Jimmy Vallee Guests on the M and A Masters Podcast Discussing Trends in the Energy Mergers and Acquisitions Recently Robust Space
Transcript of Energy Mergers and Acquisitions Expert, Attorney Jimmy Vallee with M and A Masters Host Patrick Stroth Interview
Patrick Stroth:
Hello, there. I’m Patrick Stroth. Welcome to M&A Masters, where I speak with the top experts in mergers and acquisitions. And, we’re all about one thing here. That’s a clean exit for owners and founders. This week, I’m joined by Jimmy Vallee from the law firm, Paul Hastings.
Jimmy is a partner in the Mergers and Acquisitions and Energy Practices at Paul Hastings’ Houston office. Recognized as one of Houston’s top energy deal makers, Jimmy has advised clients in more than $70 billion worth of global energy transactions.
And, when he’s not doing deals, he’s writing about the energy sector. Mr. Vallee is the author of the 2017 #1 Best Seller “Giant Shifts - Energy Trends Reshaping America’s Future.” Jimmy, welcome. And, thanks for joining me, today.
Jimmy Vallee:
Hi, Patrick. Thank you. Good to be with you.
PATRICK STROTH:
Now, as someone coming from the Houston area, I imagine that you probably had, your career choice was one of three things – cattle, football, or somewhere in the energy business. How did you pick energy?
JIMMY VALLEE:
That’s right. Well, I didn’t live on a ranch and wasn’t that good at football. So, I just naturally went into the business. No, truthfully, my family had a trucking concern in Beaumont, Texas, which is where I grew up. It serviced the oil field industry and had been doing so since around the time of the Spindletop oil discovery in Beaumont.
So, I had about four generations of my family work for that. I, certainly, would have been the fifth until the demise of that business during the 1980’s oil bust.
So, when I was young, I was exposed to a great deal of the energy business. It just kind of came naturally. And when I graduated from law school, my wife and I settled into Houston where we knew we wanted to live in Texas, and I wanted to do corporate work as an attorney. So, Houston was kind of the place to go. We settled here with our oldest daughter. And, when you’re a business attorney in Houston that means you do a lot of energy work.
So, you could say that for the first half of my career, I was doing things that were really across a lot of different sectors of the economy, not just energy, because it was pre-shale revolution.
But, around that 2005, 2006, time frame, as the shale revolution became more generally recognized, the volume of transactions in energy M&A specifically, really just increased in an exponential manner.
And, so, that’s pretty much what I focused all of my practice on since that time, which has kept us very, very busy, and looks like it’s going to continue to be busy for years to come.
PATRICK STROTH:
A lot of people that aren’t as familiar with energy, we’ll see in the news the booms and busts for 90% of people that aren’t involved in business. Their connection with oil is either their energy bill or when they go to the pump.
You’re an expert in energy mergers and acquisitions. Why is this so important for people to understand that area of expertise?
JIMMY VALLEE:
The energy business, not unlike tech or health care or financial related industry, it’s got its own language and its own legal regime. And, the failure to understand the language and that regime could be catastrophic for your client or their business.
Most people that are active in M&A matters, generally, could not even tell you the most basic differences between, say, upstream, midstream, or downstream, much less the inner workings of an overriding royalty interest or a net profits interest, compared to a working interest, or in the midstream context, the difference between gathering and, say, transmission or transportation, which are concepts that are not only dramatically different in the space but have certain regulatory implications, as well.
You layer on top of this that the industry, by its nature, is an extremely capital-intensive business. You’ve got capital projects in a lot of the M&A transactions that we’re involved in, routinely are in the billions of dollars.
You can’t risk someone that doesn’t have significant experience leading a deal of that magnitude. There are things I’ve seen in deals and recommended to clients that in 15 minutes of counseling have saved them hundreds of millions of dollars. So, it’s common that our legal fees in connection with any transaction that we do in the energy sector turns out to be a rounding error to the real value involved.
PATRICK STROTH:
The other issue is, it is not only defining an energy attorney from a non-energy attorney, but also being an M&A specialist versus someone who is a corporate attorney, or even in-house counsel for some of these firms that may have that.
You’re bringing in that level of expertise, the familiarity of, “Here’s what deals look like,” and you know those benchmarks as opposed to somebody who’s working on corporate contracts and so forth. That’s an element that they’re not as familiar with.
JIMMY VALLEE:
That’s absolutely correct.
PATRICK STROTH:
Well, what do you think makes some in the M&A sector for energy, what separates the successful ones from the ones that fall short or just seem to always have problems?
JIMMY VALLEE:
Well, as they say, “There’s really no substitute for experience.” I’ve been practicing in this sector for about 18 years, and I’ve been involved in some of the most significant energy M&A transactions that have occurred. I mentioned before, my family was involved in the business.
You could say that I showed up on the earth and was kind of talking shop around the dinner table for over 40 years about our business. I’ve seen tons of things occur first hand, personally and professionally. And, sometimes, some very bad things.
So, when my clients hire our team, you know, they’re getting a very seasoned and sophisticated group that has a history of successfully consummating material energy M&A transactions.
Others struggle because they really just don’t have the industry-specific expertise, and they’re typically trying to fake it.
We’re seeing a ton of that in our industry right now as new entrants into the sector try to capture more market share with attorneys that, frankly, don’t know what they’re doing, that are charging millions of dollars to do it. So, for the client, they end up paying more because the attorneys are learning on their dime and getting inferior value.
Clients are smart. They don’t put up with this for long. Every day, it seems like we have someone new tell us that they’re thrilled with the work we’ve done because it added tons of value to their transaction, and their prior experience with big law firm “X” left them with a very bad taste in their mouth about using big firm lawyers, generally.
PATRICK STROTH:
These intuitive, or, it’s an assumption that because of the capital requirements for energy M&A that only the largest of the large firms would get involved. And, if you’re not a seasoned expert, that would be a barrier to entry.
But, what you’re telling me is that, well, the potential out there is so big and the market’s large enough that you’ve got a lot of new entrants coming in. And, I guess they can fake it for awhile, from what you’re saying. And, that’s very, very dangerous. I wouldn’t have thought that happened out there.
JIMMY VALLEE:
No, it’s happening. And, again, we’re seeing a lot of people kind of coming to us with a very recent bad experience. And, not just bad because it cost them a lot, but bad because they didn’t have executed what they wanted executed.
It didn’t preserve the relationship of the business parties involved or anything like that. And, that’s really our whole purpose, in my opinion.
PATRICK STROTH:
And, cost is less of a factor here just because it’s critical to have a successful execution and because there’s so much capital out there for the rest of the project getting done that it’s like you said, a rounding error to get it right.
JIMMY VALLEE:
That’s exactly right.
PATRICK STROTH:
Fantastic. You’re recognized as some call, a “Futurist” for the energy sector.
And, you outline a lot of trends that could be coming up and possibilities for the future, in your book, “Giant Shifts – Energy Trends Reshaping America’s Future.”
What’s the most significant trend you see in your sector today?
JIMMY VALLEE:
Well, my answer probably a year ago would have been different to this, but now, kind of without a doubt, I’d say it’s the continued growth of private equities’ involvement in our industry.
When I began my law career in Houston, our clients that were doing energy deals, were all corporate clients. Companies like BP, Enron, Unical, Exxon, Marathon, Williams. They were all names you knew, because they were significant public companies.
But, when the shale revolution became more broadly acknowledged, you started to see the rise of, not only the financial buyer, but also master limited partnerships in our business, which really drove… Those two buying parties drove the volume of M&A transactions in our sector.
But, with the downturn in oil prices that occurred starting with the Thanksgiving surprise by OPEC in 2014, MLP’s have been hit very hard. In fact, mini-upstream MLP’s have gone bankrupt and restructured their companies.
So, I’d say after 2014, you started to see private equity really filling in a lot of the gaps and making those investments in the sector while the downturn continued. I think those firms are actually in great shape to realize some outsized returns as oil prices are continuing to improve. I think this morning they were over $70 a barrel, again.
PATRICK STROTH:
Yeah. To our dismay out in California. Yes.
JIMMY VALLEE:
Right. And, this continued unrest around the world, many are suggesting those prices could continue to rise. So, it’ll be a good time to be a seller once again, and you’ve got the people who kind of got in at a good price when the industry wasn’t doing so well.
PATRICK STROTH:
Do you believe private equity is finding value in these investments?
Because, a lot of times their objective is, they want to make an acquisition, see if they can add value to that acquisition, and within a shorter time window of five to seven years, go ahead and spin that off and realize a particular return.
Is that something that, for now, you see that jives well with the energy sector?
JIMMY VALLEE:
With oil and gas, I certainly think that’s the case. Electricity, I’m not so sure. And, then, I’d say it also depends. What was the specific asset we’re talking about? Private equity has… They’ve not been unassailed by the downturn. The TXU bankruptcy was a big issue. The Samson Resources bankruptcy was a big issue.
And, those were big private equity players involved with taking those companies, taking them over and, then, the downturn hurt them. But, I also think that there’s been a ton of investments in smaller companies that were kind of either doing greenfield projects or were expanding an acreage position, or something like that, that they’ve been making these investments and these smaller acquisitions through their portfolio companies during the downturn, that stand to do very, very well.
And, certainly, if you look at the history of private equity, kind of post-shale revolution, I think, as a sector, it’s done extremely well which has, in turn, brought a lot of capital to those funds that provided the dry powder for them to make the investments.
PATRICK STROTH:
Gotcha. When we’re talking M&A and trends and private equity, that leads into an area that’s another trend that’s been in other sectors, not just energy. And, that’s the increased usage of an insurance product, called “rep and warranty insurance.”
And, now, for those of you in the audience that may not have heard of rep and warranty, it is, within a purchase sale agreement, the seller makes a set of disclosures to a buyer about the elements of the company, everything from their ownership structure, their capital, their financing, all the way out to human resources, environmental issues, and all this.
And, they disclose all of their warts and things to the buyer, and the buyer is responsible to perform due diligence, to test the accuracy of those disclosures. And, then, they make the decision whether or not to purchase the company at a set price.
Within those purchase sale agreements is an indemnification clause where, if any of those disclosures are inaccurate, and those inaccuracies, post deal, lead to the buyer suffering financially, within the terms of the contract, the buyer can call back a small or significant portion of the sale proceeds directly from the seller.
Now, that’s a huge risk for sellers that, for a while, they had no option, and they had to deal with until the insurance industry came in, and they had a product they could say, essentially, they look at the reps and warranties, they look at the due diligence by the buyer, and they exchange for a premium, they’ll insure the deal. They transfer the indemnity obligation away from the seller to the insurance company.
Buyers like it because, if they do suffer financial loss, they just go to the insurance company. They don’t have to spend the time or the expense pursuing the seller in court to get a recovery. Sellers love this because they get a clean exit. They get their funds at closing. And, they don’t worry about a clawback, because any event is then covered by insurance.
It's been something that’s been growing in other segments and, Jimmy, what have you seen in the energy sector?
JIMMY VALLEE:
Well, we’re also seeing a rise in the use of rep and warranty insurance. In fact, as I was listening to your description, I found myself wondering, it is an indemnity, which is effectively what an insurance policy is, and I kind of scratched my head why it hadn’t developed more in the past. But, I think, with the significant rise of private equity…
You know, when a private equity firm is on the sale side, you mentioned a clean exit.
That’s exactly what they want. They want to be able to exit and know that they can distribute the net proceeds from the transaction to their investors without having to worry about some type of an overhang like an indemnity or some type of clawback.
So, in that situation, a rep and warranty insurance product makes a lot of sense because the constituent parties to the transaction can offload that risk to a third party insurer who’s, frankly, in that business to do that type of thing.
So, what we’re starting to see more and more, you know, a lot of our deals occur in some type of an auction process where a target is going to market with their asset and, so, what we’re seeing is now bidders that are corporate buyers are becoming very sophisticated about this, and they’re starting to add their willingness to have rep and warranty insurance involved in the transaction because their advisors are telling them, frankly, it will make their bid more competitive, vis a vis, their peers, who are also competing for the asset.
So, yes, we have seen a big rise in it. I imagine it’s going to continue.
PATRICK STROTH:
Yes, I think, to put it in a real basic, non-M&A analogy, it’s essentially, again this is me pulling California into this, but if you’ve got a nice, desirable home in California, you’re going to have multiple bidders, and if somebody came in with a no-contingent offer in cash, that offer will often be selected over more expensive offers, and so forth.
It is, as one other attorney I’ve spoken to talked about it, in auctions, at least in Silicon Valley for highly desirable product target companies, is essentially, if you don’t have rep and warranty as part of your offer, you’re not going to win. And, so, it’s come from being a luxury item or a value-add within an offer, to almost becoming a routine portion.
I see that in a number of industries and not just energy.
JIMMY VALLEE:
Let’s look at your California house analogy a bit, it’s not just coming in with a no-contingency offer, it’s also, effectively, a covenant not to sue if something turns out wrong with the house. Right?
So, let’s say that, to think about California, that you’d been subject to a mudslide which you failed to disclose, and you were able to do the repairs or whatever. You lived somewhere in Malibu. You got the repairs done. You kept the house.
And, then, you didn’t disclose that on your home sale. This would, effectively, be shifting that risk to the insurer.
PATRICK STROTH:
Yes. Exactly. That’s exactly how that works.
Jimmy, what would your number one piece of advice be for companies or for owners and founders that have a company, they’ve built it from scratch, they’ve got it up and going, and they’re looking at the back nine of their career, and they may not be passing the firm down to a family member, but they’re looking for an exit.
What’s the number one piece of advice you would give to people in that position? They’re not going to do something today, but it’s now foreseeable.
JIMMY VALLEE:
My number one piece of advice and, admittedly, this sounds a big self-serving, would be to hire experienced advisors in the sector that your business is participating in.
With respect to my business, you need to have an experienced investment banker in energy M&A and an experienced M&A lawyer doing your deal that has a track record for doing the types of deals that you’re about to undertake.
I see it so often that people look at this, and they either get sticker shock because the hourly rate or something like that, and they are just simply being penny wise and pound foolish in trying to implement a material generational event.
If this is an entrepreneur who’s built up a company that will provide wealth to their family for generations, they owe it to everybody to make sure that they maximize value in that transaction. And, the only way to do that is to have people who can help you implement the transaction in the most creative manner possible.
PATRICK STROTH:
I would probably add on to that, the community in the M&A world, but also in energy itself, it’s probably a small world. And, if you’re going into a transaction, and you’ve been running a business your entire career, you don’t know that community at all.
So, you need somebody within that community, not only who’s known but knows others that are all reputable and, I think that that’s another thing that’s beneficial because, as you mentioned earlier as we were talking, they’re not bad actors, but you’ve got some people that are experienced and less experienced.
And, you know who the good corporate citizens are, and you know the ones that may not be living up to certain standards for the clients or whatever. And, you know all that.
JIMMY VALLEE:
That’s right.
PATRICK STROTH:
And, so, they have access to that entire network knowledge base with one phone call with you at Paul Hastings.
JIMMY VALLEE:
That’s a very good point.
PATRICK STROTH:
Great. Is there anything we missed?
JIMMY VALLEE:
I don’t think so. Generally, I’d say, it appears that we’re finally pulling out of the doldrums in the oil and gas sector.
It’s been a rough couple of years for many of our friends and clients in the sector. But, it’s nice to see the uptick in the energy M&A activity. We’re extremely busy again. I think we’re involved in 13 active transactions at the moment. And, the future looks like that’s going to continue.
So, it’s exciting to be back on the side of the industry where it’s active and people are doing deals again.
PATRICK STROTH:
Fantastic. I do want to go ahead and emphasize again and really highlight last year’s best seller that you wrote, “Giant Shifts – Energy Trends Reshaping America’s Future.” And, it’s not a technical book just about oil and gas, but it goes over a lot of issues that are out there.
Trends are unique to the energy industry but, also, corporate America where you’re talking about generational dynamics within oil and gas. You talk more about private equity and their involvement in energy. You talk about the fracking boom, followed right behind that with the shale revolution and how that’s converted America from being a big buyer of energy to now being a net exporter of energy.
And, I highly recommend it.
Also, again, showing a little of our California tilt here, we appreciate the hat tip because, in there, you make an argument how Houston is now oil’s Silicon Valley. And, it’s a real easy read. It’s something that we would highly recommend.
In addition to people getting your book, “Giant Shifts – Energy Trends Reshaping America’s Future,” Jimmy, how can our listeners reach you with their questions and, potentially, their situations, because you’re the go-to guy for this subject.
JIMMY VALLEE:
I can, of course, be reached through the Paul Hastings website at www.paulhastings.com, or me, personally, you can reach out to me through my author website or book website. The author website is www.jimmyvallee.com, and the book website is www.giantshifts.com.
PATRICK STROTH:
Fantastic. Do we have a corporate number for you?
JIMMY VALLEE:
Yes. You can call me at 713-860-7307.
PATRICK STROTH:
Fantastic. Jimmy, it’s been an absolute pleasure. Thank you very much for being here today. And, everybody, if you can’t call Jimmy today, at least go out and buy his book.
JIMMY VALLEE:
Thank you for that, Patrick. I really appreciate it.