The latest issue of Barron's includes a list of the world's 30 best CEOs. The names are organized alphabetically (i.e., there's no #1, #17, or #30). Of the 30 CEOs on this year's list, 21 were also on last year's list. One of those "returnees" is Bob Simpson.
It's hard to argue against including the head of XTO Energy (XTO). The company's long-term performance has been spectacular. Furthermore, XTO employs a strategy that relies heavily on excellent decision making at the top. In fact, very few companies have a clearer history of being shaped by the major capital allocation decisions of top management.
One of the criteria for making Barron's list was the expectation that the CEO would be missed by investors if he unexpectedly departed. I don't know if Bob Simpson's departure would send XTO shares spiraling; but, I do know that XTO's strategy requires remarkable management at the top.
The company was founded in 1986 by Steve Palko, Jon Brumley, and Bob Simpson. Brumley left in 1996; Palko left in 2005. This is how Simpson described his company's founding in a 1999 interview with The Wall Street Transcript:
We brought to the company the best of the philosophy we learned at Southland, which is to buy quality production and make it better. We started with six folks and no reserves, and we've used that strategy to build the company to what it is today a buyer of long-lived, quality properties in areas we understand. We then make the properties better.
The Barron's article mentions that XTO's share price has increased nearly fifty fold since the company went public in 1993.
Such share price performance isn't surprising when you consider XTO's business performance. Over both the last five and ten years, XTO's revenues, earnings, and cash flow per share have grown by double digits – and none of the first digits is a one!
While the entire energy sector has performed well over the last few years, the gap in growth and value creation between XTO and its competitors is real. The longer the period of comparison, the better XTO looks.
Improving acquired properties has been the key to XTO's business growth and share price growth.
Later in the same TWST interview, Simpson explained why it has been possible for XTO to improve the properties it purchases from major oil companies.
Of course, they are intelligent organizations doing what is logical for their strategy focusing their best people on their main assets. Ironically, this is what we do on a step-down basis. What was considered a small project with junior talent at a major will be a major project with major-league talent at (XTO)."
Unlike most energy companies, XTO's future is explicitly dependent upon acquisitions. The company has grown through acquiring and improving properties. While XTO can plow a lot of its free cash flow back into the business through investments in already owned properties, it won't be able to provide the kind of stellar performance investors have come to expect unless it can continue to find good acquisitions.
XTO was a lot smaller in 1999 than it is today. But, the company's attitude towards acquisitions has remained the same:
XTO is highly focused. We have a very narrow and successful strategy as our performance has shown…We don't just bid on whatever property comes up. We wait until we see the right target and then we shoot both barrels. Again, within that criteria are quality, long-lived properties with high margins.
The company's strategy is described quite well on its website.
This is how XTO describes its strategy:
Step 1 – Property Acquisition: XTO Energy acquires properties located in the best major producing areas of the United States. These properties typically have been productive for decades and, most importantly, are expected to produce oil and gas for many years to come. These low-risk assets exhibit a common set of characteristics:
• Proven production history with shallow rates of decline
• Relatively low costs that maximize profit margins
• Geologically complex reservoirs that offer up additional potential
• Development opportunities and extensive upsides that promise to increase reserves
The advantage of acquiring properties with established production histories is the predictability of future production.
Step 2 – Development Activities: We look to increase production and reserves through low-risk means including recompletions, development drilling and the reduction of operating costs. By increasing production or lowering the rate of production decline, we are able to generate cash flow that is over and above the forecast used to acquire the reserves. This incremental cash flow creates value for our shareholders. Our development programs also unveil additional reserves which then provide an inventory of upsides for future growth projects.
A two step process to build a $20 billion company?