6 Valuation Principles Family Business Directors Should Know in 2021

Mercer Capital is pleased to sponsor the 5th annual It’s All Relative Family Business Symposium, hosted by the Ole Miss Center for Innovation and Entrepreneurship. The 2026 program will focus on governance and boards, with sessions designed to help family business leaders think more strategically about structure, stewardship, and long-term continuity.The Symposium takes place September 15-16, 2026, in Flowood, Mississippi. Travis Harms, Tripp Crews, and Zac Lange will represent the firm at the Symposium.In addition, Travis Harms and Tripp Crews are also leading the Tuesday afternoon session on “Dividend and Redemption Policies,” which explores how family businesses can balance shareholder liquidity needs with the capital required to support the long-term health of the business.Travis Harms, CFA, CPA, ABV, is President of Mercer Capital and leads the firm’s Family Business Advisory Services Group. He focuses on financial education, valuation, and strategic financial consulting for multigenerational family businesses.Tripp Crews, ABV, is a Vice President with Mercer Capital and serves on the firm’s Transaction Advisory Services team, the Agribusiness Industry team, and the Family Business Advisory Services Group. He works on valuation and transaction-related matters for closely held businesses and family enterprises, with particular experience in agribusiness and ownership transition issues.Zac Lange, CPA, ABV, is a Vice President with Mercer Capital and serves on the firm’s Family Business Advisory Services Group. He focuses on supporting family businesses and litigants with valuation, financial analysis, and dispute-related matters, including corporate planning and reorganizations, financial reporting, and fairness opinions.Mercer Capital regularly works with family business owners and advisors on valuation and strategic financial matters involving ownership, governance, succession, and long-term planning. The firm is proud to support programs that bring family business leaders together for practical discussion and shared learning.Mercer Capital looks forward to connecting with attendees in Flowood and participating in this year’s Symposium. To learn more about the symposium, visit the event's website: https://olemisscie.com/family-business-26/

In the first quarter of 2020, oil benchmarks ended arguably their worst quarter in history with a thud.  The concurrent overlapping impact of (i) discord created by the OPEC / Russian rift and resulting supply surge; and (ii) the drop in demand due to COVID-19 related issues was historic.  Brent crude prices began the quarter around $67 per barrel and dropped to $50 per barrel by early March before plummeting to $19 per barrel by the end of the month. WTI pricing behaved similarly although it continued to trail Brent pricing by a narrowing margin (about $5 per barrel) at the end of the quarter.  For context, WTI recovered to a range of roughly $25 per barrel to $30 per barrel relative to when the earnings calls occurred in late April and early/mid-May.  As of yesterday, WTI closed at $37.29 per barrel.  Natural gas has trended downward but has been more stable in the U.S. as its pricing is generally more tied to region-specific factors.This week, we examine some of the most discussed items and trends from E&P companies’ Q1 earnings calls. We will turn our attention to those in the mineral aggregator space in a subsequent post.E&P CompaniesOperators experienced mixed earnings in the first quarter.  Although operators started the year with a positive outlook, the events that occurred in March quickly forced them to reconsider their forecasts.  Investors and participants were far less concerned with earnings figures for the quarter than future implications of current events.Theme 1: Setting Priorities During Uncertain TimesOperators seemed inclined to comment on their priorities moving forward.  Making cuts to capital expenditures was predicted and unanimous among the group; however, the operators discussed other measures that they are implementing to combat the current depressed environment.“Paying our interest expense, retaining our people and paying our dividend remain our priorities through these uncertain times.” – Travis Stice, CEO, Diamondback Energy“First, optimizing our cash flow by adjusting our spend rate, production and cost structure.  Second, maintaining a strong balance sheet.  Third, continuing to return capital to shareholders through our dividend.  And finally, maintaining flexibility to cut further while also preserving our operational capacity.” – Timothy Leach, Chairman & CEO, Concho Resources“Our capital allocation priorities are balance sheet, dividend and capital spending.” – Scott Sheffield, Chairman & CEO, Pioneer Natural ResourcesTheme 2: Maintaining Bank Relationships in Times of NeedBanks will continue to play a substantial role as many of the operators relied on tapping into their credit lines and/or other debt instruments to satisfy liquidity needs.“Our banks are very strong.  Our credit facility is strong.  We don’t have covenants really in there, debt-to-capital covenants, only one we have, and we’re well south below that and we’re not in any realm of even approaching that.  Our debt would have to go up by $8 billion to hit that covenant level.  So, I told you we’ve got a lot of cushion.” – John Hart, CFO & Treasurer, Continental Resources“As of today, the undrawn capacity on our credit facilities total $6.75 billion.  We believe a strong balance sheet is essential to succeeding in this industry and we are committed to maintain our investment grade credit rating.” – Don Templin, CFO, Marathon Petroleum CorporationTheme 3: Prepared for the Worst While Hoping for the BestMany operators focused on their individual advantages to convey their resilience during the difficult pricing environment.“Diamondback is prepared to operate in a lower oil price environment and our cost structure will prove to be a differentiator through this downturn.  Low interest expense, low leverage, industry leading low cash G&A, a full hedge book, strong midstream contracts and benefit of Viper and Rattler will allow them to operate effectively through these uncertain times.” – Travis Stice, CEO, Diamondback Energy“Just as Pioneer entered this downturn as one of the best positioned companies, we will emerge just as strong.  The key points here, obviously, is maintaining our top-tier balance sheet through capital discipline, combined with significant cost reductions in 2020.” – Scott Sheffield, Chairman & CEO, Pioneer Natural Resources“We still have levers we can pull if conditions deteriorate further, and we will maintain flexibility to make additional cuts to our spending.” – Timothy Leach, Chairman & CEO, Concho ResourcesTheme 4: Providing Flexibility with LiquidityE&P companies are attempting to maximize liquidity to allow financial flexibility.“Just to be on the safe side, we did increase our liquidity position in early April by adding a 364-day credit facility, a little over $900 million that get our liquidity up to $2.4 billion.” – Scott Sheffield, Chairman & CEO, Pioneer Natural Resources“We’ve taken steps to maintain our financial flexibility.  We’ve secured $3.5 billion of additional liquidity, including a new $1 billion 364-day revolver, and issued $2.5 billion of senior notes.” – Mike Hennigan, CEO, Marathon Petroleum Corporation“With our reduction in spending, current hedge protection and suspensions of our buyback program, we expect to maximize liquidity and retain cash to pay down debt.” – Travis Stice, CEO, Diamondback Energy There is no question that E&P companies were forced to react quickly during the first quarter of 2020.  Macroeconomic events mixed with a global pandemic slashed demand and caused prices to plummet.  The operators tried to convey their confidence and resilience with their strategies moving forward.  Time will tell whether they come out of this situation as stronger companies.

Joint ventures (JVs) are fairly ubiquitous in the energy sector with as much as 71% of upstream investment through alliance or JV relationships. Companies will often enter into JVs to share the sheer capital intensive load of upstream and midstream activities.An oil and gas JV in its most basic form is fairly straightforward. A company will take on the operator role by working the field and constructing or managing the infrastructure in a given area, and another company will assume a non-operator role by providing capital so that each player is mutually benefited. Those entering into these relationships may contribute assets, capital, technologies, or even combinations of the aforementioned in order to access advantages such as scale, risk sharing, or entry into a specific market or play and both share in the future costs.Megaprojects of over $1 billion are largely structured as JVs and are especially useful to capitalize on synergies, infrastructure, and risk sharing. In an EY study of 365 megaprojects, JVs made up 85% of the projects in upstream activities and over 50% were in LNG and pipeline projects. On the surface, this may seem like an effective way for companies to structure a hedge and mitigate systematic risk through diversification of assets, but in reality, the benefits of a JV are much harder to realize. Management considerations quickly become complicated and time horizons tend to be short-lived. Research has shown that as many as 70% of JVs in oil and gas tend to fail within 5 years. From a valuation perspective, struggling or failing JVs can put a strain on overall company value as future income streams are subjected to a greater amount of uncertainty and, thus, are further discounted. In addition, most JVs lack a defined exit plan as a study from Boston Consulting showed that only 19% of respondents had a clear exit strategy. Even in a well-structured JV agreement, the absence of an exit strategy in an environment of high failure rates inevitably results in large tangible and intangible exit costs that can erode the value the JV initially was set up to create. Does the success of the JV hinge on the quality of the oilfield or the technical ability of the operator?Put simply, executing a successful joint venture requires a number of items working in harmony such as solid due diligence, good location, cooperation between both firms, and a degree of luck on the bet they are making.It seems a bit contradictory that a large number of projects are structured as joint ventures if they have such a high failure rate. This begs the question, does the success of the JV hinge on the quality of the oilfield or the technical ability of the operator? The answer, we think, lies somewhere in the middle.Location, Location, LocationEven with the difficulties of maintaining a successful JV, many companies have been entering into joint ventures to take advantage of the oil boom that the U.S. has enjoyed for the past several years. Not surprisingly, a large portion of recently formed upstream JVs since 2016 has been in the Permian Basin, and several large midstream JVs have been formed in the Gulf of Mexico. Recently, Williams Companies Inc. announced that it is forming a joint venture with privately-held Brazos midstream in the Permian Basin to gain exposure to crude and NGL and position itself for potential midstream opportunities. Williams is offering their gas gathering assets for a 15% stake in Brazos as part of the JV terms, with Brazos retaining 85% in the venture as well as operatorship. Almost all of the assets including gas and crude pipelines, storage and a planned processing plant are coming from Brazos Midstream with Williams offering dedicated acreage, a small amount of gas gathering infrastructure and inexpensive sources of financing. Companies have been scrambling to get a piece of the pie in the more recent surge in demand for natural gas.Even though the Permian has seen a large amount of activity and natural gas prices remain low, companies have been scrambling to get a piece of the pie in the more recent surge in demand for natural gas. Royale Energy has recently entered in a JV with California Resources Corp. to drill 30 wells throughout the Rio Vista Field, the largest dry gas field in California. This agreement expands on a previous JV and will give Royale up to three years to drill in any of the formations on the property.The historic property is abundant with gas, producing approximately 4 trillion cubic feet from more than 15 stacked gas reservoirs, and according to Royale, “The joint venture will lead to multiple years of drilling activity at Rio Vista at a time of upward trending natural gas prices due to declining natural gas inventories nationwide.”These transactions are but a few of the many JVs structured in areas to take advantage of the location and the resources it has to offer in a demanding market. And while it may seem like a no-brainer for the non-operator to search out operators in successful plays, many have had a history of missing the mark when it comes to structuring effective non-operated portfolios resulting in value being left on the table or outright failure.Adding Value to Non-Operating PortfoliosOil and gas companies are typically skilled at maximizing value with their operated assets. But more often than not, these companies tend to take a backseat approach to their non-operating portfolios, almost akin to treating them like equity investments. The detached and unsystematic treatment conflicts with the shared responsibility for the success or failure of their ventures.Boston Consulting Group identifies three main sources of value loss due to failure of material participation by non-operators: A nonstrategic approach, inconsistency, and lack of priority.They also outline a four-step framework for non-operators to add value to their non-operational portfolios:Clear strategic intent about what each non-operating venture (NOV) asset contributes to broader company goalsSharp risk and opportunity assessmentConsistent NOV organization and governanceRigorous execution strategies for each NOV asset The critical factors within this framework that can really determine success within a JV are operator assessment and analyzing venture risk. Non-operators with longstanding relationships and clearly defined roles and objectives (for example, ExxonMobil and Shell’s continued relationship in the North Sea) would most likely apply a less stringent approach to assessing key operator risk. But those looking to invest in active plays in the U.S. from a non-operator perspective should assess operators on the following criteria:Level of experience and familiarity of the play/assetUnderstanding and application of proven technologiesHistory of productivity and efficiencyClear understanding of role within the partnershipStrong safety, environment, and previous contract records andAlignment on ethics. Venture risk must be analyzed by non-operators to properly determine uncertainties related to the underlying objective within the JV. Resource size, character, and technology application must be considered especially when undertaking more exploratory ventures. Commercial and economic uncertainties should also be analyzed since a major culprit for failing JVs are large cost overruns and other unexpected costs.Final ThoughtsA major benefit of a JV is to gain exposure to areas and effectively deploy resources and capital where it could be best used and thus create maximum value. As we have mentioned above, however, failure rates are very high in the short term mostly as a consequence of cost overruns due to inadequate planning. But the natural frictions associated with a JV make planning and communication all the more important. While non-operators need the proper location for success in a joint venture, they can get further through proper due diligence and planning concerning operators.We have assisted many clients with various valuation needs in operator and non-operator roles in North America and around the world.  In addition to our corporate valuation services, Mercer Capital provides investment banking and transaction advisory services to a broad range of public and private companies and financial institutions.  We have relevant experience working with companies in the oil and gas space and can leverage our historical valuation and investment banking experience to help you navigate a critical transaction, providing timely, accurate and reliable results. Contact a Mercer Capital professional to discuss your needs in confidence.