Summary
- Crescent Energy combines the efforts of two famous and successful investor groups.
- The company is newly listed on the NYSE and so will take time to become seasoned.
- The general and administrative costs are in-line with or below the costs of many companies that I follow, even if the arrangement is unusual.
- The dividend framework allows for growth along with an adequate shareholder return.
- The organizational structure allows for tax deferrals and for KKR to elect the board of directors.
(Note: This article was in the newsletter on March 2, 2023)
Crescent Energy ( CRGY ) is the public combination of KKR and John Goff. Despite the fact that these two well-known entities have an admirable track record, there is considerable confusion and concern about this company. This is going to take some time to overcome. Then again, any newly listed company on the NYSE (this one listed as soon as it went public) has to be there for a while before the market accords it proper recognition. The only real discussion is what the educational process and necessary track record are.
Management Agreement
The management agreement with KKR has sparked more than a few discussions about the reasonableness of the arrangement. As shown below, this-one-looks very much in line with the companies that I follow. If anything, the cost is below average as the chart below demonstrates (even though management chose the comparisons).
Crescent Energy Management Cost Summary Presentation (Crescent Energy November 2022, Investor Presentation)
John Goff as an independent party agreed to the management administration arrangement. I doubt he would have agreed had the arrangement been expensive or above average. As John Goff has noted many times, he knows KKR very well and has interacted with them before.
The confusion appears to stem from the better-known leveraged buyouts that KKR frequently participates in. Those arrangements have a very different risk profile and hence will have a compensation structure that compensates for the different risk profile. It has yet to occur to the market that the very low financial leverage of the company is not typical of KKR. Hence the low leverage has far less financial risk than the typical leveraged buyout KKR is well known for.
Crescent Energy's Dividend Strategy
The dividend is going to be based upon adjusted EBITDAX. That is going to put a stop to a lot of the manipulation that goes on when the dividend is based upon free cash flow.
Crescent Energy Dividend Strategy (Crescent Energy November 2022, Corporate Presentation)
EBITDAX will not be influenced by an acquisition, the definition of free cash flow using maintenance capital or the whole capital and acquisition budget, or the definition of maintenance capital (which itself is a measure that varies widely from one company to another). All of this and more will influence free cash flow.
The dividend will still be influenced by commodity prices. But the attempt of the dividend strategy is to make the dividend predictable whereas in many other cases that dividend is not predictable.
The purpose of combining the efforts of John Goff and KKR was to go after some large deals presently on the market that neither could handle separately. The dividend strategy discussed above appears to aid that growth framework by using a conservative amount of cash flow to return to shareholders while allowing for some cash build to shop for discounted opportunities.
Organizational Structure
The last area of market confusion appears to be the organizational structure. This structure often allows for a deferred payment of transaction taxes while also allowing KKR to control the board of directors.
Crescent Energy Corporate Structure (Crescent Energy November 2022, Corporate Presentation)
The non-public shareholders are the ones most likely to benefit from this arrangement. Meanwhile, that noneconomic preferred stock has all the votes for the board of directors. Over time, the nonpublic part of the company will likely disappear as there is always a limit to deferring tax payments.
On the other hand, the ability to construct a corporate organization that can propose a deal with deferred tax payments can be a real advantage when bidding for properties. It has the potential to save shareholders money. Whether it is repeatable and how often in the future is of course up for discussion. But its existence is evidence of a management willing to go the "extra mile" to close a good deal for shareholders.
Operations
This company really began operations by bidding on distressed properties with established cash flow. Since many of the first properties had established production that was older, operating costs were on the high side and production decline was way on the low side (especially compared to the typically unconventional company with a lot of high decline new wells).
Crescent Energy Operating Map (Crescent Energy November 2022, Corporate Presentation)
As the company grows, there will be the ability to obtain discounted properties with considerable growth potential. Right now, that potential appears to be limited to the Eagle Ford and Unita holdings. Another acquisition could change that scenario very fast though.
The Eagle Ford, in particular is a very low-cost area with some of the best operating profitability in North America. The advantage of operating in the Eagle Ford is that there is not the "mad rush" of operators clamoring for acreage that there is in the neighboring Permian. As a result, the Eagle Ford often can sell oil at a premium during boom times while Permian operators contend with takeaway issues and corresponding product discounting. This in actual returns often results in the Eagle Ford being more profitable than the Permian because there are less issues that go with a less popular location.
On the other hand, the Unita is often associated with the less than stellar history of EPE Energy. But this is where the low debt strategy of this company will make a difference. There were a whole lot of debt driven strategies I followed to the corporate graveyard upon request after the big oil price crash of 2015.
That is not going to happen with a low debt strategy. Instead, the question revolves around the ability to make a sufficient profit even if the well decline rate is high enough to cause investor concerns. That concern should have been resolved by the price paid for the acquisition along with the discussion about the price to EBITA ratio at the time of the purchase.
It is always about the overall profit picture. So that is where the discussion needs to be going forward. Decline rates or anything else can be satisfactorily offset by anything, even robust commodity prices, to make a decent profit. Therefore, the focus on profit is essential rather than one less-than-satisfactory characteristic.
The Future
Many of these basins have reserves that technology is not yet able to produce. But older intervals like the Austin Chalk that frequently occurs in the Eagle Ford, have experienced a revival due to modern completion techniques allowed by the advance of technology.
The coming earnings are likely to reflect continuing optimization of all the acquisitions as well as the business combination with Contango. Earnings will be a little bit lower due to lower commodity prices than was the case in the second quarter. But there could still be operational improvement type expenditures. That should steadily decline in each future quarter.
Technology is likely to continue to advance to allow still more opportunities on many of these holdings. One of the more interesting experiences of the last few years is how advancing technology has turned more purchase mistakes into bargains. That is likely to continue for the time being and provides considerable downside protection not anticipated by the market.
In the meantime, investors have the ability to invest alongside some of the best names in the business at a decent price. Both are known for building and then selling their adventures at a decent price. That alone should make most investors very happy.
For further details see:
Crescent Energy: Educating The Public