Experience RS

If Buybacks Are the Answer, What Is the Question?

We agree with most that dividends and buybacks are shareholder-friendly, but with one important caveat: shareholder friendliness starts with a strong business that throws off cash flow. 

A recent call for buybacks is making waves in Canadian financial media. The demand is backstopped by a single strong, implied assumption: management teams are irrationally choosing to grow through the drillbit rather than deliver cash to shareholders. Generally, we disagree, as do the companies themselves. Some names are in fact shrinking production while failing to deliver material amounts of cash to their owners.

These are signs of weak businesses, not misguided ones.

The dilemma of, “should I send more cash to my owners or to the drill bit?” is a false question, something we know management teams realize. The industry has never been better at producing more hydrocarbon at lower cost, yet only a small number of hydrocarbon producers turn a profit. This fundamental incongruity — better productivity, worse results — begs for a new way to do business. In the past, fundamental changes in business structure meant that previously strong incumbents — think Xerox, Kodak, Pan Am — became also-rans and then forgotten. The replacement companies exploited the change in business model to become the new world-beaters.

But just as demographics are not destiny, it’s not a given that currently strong-seeming companies will fail. Instead, we would rather believe in the power of adaptation. By asking the right questions, we think businesses will not simply defend, but exploit the opportunity. History is full of inspirational examples of organizations that reinvented themselves by investing colossal resources into the new model: Microsoft, IBM (more than once), Apple.

But none of these examples help management teams in the hydrocarbon supply business figure out what to do today.

Our business is built on answering that question: “what could my company do today, next year, in the next decade, if I had clean data feeding robust analytics?" Digitalizing the producer is necessary to first surviving and then thriving, primarily because the industry is in the second phase of the efficiency game unleashed by the frac’ing revolution. If the strongest oil and gas companies continue to drive costs down and protect margins with hard-to-replicate digital strategies, then operators on the outside will face the challenge of holding on in a world they weren’t designed for.

Yes, it will cost money.  We think it’s cheaper than the cost of standing still. One thing we guarantee: share buybacks are not the best use of capital in the face of massive, structural changes in the industry.

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