The global downturn in the oil and gas sector that began in 2014 has been a painful experience for the industry. The shutdown of Lafayette-based IBERIABANK Corporation’s (NASDAQ:IBKC) equity trading and research unit, IBERIA Capital Partners, based in New Orleans, demonstrates the pain isn’t over yet.
First, let’s put some perspective on the wide-ranging impact of OPEC’s price war on U.S. shale producers that began with the 2014 Thanksgiving Surprise, our nickname for the day after the American holiday when the cartel failed to make production cuts to offset rising production from the U.S. and stabilize oil markets. The Houston-based consulting firm of Graves & Co. estimated that as of February 2017, 440,000 people lost their jobs with approximately 40% of those in the United States.
What is often lost on investors, however, is that the downturn didn’t affect just E&P and oilfield services companies, but also the financial services firms that help the capital-intensive industry raise the financial resources needed to execute their business plans. Oil and gas wells are depleting resources and current production must be constantly replaced if a company is going to maintain its asset base in proved reserves, let alone grow.
Consolidation of Energy Investment Boutiques
Over the past decade, the financial sector has been buffeted by the winds of technological change in general, and making things more challenging for firms covering the oil and gas business are the ups and downs of serving a cyclical industry. Both trends over the past six years have conspired to create substantial change. The erosion of trading desk profits resulting from widespread adoption of cheap electronic trading platforms and two energy downcycles since 2008 have created enormous stress on energy investment boutiques.
The most recent example of how hard the downturn has hit the financial sector is the decision of IBERIA Capital Partners to pull the plug on its equity trading and research division focused on the oil and gas sector. The group announced in November 2017 that it discontinued research coverage on all its Exploration & Production and Oilfield Services & Equipment names.
IBERIABANK spokesperson Beth Ardoin told The New Orleans Advocate that the trading and research arm had fewer than 20 employees, and that some would have the opportunity to move to new positions with IBERIABANK. Ardoin also confirmed that IBERIA Capital Partners was retaining its brokerage operations.
Keep in mind, IBERIA Capital Partners is not the first energy boutique to scale back or completely exit the oil and gas sector, and it may not be the last. Here is a selective look-back at other middle market energy securities firms to put some perspective on the matter.
In March 2012, the Canadian multinational bank Scotiabank (NYSE:BNS) announced it had bought Howard Weil, Inc., an energy investment boutique for an undisclosed amount. Privately-held Howard Weil was well-known as the original and most established boutique firm, serving the energy sector since 1946. The firm now goes by the name Scotia Howard Weil and continues to serve the industry under its well-capitalized parent.
In July 2012, Reuters reported that Pritchard Capital Partners, also based in New Orleans, had shut down “…due to a shortage of capital and conflicts between the firm’s founders and stockholders.” It was estimated that the firm made $12 million in revenues in 2011, but had lost $2 million. Sixty-five percent of the shop’s revenues were estimated to come from its trading desk and the firm’s demise was attributed in large part to the reduction in trading commissions. As Reuters noted, “The collapse of Pritchard…points to continuing problems for large and small Wall Street firms that depend on stock-trading commissions from hedge funds and other institutional investors.” Founder Thomas Pritchard and partner Kenneth Morris departed to join Imperial Capital to re-create an energy banking team. Keep the Imperial name in mind, it will come up again.
In April 2015, the boutique energy investment bank MLV & Co. announced the layoffs of several bankers, including the co-head of Energy Investment Banking, and moved its New York offices to a new location, ostensibly to save money. At the time, it appeared that revenue from the firm’s other businesses could support the energy team, but only three months later MLV & Co. was snapped up by FBR (NYSE:FBR), a competitor, for an undisclosed amount.
Then in February 2017, in a case of “there’s always a bigger fish,” the Los Angeles-based firm B. Riley Financial acquired FBR in a transaction valued at $160.1 million. B. Riley wasn’t done with its acquisitive streak, as just a few months later in May it snapped up Memphis-based Wunderlich Securities for $67 million.
The Wunderlich energy team quickly found a new home when Imperial Capital announced in July 2017 that it had hired seven professionals from Wunderlich Securities. Only four years earlier Wunderlich announced it was putting an injection of $40 million of private equity money to work by strengthening its energy banking and research team. In December 2015, two years after the private equity investment was made, Wunderlich reported it had grown its energy team from 13 to 34 analysts. Only two years later, the firm’s fortunes apparently had changed and as noted above, sold to B. Riley Financial.
In late 2015, Piper Jaffray bought the energy investment firm of Simmons & Co. for $139 million. Also that year, the oil and gas investment bank Tudor, Pickering, Holt & Co. merged into the larger New York firm of Perella Weinberg Partners.
Implications of Corporate Access for Small and Micro-Cap Companies
The corporate access model for many small and micro-cap energy companies is broken, and some observers might even say it is broken for the banks that promote it.
In the corporate access model, investment banks position themselves as the middle men between institutional investors and companies, providing “access” to each other. By bringing capital users and capital providers together, investment banks provide efficiency and transparency for both sides.
In exchange for their services, banks are compensated by institutional investors in two ways. First, they might receive a meeting fee for bringing a management team to an investor’s office, and hopefully earn commissions on trades placed by the investor if he or she decides to buy the company’s equity (long or short). But the real payday comes when a company decides to do a capital raise, acquire or dispose of assets, establish or refinance a credit facility, or execute a corporate transaction, at which point the bank hopefully gets a cut of the fees on the deal, often funded by the bank’s institutional investor clients. The importance of fees cannot be overstated, now that commissions on trading securities have fallen to less than a penny from $0.15 per share in the 1970s.
In the corporate access model, the issuer company typically gets research coverage from a bank analyst who writes and publishes reports that are distributed to clients, driving awareness and interest in the company’s investment opportunity and shares. Over time, we became astonished at how dependent many portfolio managers are on bank research and how many management teams rely on analysts to tell their story. And yet within this climate, many investment fund managers are curtailing their paid banking relationships given the wide availability of research from a variety of investment banking sources. The challenge for the banks, however, is that between deals they provide this research for “free” in the hope that it will result in trading commissions and fees from future deals.
Consolidation and dislocation in the energy banking and research sectors is nothing new, but the acquisition and outright shuttering of so many middle-market firms since 2012 demonstrates that energy boutiques can’t rely on trading revenues driven by research, and unless a firm is sufficiently capitalized it is difficult to survive the inevitable downturns. Clearly, the corporate access model isn’t working even for many of the banks that rely on it.
With the demise of trading and energy equity research at IBERIA Capital Partners, we find it difficult to believe that many investor relations officers are worried about having “one less mouth to feed” when they may already have 18 other sell-side analysts covering their ticker. However, for small-cap oil and gas companies that are not Permian Basin pure plays, the current darlings of oil and gas institutional investors, IBERIA’s decision to drop 30 E&P and 16 oilfield services names has broader implications.
The cumulative loss of middle-market firms can pose long-term problems for small and micro-cap companies which have a difficult time attracting bulge bracket firms on Wall Street. For management teams that rely on the corporate access model, the loss of research teams at middle-market firms means fewer communications channels to institutional investors, making it more difficult to build and maintain awareness in their investment value propositions.
Implications of fewer middle-market firms and institutional investors interested in the sector include lack of trading liquidity, steep discounts on secondary offerings and severe disconnects between the intrinsic value of an oil company’s assets and its prevailing market value. These situations tend to attract opportunistic activist investors, and market mispricing can leave a tremendous amount of unrealized value on the table for shareholders.
We have seen more than one example of an institutional investor liking a story and wanting to make a position in the name, but the lack of trading liquidity often proves too much of a barrier.
In our view, management teams seeking to close valuation gaps and increase trading liquidity can benefit shareholders by supplementing their institutional outreach with strategies for reaching investors that the banks do not serve.
There are many boutique banks and broker/dealers focused on the energy sector that are still around, including Johnson Rice, Euro Pacific Capital, Northland Capital Markets, Roth Capital Partners, Stephens Inc. and Seaport Global Securities, SunTrust Robinson, Capital One Southcoast, among others. We have friends at these firms, and we want to see them succeed. In fact, we can anticipate that some of these firms may be recruiting former IBERIA Capital Partners' analysts and traders, because it is difficult to find good talent in the energy business in the field, at headquarters and even on the trading desk. Our guess is that emails are flying back-and-forth and phone calls are being made.
The shrinking world of sell-side coverage for energy companies means investors have fewer sources of credible information. Management and shareholders, however, can’t afford to wait to supplement their corporate access channels with communications targeted directly at investors.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.