Managing an Upstream Portfolio in the Face of Volatility

When oil prices tumbled at the end of 2014, Lime Rock Partners knew that it would likely be a prolonged period of volatility and set about getting portfolio companies in shape to weather it. Managing director Will Franklin tells Privcap about its strategies, and why Lime Rock is investing in oilfield service technology.

Having the foresight to batten down the hatches of its portfolio companies once oil prices dropped in late 2014 proved fruitful for Lime Rock Partners and other energy specialists looking to ride out the storm.

Lime Rock’s managing director, Will Franklin, says, “Through some combination of good luck and foresight, we made only one new oilfield service investment from late 2011 to the oil market crash in late 2014. With a more focused portfolio and no ‘top-of-the-market’ investments, we could spend our time helping our companies think about strategies for a longer, more protracted downturn, rather than a quick recovery.”

Throughout the last 17 years, the firm has made more than 80 investments in the upstream oil and gas sector, with more than $5.5B in total private capital commitments, including nearly $4B made to six Lime Rock Partners funds. Franklin’s expertise is in oilfield services, and the firm’s investment team is comprised of veterans of this sector, along with exploration and production.

Having people in the boardrooms of both oilfield services and E&P companies allowed insight into what was happening in those sectors and what competitors were doing, he says.

“We made sure our teams were focused on their businesses,” says Franklin. He explains that there were a number of growth-oriented investments the firm had been evaluating, but that it then took a step back after the first part of the year when oilfield activity dropped off. Two of the deals Lime Rock had been eyeing earlier in 2015 were done by competitors over the course of the summer. “It will be interesting to see who had the right answer,” says Franklin.

Over the summer, there was a sense that oil prices had hit bottom, so much so that bankers were active again and deals began flowing, he adds. “For the most part, those went back on hold pretty quickly. Now we’re seeing second-look deals that were previously on the market—a number of pressure-pumping deals, deals with and without management teams, where equity or the bank has parked them.”

The cycle of the past year has forced Lime Rock and other energy-focused firms to raise the bar on diligencing potential deals. There are fewer deals happening, and it allows these firms to really think hard about the potential investments in front of them.

“Times like this really reinforce having a high-caliber team,” says Franklin. “We’re looking at why a company needs to do a deal right now. But there are opportunities: We have done two U.S. shale-oriented oilfield service deals—our first since 2011—in the last year.” Lime Rock is also in the late stages of diligencing an international opportunity, he adds, and in all these deals, the firm is spending more time on what scenario is required for a company to maintain pricing or utilization, along with scrutinizing the balance sheet.

While other energy specialists in PE have spent much time in the last year eyeing floundering companies that could be potential acquisitions, Franklin says that he’s “just beginning to see the early stages of truly attractive distressed opportunities, where lenders are asking new equity investors to look at things.” He notes that Lime Rock has recently evaluated two specific deals that had previously been on the firm’s radar, and now the banks are pressing the companies to do something if there isn’t a turnaround.

“Overall, deal flow seems off,” Franklin says. “That isn’t a bad thing, as it allows you to be more deliberate in where you invest your time. Where we’ve been spending more of our time with deals similar to those that we’ve already completed. We’re looking at what sort of oilfield services deals help operators get through extended bouts of low commodity prices, reducing costs and improving recoveries.” He notes that they’re also looking at companies that solve specific problems, particularly in the shale formations.

Lime Rock has strategies for maintaining or improving the value of its portfolio companies during the latest volatile cycle. Franklin says the action depends on the company and situation, but cost reduction is one—the severity hinging upon how much spending needs to be reduced. On the balance sheet side, “we viewed pretty early that this would be a protracted downturn, jumped in with our teams, and focused on cap-ex,” he says. There’s also an “intense focus” on receivables and collections—managing the inventory and inventory cycle of oilfield services portfolio companies.

Franklin notes that in some cases, the firm is not only helping its teams manage through trying times, but also having them invest in research and development to remain technologically differentiated and able to secure business now or down the road. Lime Rock historically had a part of its oilfield service technology portfolio that was venture-capital oriented, involving companies that were at the commercialization stage and needed growth capital. Then the firm changed course.

“In the last five years, we took our oilfield tech investing experience and strategically morphed that into a core part of what we look for in larger oilfield service investments. We are looking for technological differentiation, but also for things that are for sure commercially viable and step-outs or extensions of current product lines.”