The North American energy sector -- from exploration and production (E&P), oilfield services and midstream -- still has a big target on its back again this year among activists that want to force changes, according to Moody's Investors Service.
Energy is identified as one of the eight sectors expected to be the most active for shareholder targeting, with the technology sector likely the most active this year.
Why energy? It's an easy target, according to Moody’s. Companies "have tangible assets that can be sold, spun off or placed in a master limited partnership (MLP) to unlock shareholder value. Activists have also targeted companies with weak corporate governance." Shareholders in the past year have led a big charge that successfully revamped governance at, among others, Chesapeake Energy Corp., Hess Corp., SandRidge Energy Inc. and Transocean Inc. Regulated industries such as utilities have been left out of the fray.
"The North American energy sector is one of the biggest targets for activist investors, and the combination of robust cash flow and weak capital returns will keep the sector in activists' sights in 2014," said senior credit officer Gretchen French. "Companies with heavy capital spending plans, weak returns on capital, disparate assets, lagging stock performance, low financial leverage and high cash balances will be the most vulnerable."
Possible targets for this year's assault could be Encana Corp. and Denbury Resources Inc. Even with a new strategic plan and new CEO, Encana "has had poor returns over the last few years." Denbury, an enhanced recovery oil specialist, could be exposed to activism as well "due to weaker share performance." Uncertainty also is elevated with the recent entry of activist shareholders at Williams and Talisman Energy Inc., which already was in the midst of an asset repositioning when activist Carl Icahn bought into it.
Activists have tended to push credit-negative agendas, but in some instances, changes improved the credit profiles by imposing more financial and capital discipline and improving corporate governance, French noted. For example, activists have appeared to have had a positive influence at Chesapeake, where CEO Aubrey McClendon was ousted and the board made over, and at SandRidge, where CEO Tom Ward, a Chesapeake co-founder, was dismissed.
"Certain industry characteristics make the energy sector a prime target for activist investors," said French. "The sector is rich in hard assets...In addition, the entrepreneurial culture of the North American energy sector has in certain cases created powerful chief executives, weaker checks and balances on corporate leadership and poor executive compensation practices."
For instance, Kinder Morgan Energy Partners LP has announced it is looking for ways to improve shareholder returns. Transocean Inc. is considering an MLP. "And while Hess appears to be largely finished with its debt reduction and asset restructuring and is moving ahead with share repurchases," said French, "it remains to be seen to what extent Occidental Petroleum Corp. will reduce debt in order to offset the loss in cash flow and diminished portfolio quality that will occur with the spin-off of its California business along with planned asset sales" (see Daily GPI, Feb. 14).
Among North American E&P companies, "proactive actions" such as asset sales and stock buybacks are underway at Apache Corp. and Devon Energy Corp., which also formed a midstream MLP with Crosstex Energy. Valero Energy Corp., Phillips 66 and Marathon Petroleum Corp. also have formed midstream MLPs.
Share buybacks are being pursued by Halliburton Co. and Cameron International Inc., while spinoffs have lifted shares at National Oilwell Varco Inc. and Noble Drilling Corp. In the midstream space, Oneok Inc. has spun off its natural gas distribution business, while Energy Transfer Equity LP has authorized a stock split and $1 billion buyback program. For the U.S.-based majors, an increased focus is on capital discipline.
"Energy companies are long-term businesses requiring large capital investments that may not be realized for several years," she noted. "Many upstream E&Ps, in particular, have been increasing capital spending well in excess of cash flow in order to transition their portfolios away from low-priced natural gas in North America to higher-return oil plays." But shareholders today are less tolerant of elevated spending.
There were 220 shareholder activist cases last year in North America, versus 209 in 2012 and 179 in 2011, according to Moody's. Around 80% of the 2013 cases were new, while 20% were instances where activists launched campaigns in 2012 and renewed their efforts the following year. To date in 2014, at least five campaigns have been launched at companies that include Dow Chemical Co.
Activists continue to be motivated by the tremendous pile of cash still sitting on U.S. nonfinancial company balance sheets, currently around $1.5 trillion, according to Moody's. They command "ever-growing war chests as they attract more inflows" and have "gained ground as institutional investor and media perceptions have changed. Once viewed as uncouth 1980's-style corporate raiders chasing quick rewards, activists are now more often viewed as agents of longer-term change for the good."