has improved alignment with unit holders.

RSE’s strategy of returning capital through significant share buybacks and tender offers has been accretive to NAV per share. The company executed a major buyback in March 2024, acquiring 15 million shares at 1,050 pence each (over 35% of shares outstanding). The potential for further buybacks or a wind-down scenario could address the persistent NAV discount and illiquidity, offering significant upside for unit holders. I suggest reviewing the December 2022 write-up from Chevalierd'Aven for additional background.

Investment Thesis

Market implied valuations: At ~900 GBp per share, RSE is trading at 33% discount to headline NAV. However, 74% of net asset value now consists of cash or liquid public positions. The discount to public investments is approximately 14% and the implied discount to private assets is 111%. Even writing off all remaining decarbonisation investments would suggests mid-teen discount to NAV.

Mispricing source: technical sources of mispricing likely include lack of sell-side coverage due to (1) small market capitalization, (2) UK-listing, (3) closed-end fund (few natural buyers), and (4) unusual combination of conventional and decarbonisation assets. Analytical complexity is driven by a combination of public and private holdings, fee structure, and underlying foreign currency. 

RSE also suffers from historical perceptions around the Fund’s egregious performance fee structure prior to the revised IMA in 2019. The Investment Manager charged a 20% performance fee on individual gains, regardless of overall portfolio level performance and before tax (typically more than 28%). A wind-down vote triggered by failures on Invested Capital Target Return and share price resulted in substantial revisions to the IMA. The revised performance fee structure is much more aligned with unit holders. Riverstone Group also owns 8% of RSE shares, suggesting further alignment.

Chevalierd'Aven presents a compelling case that the manager's performance is better than it initially appears. In summary, despite committing when WTI was at $100, RSE's slower cash deployment led to a portfolio investment at an average oil price of $51. This enabled RSE to capitalize on distressed valuation opportunities, particularly in Western Canada and the Permian. Onyx Power has been an exceptional purchase at bargain prices, aided by the effects of the war in Ukraine. However, the performance of decarbonization investments has been mixed.

The company explains the discount as follows: “The Company’s shares have, for a considerable period, been trading at a discount to NAV per share for reasons, including, but not limited to, general market conditions in the energy sector, liquidity concerns, perceived issues with the terms of the Investment Management Agreement and actual or expected Company performance as the Company transitions to maximise value from the conventional portfolio allowing investment into its decarbonisation strategy.”

Buybacks (Catalyst 1): RSE has over half of total outstanding shares since the programme was announced in 2020, ranking among the largest buybacks for closed-end funds. The board balances the buyback with potential consequences: “diminished share liquidity, limited capital for future investments, restricted investment scope, smaller transaction sizes with higher volatility, reduced deal frequency, increased concentration, and lower diversification, thereby elevating risk." The Board evaluates “opportunities for additional share buybacks or tender offers based upon projected cashflow from potential significant asset investment and divestitures.”

In August 2023, RSE announced a tender offer for up to 30.4% of its outstanding shares, at a price of 578 pence per share. As of 16 August 2023, RSE's cash reserves stood at $123 million. The company planned to allocate up to $100 million (£80 million) for share repurchases from tendering shareholders.

The recent tender offer launched in February 2024, priced at GBP 10.50 per share, represents an additional strategic move to return capital to shareholders and improve shareholder value. The offer, closing in March 2024, was a premium of approximately 31% over the closing market price, reflecting the company’s confidence in its valuation.

On 28 March 2024, RSE successfully executed a tender offer, acquiring and cancelling 15,047,619 ordinary shares at a price of 1,050 pence per share, totalling £158 million ($198.6 million). The buyback of 35.66% of shares, set at a 16.2% discount to the 31/12/23 NAV were all significantly accretive to the NAV per share. Similar buybacks and tender offers are likely as RSE realises additional assets.

Wind down (Catalyst 2): At some point, the persistent NAV discount and high portion of liquid holdings / cash make it logical to wind down or run-off the fund. Given that decarbonization investments have performed poorly, with an aggregate mark of 0.44x cost, it is hoped that the Board will continue returning capital and gradually wind down the company. However, the manager might be reluctant to sell the listed assets in the short term, as the performance fee requires filling a $61 million gap, after which they would be entitled to $32 million.

Either the Board or shareholders holding in aggregate at least 10% of the voting securities can call an EGM at any time to vote on the liquidation of the Company (75% of the votes cast in favour required) or run-off of its portfolio (50% of the votes cast in favour required). Under both these scenarios, the manager would be entitled to twenty times the most recent quarterly management fee (7.5% of NAV).

Whilst the buyback and tender programmes are effectively driven by the independent board, a successful wind-down vote would likely require the support of the ‘Cornerstone Investors’ which also have an economic interest in the investment manager. Riverstone and the Company’s ‘Cornerstone Investors’ own approximately over one third of outstanding shares, as reported by the company. The notable Cornerstone investors are Moore Global Investments LLC (20% ownership of RSE based on Bloomberg) and Akrc Investments LLC (Alaska Permanent Fund Corporation, 11%). Combined with Riverstone Investment Group’s 8% ownership suggest that insiders own roughly 40% of shares outstanding.

The investment manager and Cornerstone arguably have incentives to avoid liquidation or wind down given economic stakes in the ongoing management fees and potential future performance fees. However, these incentives are offset by (1) generous wind down fees equivalent to 5 years of management fees, (2) reduced RSE net asset value on which management fees are charged, especially post-HHRS buyback and relative to the Investment Manager’s much larger total AUM, (3) most public market decarbonisation investments are valued at significant losses, suggesting remaining performance fees above the hurdle rate are not imminent, and (4) meaningful ownership of RSE units by Cornerstone investors and the Investment Manager suggests significant upside wind down scenarios. Even if private assets were realised at 30% discounts to latest NAV fair values, a wind down scenario would result is +30% upside to unit holders, after the 7.5% wind-down / run-off fee.

Company overview

Riverstone Energy Limited (RSE) is a Guernsey-domiciled, closed-ended company established by Riverstone Holdings in 2013, focusing on investments in global energy companies and assets. RSE’s investment manager is Riverstone International Limited, controlled by affiliates of Riverstone, an energy and power-focused private investment firm founded in 2000 by David M. Leuschen and Pierre F. Lapeyre. Riverstone Holdings has raised approximately $41 billion in capital, committing around $43 billion to over 200 investments across multiple continents. It is one of the largest energy investors globally with an estimated $16.5 billion assets under management as of March 2023.

RSE was launched with a £760 million initial public offering in October 2013 and is listed on the London Stock Exchange. Despite prominent investors like Louis Bacon and backing from institutions such as the Alaska Permanent Fund Corp, Riverstone faced a challenging market. The sector's downturn, exacerbated by low oil prices, trade wars, and COVID lockdowns, led to significant value loss and NAV declines. However, Riverstone's prudent investment strategy, including a slower deployment of cash reserves and opportunistic acquisitions during market lows, mitigated some impacts. Employees' continued investment in the company, holding 8% of shares.

Updated approach: As of December 2020, RSE operates with a fully independent board of directors and has committed to a new investment approach focusing on the energy transition and decarbonisation opportunities​​​​​​. As of June 30, 2023, Riverstone Energy Limited's (REL) portfolio consisted of fifteen active investments. This included two in exploration and production (E&P), twelve in decarbonization projects, and one in the power sector. In selecting investments, the Investment Manager targets investments expected to generate a Gross IRR of between 20 and 30 per cent.

Fee structure: RSE's performance fee terms mandate achieving a portfolio-level cost benchmark before accruing performance fees. Once this target is met across the portfolio, performance fees become eligible for accrual. These fees are calculated deal-by-deal at 20% of gross realized profits, subject to an 8% per annum hurdle rate for each investment. Full catch-up applies once the 8% hurdle is reached.

As of Q1 2024, RSE needed to realize $60.9 million in portfolio gains to meet this benchmark.. For context, this performance cost benchmark deficit was $606 million in June 2020, reduced to $88 million by 30 September 2022, and further to $95 million by 31 December 2022.

In addition, pursuant to changes to the Investment Management Agreement announced on 3 January 2020, the Investment Manager agreed for the Company to be required to repurchase shares or pay dividends equal to 20 per cent of net gains on dispositions. REL continues to seek opportunities to purchase shares in the market at prices at or below the prevailing NAV per share.

Decarbonization investments: Throughout 2022, RSE committed $95.2 million to seven new decarbonization initiatives, increasing its total investment in this sector to $210 million. These investments include Anuvia Plant Nutrients ($20 million), T-REX Group ($17.5 million), Infinitum Electric ($17.5 million), Tritium DCFC ($15 million), Our Next Energy ($11.5 million), DCFC Loan ($9.7 million), and Group14 Technologies ($4 million). In the same period, RSE realized net distributions and realizations totaling $163.8 million. This amount comprises disbursements from Onyx ($61.0 million), Pipestone ($41.7 million), Carrier II ($34.0 million), Centennial ($22.2 million), Meritage III ($1.7 million), Rock Oil ($1.1 million), and a combined $1.4 million from ILX III, GoodLeap, and DCFC loan. The success of decarbonization investments has been unimpressive to date, partially given many were purchased near market peaks.

Recent developments: RSE’s recent progress has been defined by the success and continued monetization of Conventional assets (69% of NAV), alongside a lacklustre performance of Decarbonisation assets (19% of NAV). Notable events include:

September 2022: RSE announced the merger of its portfolio companies, Hammerhead Resources Inc. and Decarbonization Plus Acquisition Corporation IV (DCRD). This merger led to the formation of a new publicly-traded oil and gas company, with a focus on decarbonizing operations through a carbon capture and sequestration program. RSE held a significant interest in both entities, positioning it favourably in the new setup.

October 2022 to January 2023: RSE disclosed its third-quarter NAV, revealing an increase due to improvements in investments like Onyx and Hammerhead. During this period, DCRD shareholders approved the merger with Hammerhead. This merger significantly increased Hammerhead's share in RSE's portfolio, making it the largest investment.

August to October 2023: RSE provided interim results and updates on its portfolio, highlighting investments in decarbonization and energy transition. The company's NAV experienced fluctuations influenced by market conditions and the performance of specific investments, such as Hammerhead and Permian Resources.

November 2023: RSE announced the sale of Hammerhead to Crescent Point Energy Corp. This sale represented a significant uplift in RSE's investment in Hammerhead and was seen as a culmination of effective strategy and negotiations. The sale of Hammerhead Energy to Crescent Point Energy resulted in RSE receiving $175 million in cash and 8 million shares of Crescent Point Energy. This transaction was completed in December 2023, marking a significant milestone for RSE, positioning it favourably with substantial liquidity to pursue further investments or additional shareholder returns. The strategic alignment with Crescent Point Energy underscores RSE’s ability to leverage its assets effectively.

Permian Resources: RSE’s second largest exposure is Permian Resources (PR) at 38% of March 2024 NAV. Permian Resources, NYSE-listed as PR with $12.3 billion market capitalization, is an independent oil and natural gas company focused on the Delaware Basin within the Permian Basin.

Recent developments have been positive with PR’s stock returning 45% in 2023, and 18% year-to-date 2024. Permian Resources reported strong financial and operational results for the first quarter of 2024. The company produced 151,794 barrels of oil per day (bopd) and 319,514 barrels of oil equivalent per day (boed), surpassing their earlier forecasts. PR acquired Earthstone Energy in 2023. Recent PR strong performance was attributed to better well productivity and faster-than-expected integration of assets acquired from Earthstone Energy​ (Permian Resources)​​.

The company will maintain its commitment to return 50% of post-dividend free cash flow (FCF) quarterly after the transaction. RSE sold $27mn of PR in May 2023.

Onyx Power (Private): RSE’s second largest holding is Onyx at 22.6% of March 2024 NAV. On 30 November 2019, Riverstone Holdings LLC, via Onyx Power, acquired ENGIE S.A.’s coal and biomass-fired power plants in Germany and the Netherlands. Onyx Power now oversees five plants with a total capacity of about 2,350 megawatts in Wilhelmshaven, Zolling, Farge, and Rotterdam. RSE invested approximately $60mm in Onyx and it has already made distributions to RSE totalling $101 million. The latest NAV values the Onyx at $70mm.

Crescent Point Energy Corp: RSE’s third largest honding is Crescent Point Energy (renamed to Veren Inc). These were the shares received through the Hammerhead transaction.

Outlook: RSE projects sustained value from its legacy energy investments and expects further growth from its technology-driven decarbonization ventures. There are no upcoming commitments in 2024, with $6 million of unfunded commitments beyond 2025. The firm is committed to the energy transition and acquiring decarbonization assets but has stated that “its primary focus is on enhancing operational efficiency, managing liquidity, and facilitating capital formation for its current portfolio companies. This approach is particularly crucial given the challenging fundraising landscape for growth-stage, technology-intensive companies.”

Shareholders: Moore Capital Management 20.0% | Lapeyre Pierre Ferna 18.6% | Crestline Management 17.3% | Akrc Invesmtent LLC 11.3% |

Valuation

Net asset value discount

On 8 May 2024, RSE reported its NAV for 31 March 2024, reaching $18.26 per share or 1,446 pence per share, with a total value of $496 million (£393 million). This represents a 14% increase in USD and a 15% increase in GBP from the 31 December 2023 NAV. The growth resulted from significant unrealized gains in public investments, notably Permian Resources (+$40.8 million) and Crescent Point Energy (+$10.3 million). These gains were partially offset by the total write-off of several decarbonization investments, including FreeWire (-$3.5 million), T-REX (-$17.4 million), and Our Next Energy (-$3.1 million). 

As of 31 March 2024, RSE held $93 million in cash, net of the tender offer, and had an unfunded commitment of $6 million. In the first quarter of 2024, the decarbonization portfolio returned -22.9%, while the conventional energy portfolio gained 6.5%. RSE's portfolio is highly concentrated, with 93% of gross unrealized value in the top five investments. The NAV composition is now 13% unlisted decarbonization, 3% listed decarbonization, 53% listed conventional energy, 15% unlisted conventional energy, and 20% net cash.

A run-off scenario could conservatively result in +25% upside for unit holders, assuming 30% discounts to NAV on private investments. Meaningful downside scenarios require some combination of lower oil prices weighing on liquid stakes, widening discount to NAV, severe discounts on private investments, and minimal share buybacks.

The return to risk for RSE appears highly asymmetric at current levels. Downside is protected by high cash balances. Given the high allocation to PR US, OTM put options can be purchased to further improve asymmetry and return exposure to extreme oil price movements.

Risks

Commodity exposure: Deterioration of public and private equity prices could occur if there’s another commodity downturn. From a portfolio perspective, there is room for additional commodity exposure (particularly oil and coal) which should increase from escalation in geopolitical risks and/or inflation.

Illiquidity: Market capitalisation is low at ~$310mn, although the underlying fund holdings now mostly consist of liquid positions and cash. Ongoing buybacks have reduced free float outside of the Cornerstone investors.

Mismanagement: As discussed, there are reasons to believe that management of the assets has improved. However, there have been notable misteps on the decarbonization portfolio. Conerstone invetors also have incentives to keep the status quo.

Catalyst

Continued buybacks and tender, wind-down